Was a subsidiary's asset dividend to its parent exempt when the parent assumed liabilities, and how was the 80-percent transfer test applied?

Plain-English summary

An auditor reviewed B--- C---, Inc.'s corporate-form changes and questioned the taxpayer's claim that every merger was statutory and exempt. Legal Division treated three documented merger steps as nontaxable under Regulation 1595(b)(3).

In July 1987, B--- C--- merged into a Delaware namesake that survived and adopted the B--- C--- name. In September, B--- C--- merged with a 3--- Corporation subsidiary and itself became a 3--- subsidiary. A December 21, 1989 certificate, filed March 30, 1990, later merged B--- C---—then named 3--- F--- S------into 3---.

The May 1989 step was different. A subsidiary declared a dividend of contracts, proprietary rights, and tangible assets to its parent, and the parent assumed liabilities. That was not a statutory merger. The assumed liabilities were sale consideration attributable in part to tangible property.

Because parent 3--- wholly owned B---, the sale could qualify as occasional if at least 80 percent of B---'s tangible personal property used in seller-permit activities transferred. Contracts and patents, trademarks, and other intangibles did not enter that percentage by themselves. Physical property moved or retained with contracts did matter. If retained seller-activity tangible property was below 20 percent, the sale was exempt.

The source lists all tangible assets as including inventory, equipment, and accounts receivable, but does not explain the accounts-receivable classification. It provides no asset values, assumed-liability amount, percentage calculation, audit adjustment, or outcome.

Four-step chronology, May asset list, percentage test, and missing record

Senior Tax Counsel David H. Levine sent the August 30, 1990 memorandum to John Huk, Supervising Tax Auditor in San Jose, responding to Huk's August 3 memorandum. B--- C---'s account is redacted. The audit memorandum and corporate documentation Levine describes are absent.

The taxpayer characterized all changes as statutory mergers. Huk believed at least one parent-liability-assumption transaction might not qualify and might be taxable. The source gives no taxpayer submission, audit workpaper, merger schedule, entity chart, ownership ledger, asset value, or disputed tax amount.

For July 1987, a California-filed certificate said B--- C--- merged into B--- C--- Delaware under Delaware General Corporation Law section 252(c). The Delaware corporation survived and changed its name to B--- C---. Levine treated the property transfer as nontaxable under Regulation 1595(b)(3). The certificate is not reproduced.

For September 1987, B--- C--- merged with a 3--- subsidiary and became a 3--- subsidiary. Levine said documentation established a statutory merger under applicable California and Delaware law, but identified no statute, entities, agreement, filing, effective date, consideration, or document.

The May 26, 1989 bill of sale was different. B--- declared a dividend to parent 3---; 3--- assumed certain B--- liabilities. The asset quotation covered assignable contracts except ULAWA and other government contracts; patents, trademarks and proprietary technology rights; and all tangible assets, including inventory, equipment and accounts receivable, except property requiring third-party consent. The source does not reproduce the bill of sale or identify any contract, right, asset, consent, or value.

Levine agreed the May step was not a statutory merger. Assumed liabilities were its sales price. Tax applied to the portion related to tangible personal property not sold for resale unless an exemption applied. The source gives no total liability, allocation, resale document, tax-paid status, rate, jurisdiction, or tax calculation.

Section 6367 and section 6006.5(b) could exempt the sale under Regulation 1595(b)(2) because B--- was wholly owned by 3---, but only if 80 percent or more of tangible personal property held or used in B---'s permit activities transferred.

Contracts did not count by themselves if they were only obligations to sell tangible property and transferred no existing property. Physical property transferred with assignable contracts or retained with excluded and consent-dependent contracts did count. Levine specifically said government contracts might cause B--- to retain related physical property. The PDF gives no contract performance assets, title, ownership, location, value, assignment, consent, or retention schedule.

Patents, trademarks, and proprietary technology rights were intangibles excluded from the percentage. The source does not address accounts receivable separately after its asset quotation classifies them within all tangible assets; no record resolves that drafting point.

Levine's conditional conclusion was mathematical: retained permit-activity tangible property below 20 percent meant the May sale was exempt. He did not determine the actual percentage.

