Was transferring a service division to a subsidiary exempt when the same corporation also operated a taxable equipment-sales division?

Plain-English summary

A corporation operated two integrated-circuit divisions: one manufactured and sold test equipment, while the other performed testing services without selling tangible property. Management disputes led the corporation to transfer the service division's assets and liabilities to an inactive subsidiary, with ownership then divided between the two principal shareholders.

The Appeals recommendation first found a sale because the separate subsidiary assumed liabilities and the ownership and business relationships changed. Federal tax-free-reorganization treatment did not establish that no California sales-tax sale occurred.

The transfer nevertheless qualified as an occasional sale. Although the divisions shared a building, switchboard, benefits, utilities, and some historical staff, they had separate management, physical areas, addresses, docks, personnel, customer bases, and daily operations. Neither division's customers were required or incentivized to use the other. The service division therefore was a separate business that did not require a seller's permit.

Reorganization, operational separation, and source limits

Hearing Officer Susan M. Wengel heard A--- M---, Inc.'s redetermination petition on April 16 in a year and location redacted from the source. Attorney S--- M--- and systems- and service-division presidents G--- W--- and C--- C--- appeared for the petitioner; Senior Tax Auditor Vern Oswald and Supervising Tax Auditor John Wishart appeared for the Department. The tax period and measure are redacted.

Before the transfer, C--- managed the service division and W--- managed the systems division; each held 39.7% of petitioner stock, and three inactive minority shareholders held the other 20.6%. The systems division sold expensive integrated-circuit test equipment, often to large companies. The service division made no tangible-property sales and tested products for smaller companies, companies awaiting equipment, or companies outsourcing overflow work.

Management disputes led to separation. The petitioner had formed inactive subsidiary L--- L---, Inc. in 1978 and used it in July 1986 to receive all service-division assets and liabilities plus proportional responsibility for several petitioner liabilities. C--- exchanged petitioner stock for 79.4% of L---; W--- received C---'s petitioner shares and reached 79.4% there. The minority owners retained 20.6% of petitioner and received 20.6% of L---, with rights to require W--- and C--- to buy their respective shares.

The Department treated L---'s assumption of liabilities as consideration under section 6006. The petitioner argued that federal tax-free-exchange treatment meant no California sale. Wengel disagreed: title or possession moved to a separate corporation, ownership and business relationships changed, and the entities thereafter operated independently.

The petitioner cited Macrodyne Industries, Inc. v. State Board of Equalization, 192 Cal. App. 3d 579. The reporter citation resolves to the named case with canonical capitalization MacRodyne. Wengel distinguished it because that parent remained jointly liable after transferring divisions and retained common officers, directors, and relationships. Here, only minor shared liabilities remained: half of a payment on a named note and part of an employee bonus.

The occasional-sale issue turned on Regulation 1595. Subsection (a)(3) allowed property from an entirely separate nonselling endeavor; subsection (a)(5)(B)(2) taxed assets when service and sales operations formed one business, illustrated by a car wash linked to gasoline buying or discounts.

The divisions shared ownership, a building, telephone switchboard, attorney, medical and dental plans, and a single utilities bill apportioned by square footage and power consumption. They shared sales and accounting staff until about 1985, at least a year before the transfer. By the transfer they were separated by a wall, had distinct addresses, loading docks, engineering, operations, technical, supervisory, sales and accounting personnel, management, and customer lists, though some customers overlapped.

Customers of one division had no obligation to use the other. The service division did not perform warranty or repair work on systems equipment; no cross-division discount or other benefit existed. Although 40% of service equipment came from the systems division, most came from other manufacturers and no purchase obligation applied. Wengel found independent daily operations and future customers, so the service division was a separate nonselling business and its transfer was occasional.

After the transfer, L--- expanded into minor repair work and obtained its own seller's permit. The source does not say that later activity altered the earlier transfer analysis. Wengel recommended granting the petition.

The September 5 signed recommendation controls the issue date. The cover is dated October 26, with its first page printing 190 and continuation page printing 1990; CDTFA's live annotation dates the item October 26, 1990. The cover expressly says the recommendation was not final. It gave the Department 30 days to seek reconsideration with new evidence, request a Board hearing, or allow presentation to the Board for final consideration.

The PDF does not include the petition, briefs, exhibits, hearing testimony or transcript, shareholder or corporate records, 1978 subsidiary formation, reorganization plan or agreements, federal tax analysis, asset and liability schedules, note, bonus record, transfer instruments, business and customer records, equipment inventory, permit records, returns, audit, tax calculation, assessment, payment, reconsideration request, Board-hearing request or transcript, minutes, final order, redetermination, refund or collection record, or later appeal. It does not establish that the Board adopted the recommendation.

