Could a corporation transfer its operating assets to a wholly owned subsidiary and immediately merge that subsidiary into an unrelated buyer without sales or use tax?

Plain-English summary

A representative described an unidentified client's proposed three-party transaction. A California corporation would transfer all tangible personal property used in seller-permit activities, plus leaseholds, intangibles, and other assets, to its wholly owned Delaware subsidiary. It would retain certain intangibles, real property, and a small amount of assets not used in the permit activity.

The subsidiary would assume a substantial portion of operating liabilities and immediately merge into a separate, unrelated Delaware corporation. Its separate existence would end, its stock would convert into a right to merger consideration, and the surviving corporation would pay the California parent cash and a note after filing a Delaware certificate of merger.

Tax Counsel Elizabeth Abreu said liability assumption made the first transfer a sale. On the stated and assumed facts, it could nevertheless qualify as an exempt occasional sale because all permit-activity property transferred and ultimate ownership initially remained substantially similar through the wholly owned subsidiary. Regulation 1595 used 80-percent property and ownership tests.

The immediate unrelated merger did not defeat that first exemption if the structure had a valid business purpose other than avoiding sales or use tax. The merger transfer also could be nontaxable if Delaware's statutory-merger law was similar to California's. The letter did not analyze Delaware law or show that any step occurred.

Proposed steps, regulatory conditions, reliance limit, and missing record

Elizabeth Abreu responded on September 24, 1993 to Mr. D--- B. F---'s July 22 request. The representative did not identify the client, Transferor, Acquisition, or Transferee. Every step was described in future tense.

In step A, Transferor would convey all tangible personal property used in activities requiring a seller's permit to Acquisition, its wholly owned Delaware subsidiary. Leaseholds, intangibles, and other assets would accompany it. Transferor would retain certain intangibles, real property, and a small amount of assets not used in the permit activity. Acquisition would simultaneously assume a substantial portion of Transferor's business-operating liabilities.

In step B, Acquisition would immediately merge into a separate Delaware Transferee. Acquisition would cease to exist, Transferee would survive, a certificate would be filed with Delaware's Secretary of State, and Acquisition's outstanding stock would convert into the right to receive aggregate merger consideration.

In step C, after the certificate filing, Transferee would pay Transferor cash and a note. The request stated that valid business reasons included further insulating Transferee from potential liabilities. It asked whether Regulation 1595(b)(2) and (3) produced no California sales or use tax liability for any involved company.

Abreu applied Regulation 1595(b)(4) first: Acquisition's liability assumption was consideration, so the asset transfer was a sale. Sections 6006.5(b) and 6367 could still exempt it if Regulation 1595(b)(2)'s property and ownership conditions were satisfied.

For property, substantially all meant at least 80 percent of all tangible personal property held or used in permit-requiring activities, including property outside California. The request represented that all such property would transfer. It gave no inventory, location, use, value, percentage calculation, or allocation.

For ownership, substantially similar meant at least 80 percent of real or ultimate ownership remained unchanged immediately after transfer. Abreu assumed Transferor would own all Acquisition stock immediately after the sale and assumed Transferee was unrelated. She concluded that the immediate merger would not defeat the first-step ownership condition if the structure had a valid business purpose apart from avoiding sales or use tax.

The first transfer therefore qualified only on those hypothetical facts and assumptions. For the second transfer, Abreu said Regulation 1595(b)(3) would make Acquisition's statutory-merger transfer nontaxable only if Delaware merger law was similar to California law. The source quotes or analyzes no Delaware statute and supplies no Delaware legal opinion.

Section 6596 was an independent reliance limitation. Abreu said its primary conditions included a written request disclosing all relevant facts and taxpayer identity. Because the client was unidentified, this was general hypothetical advice outside section 6596—not taxpayer-specific protection against tax from incorrect written advice.

The PDF omits the July 22 request except for its quotation; every company and taxpayer identity; corporate charts, incorporation and ownership records; asset inventories, locations, uses, appraisals, values, schedules, percentages, transfer instruments, liability schedules and assumption agreement; merger agreement, stock terms, certificate, Delaware statutes or legal analysis; cash and note amounts; closing records; business-purpose evidence; permits; returns; audit, assessment, payment, refund, administrative action, litigation, or later outcome. It does not establish that any proposed step occurred or that any condition was verified.