Finally, a certificate of ownership and merger dated December 21, 1989 and filed with California on March 30, 1990 said B---—then 3--- F--- S------merged into 3--- under California Corporations Code section 1110 and Delaware General Corporation Law section 253. Levine treated that merger's tangible-property transfer as nontaxable. The certificate and property record are absent.

The PDF supplies no August 3 audit request; taxpayer arguments; certificates, merger documents, statutory texts or filings; bill of sale; contract and consent records; patents, trademarks or technology schedules; inventory, equipment, receivables or other asset records; liability and resale evidence; values and percentage calculation; return, audit conclusion, assessment, payment, refund, administrative action, appeal, or later outcome.

The live annotation relabels B--- and 3--- as Corporations B and C. It preserves the 1989 dividend, assumed liabilities, three asset groups, sales price, taxable tangible-property portion, resale qualification, occasional-sale alternative, contract and intangible treatment, third-party-consent property, and under-20-percent retention condition. It omits the auditor, taxpayer and audit dispute; August 3 request; every 1987 and December 1989 statutory merger, certificate, filing and statute; May 26 bill-of-sale date; ULAWA and government-contract specifics; accounts receivable inside the tangible assets list; missing records and calculations; and absent audit or tax outcome.

What this means for you

Corporate groups moving subsidiary assets upstream

Under this memorandum, a dividend label did not prevent a sale when the parent assumed liabilities. The asset transfer still needed its own supported exemption.

Accountants and tax professionals

Compute the 80-percent test from valued tangible property, not contract counts or proprietary rights, while tracing physical assets tied to every assigned or retained contract.

Common questions

Q: Were the statutory mergers taxable?
A: No under this audit advice. The memorandum treated property transfers under the three described statutory mergers as nontaxable.

Q: Why was the May 1989 dividend a sale?
A: The parent assumed liabilities in return for the transferred assets.

Q: Did excluded contracts automatically prevent the 80-percent test from being met?
A: No. The contracts themselves were not tangible property, but physical property retained with those contracts counted.

Q: Did patents and trademarks enter the percentage?
A: No. The memorandum treated them as intangibles outside the tangible-property calculation.

Q: Did the source establish that 80 percent transferred?

A: No. It states the conditional test but gives no asset schedule, values, numerator, denominator, or calculation.

Q: Why are accounts receivable notable?

A: The quoted bill-of-sale category calls inventory, equipment, and accounts receivable part of all tangible assets; the analysis does not separately resolve that wording.

Q: What happened in the audit?

A: The source supplies no audit conclusion, assessment, payment, refund, administrative action, appeal, or later outcome.

Citations and references

• California Revenue and Taxation Code §§ 6006.5(b) and 6367
• California Sales and Use Tax Regulation 1595(b)(2) and (b)(3)
• California Corporations Code § 1110 — cited for the December 1989 merger
• Delaware General Corporation Law sections 252(c) and 253 — cited for the July and December 1989 merger records
• August 3, 1990 audit memorandum; merger documentation and certificates; May 26, 1989 bill of sale — identified but not included
• Entity, ownership, merger, filing, contract, consent, government-contract, proprietary-right, asset, receivable, liability, resale, value, percentage, tax, audit, administrative, and outcome records — described or implicated but not included

Verbatim support

From the official August 30, 1990 David H. Levine memorandum:

We agree that this transfer of assets was not pursuant to a statutory merger. The sale price (that is, the assumed liabilities) is subject to sales tax with respect to the portion related to tangible personal property not sold for resale unless that sale is entitled to an exemption.

However, if tangible personal property related to these contracts was transferred along with the contracts or retained with respect to those contracts not transferred, then that tangible property would, of course, be relevant to the analysis.

If the tangible personal property retained by B--- C--- by virtue of the contracts it retained and by virtue of being unable to transfer without the consent of a third party consisted of less than 20% of the tangible personal property it held in the course of activities requiring a seller’s permit, then B--- C---’ sale to 3--- was an exempt occasional sale.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.1527
• Original supporting opinion: 395.1527 PDF

Original ruling text

State of California

Board of Equalization
Legal Division

Memorandum

To:

Mr. John Huk
Supervising Tax Auditor
San Jose Auditing

From:

David H. Levine
Senior Tax Counsel

Subject:

B--- C---, Inc.
SR -- XX-XXXXXX

395.1527

Date:

