Could a shutter manufacturer sell fixtures to its 95%-owned sales company on the same tax basis as sales to independent home-improvement stores?

Plain-English summary

A company manufactured, sold, and installed residential shutters. It sold directly to residential customers and to independent home-improvement stores. Store prices were lower than direct-customer prices; installation was separately stated to stores but included in the customer's price whether the customer contracted through a store or directly.

The manufacturer proposed forming a 95%-owned sales company. The affiliate would buy shutters, make customer sales, and consummate the customer transaction, while the manufacturer actually furnished and installed the shutters for a fixed installation charge.

The Board said related-party transfers are generally disregarded when they are not structured at arm's length. If the manufacturer and affiliate were separate legal persons and the manufacturer charged the affiliate the same or an equivalent price as unrelated stores, their transactions could receive the same tax treatment as the independent-store sales.

The opinion assumed the companies were separate “persons,” the shutters were fixtures, and the manufacturer's existing Regulation 1521 reporting was correct. It also warned that divisions of the same entity cannot sell property to each other. Because the taxpayer was unidentified, the advice carried no section 6596 reliance protection.

Proposed structure, assumed reporting, related-party authorities, and limits

Senior Tax Counsel Sharon Jarvis wrote on June 3, 1997 to attorney R--- J. H--- in response to his March 28 letter to Assistant Chief Counsel Gary J. Jugum. The client was identified only as S---, which Jarvis assumed was not its true name. She therefore warned that the opinion did not qualify under section 6596.

S--- manufactured, sold, and installed shutters in residences. It sold directly to residents and to independent home-improvement stores, always performing installation itself. Its store price was lower than its direct price, and it separately stated installation to stores. Customer-facing prices included installation whether the customer contracted with a store or S---.

S--- proposed a new sales company, N---, 95 percent owned by S---. Counsel assumed S--- and N--- were separate section 6005 “persons,” such as corporations, rather than divisions. A footnote applied section 6006: one person cannot make a sales-tax sale to itself, so a transfer between divisions of the same entity is not a sale.

N--- would buy shutters from S--- and make customer sales. N--- would consummate the customer contract, while S--- furnished and installed the shutters for a fixed charge. S--- proposed an affiliate price similar to its independent-store price and asked whether tax could be measured by the affiliate price excluding installation despite related ownership.

The request represented that, after a prior Board audit, S--- reported as a Regulation 1521 construction contractor: shutters were fixtures; S--- as manufacturer-contractor was the retailer of fixtures it furnished and installed; and independent-store tax was measured by the shutter price excluding separately stated installation. Because the client was unidentified, Jarvis could not review the audit file or confirm that description. She expressly assumed fixture treatment and correct existing reporting.

Jarvis said transfers between a corporation and a majority-owned subsidiary are generally disregarded when not structured as if at arm's length. She cited Annotation 330.1875, which uses cost coverage as an arm's-length indicator for a related equipment lease; Annotation 330.4070, which distinguishes a same-person division from a separate subsidiary in a uniform-leasing structure; and Mapo, Inc. v. State Board of Equalization, 53 Cal.App.3d 245 (1975). Those authorities are examples; their equipment- and uniform-lease facts are not the shutter facts.

If S--- and N--- acted as if at arm's length, staff would treat their transactions like S---'s independent-store sales. Jarvis considered the sales arm's length if S--- charged N--- the same or an equivalent price as unrelated stores. The source does not supply the proposed price, define “equivalent,” compare other terms, or show actual invoices, payments, credit, risk, warranty, returns, installation obligations, or conduct.

Jarvis invited a further request with transaction details, each entity's legal nature, and relevant documents such as the furnishing-and-installation contract. The PDF does not include the March 28 request, identities, organizational records, ownership evidence, prior audit, customer or store contracts, price lists, unrelated-sale comparables, N--- agreement, fixed installation charge, invoices, installation records, fixture evidence, returns, tax computations, completed transaction, audit, assessment, Board adoption, appeal, or later outcome.