The live annotation preserves the California transferor, permit-activity property, other assets, liabilities, wholly owned subsidiary, unrelated Delaware merger, property and ownership conditions, valid non-tax business reason, similar-law condition, and conditional no-tax conclusions. It omits the representative and request date; the client's anonymity and hypothetical posture; leaseholds, intangibles, retained assets, cash and note, certificate filing, stock conversion, and liability-insulation purpose; liability assumption as consideration and the first step's status as a sale; the two 80-percent definitions; every statute and regulation number; Abreu's assumptions; section 6596 denial; missing records; and absence of any completed transaction or outcome.

What this means for you

Businesses structuring an acquisition

Under this hypothetical advice, an assumed-liability transfer could still qualify as occasional only if the property, immediate ownership, and non-tax business-purpose conditions were actually supported.

Accountants and tax professionals

Build the asset and ownership calculations, document the business purpose, and obtain support for the foreign merger law. Anonymous advice did not provide section 6596 protection.

Common questions

Q: Why was the subsidiary transfer considered a sale?
A: The subsidiary assumed the parent's liabilities, and the regulation treated that assumption as consideration.

Q: Why could the sale still be exempt?
A: The proposal said all seller-activity tangible property would transfer, and counsel assumed the parent would own all subsidiary stock immediately afterward.

Q: Did the immediate unrelated merger destroy ownership continuity?
A: Not if the structure had a valid business purpose other than avoiding sales or use tax.

Q: Was the merger automatically exempt?
A: No. The letter conditioned the result on Delaware having statutory-merger laws similar to California's.

Q: What did the two 80-percent tests measure?

A: One measured tangible personal property used in permit-requiring activities, including out-of-state property. The other measured unchanged real or ultimate ownership after transfer.

Q: Were the transaction parties identified?

A: No. The representative used only Transferor, Acquisition, and Transferee and did not name the client.

Q: Did section 6596 protect reliance on the letter?

A: No. Counsel expressly classified it as general hypothetical advice because the client was unidentified.

Q: Did the companies complete the transaction tax-free?

A: The source does not say. It provides no agreements, closing evidence, Delaware-law analysis, returns, assessment, or later outcome.

Citations and references

• California Revenue and Taxation Code §§ 6006.5(b), 6367, and 6596
• California Sales and Use Tax Regulation 1595(b)(2) — substantially-all-property and substantially-similar-ownership conditions
• California Sales and Use Tax Regulation 1595(b)(3) — statutory merger condition
• California Sales and Use Tax Regulation 1595(b)(4) — assumed liabilities as consideration
• July 22, 1993 representative request — quoted in part but not included separately
• Identity, corporate, ownership, asset, value, transfer, liability, merger, consideration, Delaware-law, business-purpose, permit, return, audit, tax, administrative, and outcome records — described or implicated but not included

Verbatim support

From the official September 24, 1993 Elizabeth Abreu letter:

Since Acquisition is assuming liabilities of Transferor and assumption of liabilities is consideration (Regulation 1595(b)(4)), the transfer of the assets from Transferor to Acquisition is a sale.

It is our position that if there is a valid business purpose for structuring the transaction in this manner other than the avoidance of sales or use tax, the substantially similar ownership requirement will be met since the transfer was to Transferor's wholly-owned subsidiary.

If Delaware has statutory merger laws similar to those of California, under Regulation 1595(b)(3) tax does not apply to the transfer of the property of Acquisition to Transferee pursuant to the statutory merger.

Since you have not identified your client, this opinion does not come within the provisions of section 6596 but rather is simply general advice regarding a set of hypothetical facts.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.1295
• Original supporting opinion: 395.1295 PDF

Original ruling text

395.1295
STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION
LEGAL DIVISION (MIC:82)
450 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) 324-8208

MEMBER
First District
BRAD SHERMAN
Second District, Los Angeles
ERNEST J. DRONENBURG, JR.
Third District, San Diego
MATTHEW K. FONG
Fourth District, Los Angeles
GRAY DAVIS
Controller, Sacramento

September 24, 1993
BURTON W. OLIVER
Executive Director

Mr. D--- B. F--C--- & L--XXX --- -----, CA XXXXX
Dear Mr. F---:
This is in response to your letter dated July 22, 1993 in which you state: "This is a request for a legal opinion regarding the application of sales or use taxes to a business transaction between our client and another party. The sequence of events, as contemplated, is as follows: "A.

A California corporation (hereinafter 'Transferor') will transfer all of its tangible personal property used in activities requiring the holding of a seller's permit or permits to its wholly-owned subsidiary Delaware corporation (hereinafter 'Acquisition'). Concurrently, Transferor will also transfer to Acquisition various other assets including leaseholds and intangibles. The only assets to be retained by Transferor are certain intangibles, real property, and a small amount of assets not used in the activity requiring the holding of a seller's permit. Simultaneous with the transfer of the assets, Acquisition will assume a substantial portion of the liabilities of Transferor related to the operation of the business.