August 30, 1990

(916) 445-5550
ATSS 485-5550

This is in response to your memorandum dated August 3, 1990. You are auditing B--C---, which has undergone several changes in its corporate form over the past few years. Taxpayer contends that all mergers are statutory and exempt from tax. You believe that at least one of the transactions in which the parent assumed liabilities of taxpayer may not qualify as a statutory merger and may be taxable. In July 1987, B--- C--- merged into B--- C--- Delaware. B--- C--- Delaware was the surviving corporation, but changed its name to B--- C---. A Certificate of Merger filed with the California Secretary of State certified that the merger was pursuant to the provisions of subsection (c) of section 252 of the General Corporation Law of Delaware. We conclude that this was a statutory merger and the transfer of property pursuant to that merger was not subject to sales or use tax. (Reg. 1595(b)(3).) In September 1987, B--- C--- merged with a subsidiary of 3--- Corporation and itself became a subsidiary of 3---. The documentation shows that this was a statutory merger pursuant to the applicable provisions of California and Delaware law. We conclude that no sales or use tax applies to the transfer of property pursuant to that merger. (Reg. 1595(b)(3).) In May 1989, B--- C--- declared a dividend to its parent 3--- in return for which 3--assumed certain of B--- C---’ liabilities. This property was transferred to 3--- by a bill of sale dated May 26, 1989. The assets transferred were:

Mr. John Huk

-2-

August 30, 1990
395.1527

“1.

All contracts to which B--- is a party and which can be assigned by B--without the consent or approval of the other party thereto, excluding the ULAWA and any other government contracts to which B--- is a party.

“2.

All of B---’s right, title, and interest in any patents, trademarks, or any other proprietary rights in any technologies owned in whole or in part by B---.

“3.

All tangible assets of B---, including, without limitation, inventory, equipment and accounts receivable, except such as may not be transferred without the consent of any third party.”

We agree that this transfer of assets was not pursuant to a statutory merger. The sale price (that is, the assumed liabilities) is subject to sales tax with respect to the portion related to tangible personal property not sold for resale unless that sale is entitled to an exemption. The relevant exemption is provided by section 6367 for occasional sales as defined by subdivision (b) of section 6006.5. Since B--- C--- was a wholly-owned subsidiary of the purchaser, 3---, if it transferred substantially all the tangible personal property it held or used in the course of its activities requiring a seller’s permit (80% or more), then its sale to 3--- is an exempt occasional sale. (Reg. 1595(b)(2).) The contracts transferred to 3--- do not appear relevant to the calculation of the percentage of B--- C---’ property transferred to 3---. It appears that the contracts were obligations to sell tangible personal property but may not have involved the transfer of existing tangible personal property to 3---. It this were the case, the fact that not all contracts were transferred by B--- C--- is not relevant to the analysis. However, if tangible personal property related to these contracts was transferred along with the contracts or retained with respect to those contracts not transferred, then that tangible property would, of course, be relevant to the analysis. For example, government contracts were involved, and it is possible that B--- C--retained certain tangible personal property related to those contracts by virtue of retaining the contracts. The transfer of B--- C---’ patents, trademarks, and other proprietary rights in technologies also does not factor into the calculation of the percentage of tangible personal property transferred to 3--- because these items are intangibles. The assets transferred specifically included all tangible assets of B--- C--- except those assets which could not be transferred without consent of a third party. If the tangible personal property retained by B--- C--- by virtue of the contracts it retained and by virtue of being unable to transfer without the consent of a third party consisted of less than 20% of the tangible personal property it held in the course of activities requiring a seller’s permit, then B--- C---’ sale to 3--- was an exempt occasional sale.

Mr. John Huk

-3-

August 30, 1990
395.1527

In a certificate of ownership and merger dated December 21, 1989 and filed March 30, 1990 with the California Secretary of State, B--- C--- (then under the name of 3--- F--- S---) certified that it merged into 3--- pursuant to section 1110 of the California Corporations Code and section 253 of the Delaware General Corporations Law. We conclude that this was a statutory merger and no sales tax applies to the transfer of any tangible personal property pursuant to that merger. (Reg. 1595(b)(3).) If you have further questions, feel free to write again.

DHL:wak
2419C

395.1527.doc