The live annotation unusually preserves extensive operational facts, ownership percentages, July 1986 reorganization, shared and separate services, customer independence, Regulation 1595 alternatives, and the exempt result. It uses October 26, 1990 rather than the signed September 5 issue date. It omits the no-sale and federal-exchange argument, assumed-liability details, MacRodyne comparison, minority buyout rights, 40% equipment fact, later repair work and permit, redacted hearing and tax data, cover typo and nonfinal options, missing records, and absent Board action.

What this means for you

Businesses separating service and sales operations

Shared ownership and administrative services do not automatically merge two divisions for occasional-sale purposes when their actual markets and operations are independent.

Accountants and tax professionals

Document separate control, staff, facilities, customer relationships, pricing, and operational dependencies. Also identify assumed liabilities, which can make a restructuring a sale before exemption is considered.

Common questions

Q: Why was the subsidiary transfer considered a sale?
A: Assets and liabilities moved to a separate corporation, ownership interests changed, and the entities then operated independently.

Q: Why was the sale exempt?
A: The transferred service division was a distinct nonselling business whose activities did not require a seller's permit.

Q: Did sharing one building defeat separation?
A: No. The divisions were divided by a wall, had separate addresses and docks, and allocated utilities by space and power use.

Q: Were their customer activities linked?
A: No. Customers received no requirement, discount, warranty service, or other benefit tying purchases from one division to use of the other.

Q: How much service-division equipment came from the systems division?

A: Forty percent, but most came from other manufacturers and the service division had no obligation to use affiliated equipment.

Q: Why did the cited MacRodyne case not control?

A: In that case the parent remained jointly liable and common governance and relationships continued. Here, ownership and operations separated, apart from limited shared responsibility for a note payment and employee bonus.

Q: Why is this page dated September 5 rather than October 26?

A: September 5 is the Hearing Officer's signed decision date. October 26 is the later transmittal date used by the live annotation; its first page omits a digit from 1990.

Q: Did the exemption recommendation become final?

A: The source does not establish that. The cover expressly said it was not yet final and explained reconsideration, Board-hearing, and final-consideration paths.

Citations and references

• California Revenue and Taxation Code sections 6006 and 6367
• California Sales and Use Tax Regulation 1595(a)(1), (a)(3), and (a)(5)(B)(2)
• MacRodyne Industries, Inc. v. State Board of Equalization (1987) 192 Cal. App. 3d 579 — reporter citation resolves to the named case
• Petition, briefs, testimony, corporate and ownership records, reorganization and liability documents, operational evidence, tax proceeding, reconsideration or hearing records, Board action, and outcome — described or implicated but not included

Verbatim support

From the official September 5, 1990 recommendation and October 26 transmittal:

You are advised that this recommendation has not yet become final and that there are three options available to the Board's Department of Business Taxes:

Under the provisions of Revenue and Taxation Code Section 6006 this transfer of title or possession is a sale and subject to California's sales tax.

Neither division relied upon the other for its daily operations or for its future customers.

As the service division was not engaged in any activities which would have required it to obtain a seller's permit, it is concluded that the sale of the service division is an exempt occasional sale.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 395.0378
• Original supporting opinion: 395.0378 PDF

Original ruling text

395.0378

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION
1020 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) 327-5428

October 26, 190

A--- M---, Inc.
XXX --- Way
---, CA XXXXX
Dear Mr. W---:
Re:

SR – XX-XXXXXX-010

Enclosed is a copy of the Decision and Recommendation pertaining to the petition for redetermination in the above-referenced matter. I have recommended that petition be granted as explained in the Decision and Recommendation. You are advised that this recommendation has not yet become final and that there are three options available to the Board’s Department of Business Taxes: 1. If, after reviewing the Hearing Decision and Recommendation, the Department believes it has new evidence and/or contentions not previously considered by the Hearing Officer, it may file a Request for Reconsideration within 30 days from the date of this letter and clearly set forth any new contentions. If new evidence is the basis for filing the request, the evidence must be included. The Department will direct any such request directly to me with a copy to you. I will subsequently notify you whether the request has been taken under review or whether the request is insufficient to warrant an adjustment. If I conclude that no adjustment is warranted, I will then notify the Department of the procedures it can follow to request an oral hearing before the Board. 2. If, after reading the Hearing Decision and Recommendation, the Department finds that there is no basis for filing a Request for Reconsideration, but nevertheless desires to have an oral hearing before the Board, a written request must be filed within 30 days from the date of this letter with Ms. Janice Masterton, Assistant to the Executive Director. A copy of any such request will be sent to you.