The live annotation preserves the existing sales channels and pricing, installation treatment, construction-contractor reporting, proposed 95-percent-owned separate entity, affiliate structure, arm's-length requirement, same-or-equivalent unrelated-store price, and conditional result. It omits the lawyer and officials, unidentified client and section 6596 warning, March 28 request, sections 6005 and 6006, footnote on divisions, prior-audit verification limit, assumed fixture and reporting facts, precise Regulation 1521 subdivisions, both prior annotations and Mapo, request for documents, missing records, and absent transaction or outcome. It also prints majority-owed subsidiary where the supporting letter says majority-owned.

What this means for you

Manufacturers using affiliated sales companies

Use contracts, pricing, invoicing, credit, warranty, risk, and actual conduct comparable to unrelated distributors. This letter used price as a stated safe indicator but had no completed transaction to test.

Construction contractors

Confirm whether installed property is a fixture and who furnishes and installs it as construction contractor. The opinion could not verify the prior audit and assumed those facts.

Accountants and tax professionals

Test whether the affiliate is a separate section 6005 “person,” preserve ownership evidence, and compare prices and other terms with equivalent independent sales.

Common questions

Q: Did 95% ownership automatically cause the transfers to be ignored?
A: No. The opinion allowed ordinary treatment if the entities conducted equivalent arm's-length transactions.

Q: What pricing supported arm's-length treatment?
A: The same or an equivalent price as sales to unrelated home-improvement stores.

Q: Could an internal division make the same sale?
A: No. A person cannot make a sales-tax “sale” to itself.

Q: Was the unidentified client protected under section 6596?
A: No. The letter expressly says it was not.

Q: What existing reporting did counsel assume?

A: Shutters were fixtures, S--- was the manufacturer-contractor and retailer, and tax on independent-store sales used the shutter price excluding separately stated installation.

Q: Did staff verify the prior audit?

A: No. The unidentified client prevented file review, so Jarvis assumed the request characterized the audit and current reporting correctly.

Q: Were equal prices the only possible arm's-length evidence?

A: The letter says the same or equivalent unrelated-store price would be sufficient for its treatment, but supplies no actual price or other transaction terms.

Q: Did the proposed affiliate begin operating?

A: The source includes no formation record, contract, sale, installation, return, audit, or later outcome.

Citations and references

• California Revenue and Taxation Code §§ 6005, 6006, and 6596
• California Sales and Use Tax Regulation 1521(a)(5), (b)(2)(B), and (b)(2)(B)(2)(b)
• California Sales and Use Tax Annotation 330.1875, dated July 8, 1992
• California Sales and Use Tax Annotation 330.4070, dated February 15, 1995
• Mapo, Inc. v. State Board of Equalization, 53 Cal.App.3d 245 (1975)
• March 28, 1997 request and prior Board audit — identified but not included
• Proposed entity, ownership, customer, store, pricing, furnishing, installation, fixture, reporting, contract, invoice, tax, administrative, and outcome records — described or implicated but not included

Verbatim support

From the official June 3, 1997 Sharon Jarvis letter:

I assume that S--- is not the true name of your client. As such, please be aware that this opinion letter does not come within the provisions of Revenue and Taxation Code section 6596.

For purposes of this opinion letter, we assume that both S--- and N--- are separate “persons” as defined in Revenue and Taxation Code section 6005, e.g., each is a corporation, and one is not merely an internal division of the other.

We would consider the sales of shutters by S--- to N--- as arms length transactions if S---’s sales to N--- are made at the same or equivalent price as its sales to unrelated stores.

If you have further questions, please write again and provide us with more details of the transactions, the nature of each entity ... and copies of any relevant documents such as the contract between S--- and N--- for the furnishing and installation of the shutters.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.1251.500
• Original supporting opinion: 395.1251.500 PDF

Original ruling text

395.1251.500

STATE OF CALIFORNIA

JOHAN KLEHS
First District, Hayward

STATE BOARD OF EQUALIZATION
LEGAL DIVISION (MIC:82)
450 N STREET, SACRAMENTO, CALIFORNIA
(PO BOX 942879, SACRAMENTO, CALIFORNIA 94279-0082)
TELEPHONE (916) 324-2634
FAX (916) 323-3387

DEAN F. ANDAL
Second District, Stockton
ERNEST J. DRONENBURG, JR.
Third District, San Diego
KATHLEEN CONNELL
Controller, Sacramento
___

June 3, 1997

JOHN CHIANG
Acting Member
Fourth District, Los Angeles
___
E. L. SORENSEN, JR.
Executive Director