"B.

Immediately following the transfer of assets and the assumption of liabilities, Acquisition will be merged with and into a separate Delaware corporation (hereinafter 'Transferee'). The separate existence of Acquisition will cease, and Transferee, as the surviving corporation shall continue to exist. Acquisition and Transferee will file a Certificate of Merger with the Secretary of State of the State of Delaware. The

Mr. D--- B. F---

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September 24, 1993
395.1295

outstanding capital stock of Acquisition will be converted into the right to receive an aggregate amount equal to the Merger Consideration. "C.

On the closing date, after filing the certificate of merger, Transferee will pay to Transferor the Merger Consideration, consisting of cash and a note.

"There are valid business reasons for structuring the transaction in this manner, including additional insulation of Transferee from potential liabilities." You ask whether you are correct in concluding that the transaction, if completed in the manner described above, will result in no California sales or use tax liabilities on the part of any of the companies involved in accordance with Regulation 1595(b)(2) and (3). Since Acquisition is assuming liabilities of Transferor and assumption of liabilities is consideration (Regulation 1595(b)(4)), the transfer of the assets from Transferor to Acquisition is a sale. Thus the first question is whether this sale is an exempt occasional sale under Revenue and Taxation Code sections 6367 and 6006.5(b). Revenue and Taxation Code section 6367 exempts from tax the gross receipts from occasional sales of tangible personal property and the storage, use, or other consumption in this state of tangible personal property, the transfer of which to the purchaser is an occasional sale. Revenue and Taxation Code section 6006.5(b) includes in the definition of occasional sale transfers of all or substantially all property without a substantial change in ownership. The requirements for this type of occasional sale exemption are set forth in Regulation 1595(b)(2), which reads in part: "(2) TRANSFERS OF SUBSTANTIALLY ALL PROPERTY WITHOUT SUBSTANTIAL CHANGE IN OWNERSHIP. Tax does not apply to a transfer of all or substantially all the property held or used by a person in the course of activities for which the person is required to hold a seller's permit or permits or would be required to hold a seller's permit or permits if the activities were conducted in this state, provided that after the transfer the real or ultimate ownership of the property is substantially similar to that which existed before such transfer. 'Substantially all the property' means 80 percent or more of all the tangible personal property held or used in the course of activities, including tangible personal property located outside of this state.... Stockholders, bondholders, partners, or other persons holding an ownership interest rather than a security interest in the corporation or other entity are regarded as having the real or ultimate ownership of the property of the corporation or other entity. "The real or ultimate ownership is 'substantially similar' to that which existed before a transfer if 80 percent or more of that ownership of the tangible personal

Mr. D--- B. F---

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September 24, 1993
395.1295

property is unchanged after the transfer...."
According to your letter, the 80 percent rule relating to the transfer of substantially all of the property is met because Transferor will transfer all of the tangible personal property used in activities requiring the holding of a seller's permit. We assume that Transferor will own all of the stock of Acquisition immediately after the sale of the property. We also assume that Transferee is unrelated to Transferor. The next question, therefore, is whether the rule relating to substantially similar ownership is met where the property is first transferred to a wholly-owned subsidiary and then immediately transferred by merger to an unrelated corporation. It is our position that if there is a valid business purpose for structuring the transaction in this manner other than the avoidance of sales or use tax, the substantially similar ownership requirement will be met since the transfer was to Transferor's wholly-owned subsidiary. Because the requirements of section 6006.5(b) are met, the sale of property to Acquisition will qualify as an exempt occasional sale under section 6367. The final question is whether the transfer by statutory merger of the property from Acquisition to Transferee is subject to tax. If Delaware has statutory merger laws similar to those of California, under Regulation 1595(b)(3) tax does not apply to the transfer of the property of Acquisition to Transferee pursuant to the statutory merger. Revenue and Taxation Code section 6596 provides the only basis for relief from tax if a taxpayer relies on incorrect written advice from the board. The primary conditions to qualify are that the request for opinion must be in writing and must disclose all relevant facts, including the identity of the taxpayer. Since you have not identified your client, this opinion does not come within the provisions of section 6596 but rather is simply general advice regarding a set of hypothetical facts. If you have further questions regarding Sales and Use Tax Law, please do not hesitate to write again. Sincerely,

Elizabeth Abreu
Tax Counsel

EA:cl