A--- --SR -- XX XXXXXX-010

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October 26, 1990
395.0378

3.
If neither a request for Board hearing nor a Request for Reconsideration is received within thirty (30) days from the date of this letter, the Hearing Decision and Recommendation will be presented to the Board for final consideration and action. Very truly yours,

Susan M. Wengel
Hearing Officer
SMW:te
Enc.
cc:

S--- M--H---, F---, J--- & A---, Inc.
XX South --- Street
--- ---, CA XXXXX-XXXX
(w/enclosure)
Mr. C--- C--L--- L---, Inc.
XXX --- Way
---, CA XXXXX
(w/enclosure)
Ms. Janice Masterton
Assistant to the Executive Director (w/enclosure)
Mr. Glenn Bystrom
Principal Tax Auditor (file attached)
--- --- – District Administrator (w/enclosure)

STATE OF CALIFORNIA

395.0378
BOARD OF EQUALIZATION
APPEALS UNIT
In the Matter of the Petition
for Redetermination Under the
Sales and Use Tax Law of:
A--- M---, INC.

Petitioner

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DECISION AND RECOMMENDATION

No. SR – XX XXXXXX-010

The above-referenced matter came on regularly for hearing before Hearing Officer Susan M. Wengel on April 16, 19XX, in --- ---, California. Appearing for Petitioner:

S--- M--Attorney
G--- W--President A--M---, Inc.
C--- C--President
L--- L---, Inc.

Appearing for the Department
of Business Taxes:

Vern Oswald
Senior Tax Auditor
John Wishart
Supervising Tax Auditor
Protested Item

The protested tax liability for the period October 1, 19XX through June 30, 19XX is measured by:

Item
A.

Taxable sale of service division.

State, Local, County
SCCT and SCTA
$XXX,XXX

A--- M---, INC.
SR – XX-XXXXXX-010

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September 5, 1990
395.0378

Contentions of Petitioner
1.

No sale occurred because no consideration was received by petitioner.

2.

If a sale did occur, it is exempt as an occasional sale.
Summary of Petition

Petitioner is a corporation that prior to July of 1986 had two divisions. The service division performed integrated testing services and was managed by C--- C--- (C---) who owned 39.7% of petitioner’s stock. The systems division manufactured integrated circuit test equipment and was managed by E--- W--- (W---) who also owned 39.7 % of petitioner’s stock. The remainder of petitioner’s stock was owned by three other shareholders who were not actively engaged in the business of either division. The systems division manufactured testing equipment which it sold to larger companies such as N--- S---. These companies have budgets substantial enough to allow them to purchase their own expensive testing equipment. Smaller companies cannot usually afford to purchase this expensive equipment so the service division was created to provide testing for these businesses. Customers for the service division could also be larger companies who wanted to have petitioner test their products until they could acquire their own testing equipment. Service division customers could also be companies who had so much merchandise to test that they tested half of it themselves and had the services division test the remaining merchandise. Both of petitioner’s divisions were located in the same building and shared the same telephone number. The divisions were, however, physically separated from each other by a wall that divided the building. Each division had its own separate address and receiving/shipping docks. The divisions shared the same attorney and the same dental and medical plan. They also shared a sales staff and an accounting staff until about 1985 when each began to use its own personnel. The utilities were billed as one amount, however, the bill was apportioned to each division based on square footage and power consumption. The customer bases for each division were not dependent on each other. Although there were some customers who used both divisions, the system division was attracting customers who wanted to purchase integrated circuit testing equipment. The service division attracted customers who wanted testing services. It made no sales of tangible personal property. The divisions each had its own engineering, operations and technical staffs. Each division was operated by a different major shareholder and had separate supervisory personnel. When management differences arose between W--- and C---, it was decided to place each division in a separate corporation. In 1978, petitioner had created a wholly