Mr. R--- J--- H-----, ---, --- & --- LLP
XXX South --- Street, ---th Floor
--- ---, CA XXXXX-XXXX
Re:

Unidentified Taxpayer

Dear Mr. H---:
I am responding to your letter dated March 28, 1997 to Assistant Chief Counsel Gary J. Jugum concerning the application of sales and use tax to the sale and installation of shutters by your client (“S---”). I assume that S--- is not the true name of your client. As such, please be aware that this opinion letter does not come within the provisions of Revenue and Taxation Code section 6596. You describe the factual situation as follows. S--- manufactures, sells, and installs shutters in residences. S--- sells both directly to residential customers, and to independent home improvement-type stores. In each instance, the installation of the shutters is performed by S---. S---’s sales to the stores are at a lower price than its direct sales to residential customers, and S--separately states installation charges to the stores. However, installation is included in the purchase price to the customer, whether the shutters are sold through a store or directly to the customer by S---. You indicate that S--- proposes to establish a new sales company (hereinafter “N---” ) which will be 95% owned by S---. For purposes of this opinion letter, we assume that both S--and N--- are separate “persons” as defined in Revenue and Taxation Code section 6005, e.g., each is a corporation, and one is not merely an internal division of the other.1

1

A “person” cannot make a sale, as defined in Revenue and Taxation Code section 6006, to itself. This means that a transfer of tangible personal property between divisions of the same entity is not a sale for sales and use tax purposes.

Mr. R--- J--- H---

-2-

June 3, 1997
395.1251.500

You state, “The new company will purchase shutters from S--- and make sales of shutters to customers, but the installation will continue to be done by S--- at a fixed installation charge. S--- will sell the shutters to the new sales company at a price similar to the price at which it sells to independent companies.” We understand this to mean that N--- will consummate the sales transaction with the customer, but that S--- will actually furnish the shutters and install them. You further state: “S---’s current practice is to charge sales tax as a construction contractor pursuant to Regulation 1521, following a prior audit by the Board. That is, as a construction contractor, it is treated as the retailer of fixtures that it furnishes and installs. Reg. 1521(b)(2)(B). Shutters are treated as fixtures for these purposes. Reg. 1521(a)(5). Since S--- is the construction contractor and the manufacturer, it charges sales tax on the price at which it sells the shutters to the independent companies, exclusive of installation charges. Reg. 1521(b)(2)(B)(2)(b). “The question raised is whether sales through the new sales company should be treated in the same manner. That is, should the measure of sales tax be the price charged to the sales company for the shutters exclusive of installation charges. Or, would a different result occur because the sale company is related?” (Quoted as written.) Discussion Please note that since you have not identified your client, we are unable to review the file of the prior audit and do not know whether you have correctly characterized the audit findings. For purposes of this opinion letter, we assume that your characterization of the shutters as fixtures is accurate and that S---’s existing practices in the reporting of sales and use tax are correct. However, transfers between related parties (e.g., between a corporation and a majorityowned subsidiary corporation such as S--- and N---) are generally disregarded for sales and use tax purposes if they are not structured as if at arms length. (See, e.g., Sales and Use Tax Annotations 330.1875 (7/8/92) & 330.4070 (2/15/95). See also Mapo, Inc. v. State Bd. of Equalization (1975) 53 Cal.App.3d 245.) Thus, if S--- and its related entity N--- conduct their transactions with each other as if at arms length, we would treat their transactions in the same manner as transactions between S--- and the independent home improvement-type stores. We would consider the sales of shutters by S--- to N--- as arms length transactions if S---’s sales to N--- are made at the same or equivalent price as its sales to unrelated stores. If such is the situation, sales to N--- may be treated in the same manner as S---’s sales to independent stores for sales and use tax purposes.

Mr. R--- J--- H---

-3-

June 3, 1997
395.1251.500

I hope this information is of assistance. If you have further questions, please write again and provide us with more details of the transactions, the nature of each entity (e.g., are S--- and N--- separate corporations, or is N--- a division of S--- and not a separate “person”), and copies of any relevant documents such as the contract between S--- and N--- for the furnishing and installation of the shutters. Sincerely,

Sharon Jarvis
Senior Tax Counsel
SJ:cl

cc:

Culver City District Administrator (AS)