A--- M---, INC.
SR – XX-XXXXXX-010

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September 5, 1990
395.0378

owned corporate subsidiary called L--- L---, Inc. (L---). This subsidiary was not actively conducting business so petitioner in July of 19XX used the corporation to transfer all the assets and liabilities of the service division plus a proportionate share of several of petitioner’s liabilities. 1 According to this plan of reorganization, C--- was to relinquish his stock in petitioner in exchange for 79.4% of the stock in L---. The 39.7% of stock in petitioner previously owned by C--- was transferred to W--- so that he would hold 79.4% of petitioner’s stock. The remaining minority shareholders kept their 20.6% of petitioner’s stock and were given 20.6% of the stock in L---. Each minority shareholder reserved the right to require W--and C---, respectively, to buy their stock once the reorganization was completed. The Department of Business Taxes (Department) in auditing petitioner’s records ascertained that the transfer of the assets from the service division to L--- in exchange for the assumption of liabilities by L---, was a sale within the meaning of Revenue and Taxation Code Section 6006. They further determined that the transfer of assets between a parent and a wholly owned subsidiary was a taxable sale and not exempt as an occasional sale. Petitioner contends that the transfer is a tax-free exchange under the Internal Revenue Code and should be a tax-free transfer for sales tax purposes, also. In the alternative, petitioner contends that even if a sale took place, it is exempt as an occasional sale. It is noted that subsequent to the sale L--- has expanded its operations and now performs minor repair work. It now holds its own seller’s permit. Analysis and Conclusions 1. Petitioner’s first contention is that no sale occurred because no consideration was received by petitioner. We cannot agree. Assets and liabilities were transferred from petitioner to L---, a separate corporate entity. After the transfer C--- no longer had an ownership interest in petitioner and W--- no longer had an interest in the service division. Once the transfer was completed, both petitioner and L--- conducted their business as separate entities. As petitioner’s brief states, the divisions were separated into two corporations because both divisions had separate needs and disputes arose between W--- and C--- over how petitioner’s corporate affairs should be conducted. Under the provisions of Revenue and Taxation Code Section 6006 this transfer of title or possession is a sale and subject to California’s sales tax.

1

L--- was also to remain responsible for a portion of a bonus paid to an employee of petitioner and half of any payment due on a note to S--- B—C--- and D--- Company.

A--- M---, INC.
SR – XX-XXXXXX-010

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September 5, 1990
395.0378

Petitioner contends that the case of Macrodyne Industries, Inc. v. State Board of Equalization (1987) 192 Cal.App.3d 579 is controlling and that an assumption of indebtedness by a subsidiary upon the transfer of an operating division by the parent does not constitute consideration. This case is clearly distinguishable from the present fact situation. In Macrodyne, the assets and liabilities of the divisions were transferred to the subsidiaries, however, the transfer agreement stated that Macrodyne would remain jointly liable for the same liabilities after the transfers. There was no such agreement in this appeal with the exception of several minor liabilities. Both entities remained liable for half of any payment due to S--- B--- C--- and D--Company and for bonus payments to R--- S---, an employee of petitioner. The Macrodyne case is further distinguished from the present appeal in that after the transfer in Macrodyne, the subsidiaries had directors and officers in common and maintained the same relationship with the parent as they had maintained before the transfer. In this appeal the ownership interest changed and so did the business relationship between petitioner and L---. The transfer was made so that W--- would be the majority shareholder and manager of the systems operations and C--- would be the majority shareholder and manager of the service operations. Once the transfer was completed, both entities functioned entirely on their own. It must be concluded that unless the sale qualifies as an occasional sale, the transfer from petitioner to L--- was a transfer for a consideration and is subject to California sales tax. 2. Petitioner’s second contention is that if a sale did occur, it is exempt as an occasional sale. The Department has taken the position that the systems division, which sold testing equipment, and the service division, which made no retail sales, were operating together so as to constitute one business. Because petitioner held a seller’s permit the Department’s position is that the sale of the assets of the service division are subject to sales tax. Revenue and Taxation Code Section 6367 provides an exemption for sales that are occasional sales. This statute is interpreted by Sales and Use Tax Regulation 1595(a)(1) which provides in part: “Tax applies to all retail sales of tangible personal property including capital assets whether sold in one transaction or in a series of sales, held or used by the seller in the course of an activity or activities for which a seller’s permit or permits is required or would be required if the activity or activities were conducted in this state.”

A--- M---, INC.
SR – XX-XXXXXX-010

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September 5, 1990
395.0378

This regulation goes on to state that:
Tax does not apply to the sale of property held or used in the course of an activity not requiring the holding of a seller’s permit unless the sale is one of a series of sales sufficient in number, scope and character to constitute an activity for which the seller is required to hold a seller’s permit or would be required to hold a seller’s permit if the activity were conducted in this state.” Petitioner’s systems division was clearly making the type of sales for which a seller’s permit was required and this finding is not in dispute. The sole issue is whether the two divisions were separate businesses with no relationship between the two activities except for common ownership or whether the service division and the sales divisions were operated together so as to constitute one business. This finding is crucial as Sales and Use Tax Regulation 1595 denies the occasional sales exemption if the divisions constitute one business but allows the exemption if there are two separate businesses. Section (a)(3) of Regulation 1595 provides: “A person engaged in an activity or activities requiring the holding of a seller’s permit or permits may also be engaged in entirely separate endeavors which do not require the holding of a seller’s permit or permits. Tax applies to the sale of tangible personal property held or used in the course of an activity requiring the holding of a seller’s permit. Tax does not apply to the sale of property held or used by the seller in the non-selling endeavors which do not require the holding of a permit. For example, a person may own a hardware store at one locations and a real estate brokerage at another location, with no relationship between the two activities except that of common ownership. Under these circumstances, a sale of furniture used in the brokerage business would not be a sale of property held or used in an activity requiring the holding of a seller’s permit. A sale of tangible personal property used in the hardware business would be a sale of property held or used in an activity requiring the holding of a seller’s permit.” If this section applies, the sale of the service division will be exempt as an occasional sale.

A--- M---, INC.
SR – XX-XXXXXX-010

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September 5, 1990
395.0378

Section (a)(5)(B)(2) of Regulation 1595 provides:
“Where a service enterprise and a sales business are operated together so as to constitute one business, tax will apply to the sale of the assets of the business. For example, if a car wash and gasoline station are operated at the same premises and the care wash is available only to persons who buy gasoline or if the price of the car wash is reduced if gasoline is purchased, tax applies to the sale of the car wash.” If this section applies, the sale of the service division will be subject to the sales tax. In making a determination whether petitioner’s divisions constitute one or two businesses, it appears to this hearing officer that the key language in Regulation 1595 is the language relating to the interrelationship of the activities performed by each division. It is acknowledged that common ownership was present and that one switchboard was shared by both divisions. Likewise, the divisions shared a dental and a medical plan. They, at one time, also shared a common sales staff and accounting staff. These duties were separated at lease a year prior to the sale, however, so that each division had its own sales and accounting personnel. The regulation implies that certain activities of ownership can be present and yet the businesses can remain separate entities. The testimony at the hearing emphasized the separation of control over the two divisions and the conflict over management of the business that resulted. With the systems division operated by W--- and the service division operated by C---, conflicts arose as to the way the corporate affairs should be conducted. By this point in time, the divisions shared a building but were divided by a wall so that each division had its own address and loading dock. The utilities were shared but the percentage of each entity’s payment was based upon the power consumption and square footage of the building occupied by each division. Each division had its own customer list, although some of the names appeared on both lists. The service division’s customer list was comprised mainly of smaller businesses which could not afford to buy the testing equipment. Some larger companies used the service division, however, while waiting to receive the new testing equipment. Customers of this type would be on the customer list of both divisions. While many of the above-mentioned activities were shared by the divisions, the actual operations of the businesses appear to have been kept separate. A customer which bought testing equipment from the systems division was under no obligation to use the service division. The company did not, through its service division, perform warranty or repair work on the equipment sold by the systems division. Likewise, if a customer used the service division to test

A--- M---, INC.
SR – XX-XXXXXX-010

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September 5, 1990
395.0378

circuit boards, it was not obligated to buy any equipment from the systems division. Furthermore, there is no evidence that a customer of one division would receive any benefit, such as a discount, if it used the services of the other division. It is noted that 40% of the service division’s equipment was comprised of testing equipment manufactured by the systems division. There was no obligation of the service division, however, to use petitioner’s equipment. The majority of the testing equipment used by the service division was obtained from other manufacturers. It must be concluded that even though the divisions shared common ownership and other services related to common ownership, the divisions were separate businesses which did not rely upon each other for day to day operations. Unlike the gasoline station and the car wash example used in Regulation 1595(a)(5)(B)(2), the services of the service division were not limited to customers buying equipment from the systems division. Neither division relied upon the other for its daily operations or for its future customers. As the service division was not engaged in any activities which would have required it to obtain a seller’s permit, it is concluded that the sale of the service division is an exempt occasional sale. Recommendation It is recommended that the petition be granted.

__________
Susan M. Wengel, Hearing Officer

Sept. 5, 1990
____
Date