Was an asset transfer to a wholly owned subsidiary taxable when the parent received cash days later through a joint-venture financing arrangement?

Plain-English summary

A lens and tooling manufacturer transferred capital assets to its wholly owned subsidiary as a stated capital contribution. The subsidiary immediately contributed the assets to a joint venture for a 50-percent interest. Four days after the effective transfer, the venture borrowed against the assets and distributed $225,379.25 to the subsidiary. The subsidiary issued a same-amount check to the parent, and both corporations reduced the parent's recorded investment.

The Appeals recommendation looked at the result, amount, timing, and prearranged financing rather than the capital-contribution, investment, and dividend labels. It concluded that the parent ended with cash, the subsidiary ended with the property, and the joint-venture agreement was structured to make that payment possible. The payment was consideration for the assets.

Because the transfer was for consideration, it was a sale subject to sales tax measured by the price allocated to noninventory tangible personal property. The recommendation called for redetermination under the June 1, 1989 reaudit. The source does not provide a final Board action or later outcome.

Hearing posture, transaction chronology, audit figures, and missing record

Senior Staff Counsel H. L. Cohen signed the Decision and Recommendation on September 16, 1991. The hearing occurred on June 19 of a redacted year in a redacted California location. N--- Corporation did not appear or respond to the hearing notice. Supervising Tax Auditor J. Huk and Tax Auditor G. Ellis appeared for the Sales and Use Tax Department.

The audit period was January 1, 1984 through March 31, 1987. The protested capital-asset item lists $218,318, less an $8,444 reaudit adjustment, for $209,874. A separate summary says the June 1, 1989 reaudit reduced the amount subject to tax by $68,102 to $252,745 and included the protested-item reduction. The PDF does not reconcile the protested measure with the broader reaudit total or supply the rate, tax, interest, penalty, deficiency, or complete reaudit.

On August 25, 1985, then-treasurer F--- L--- obtained a personal loan and paid liabilities tied to the petitioner's capital assets. The petitioner treated that payment as L---'s loan to it, issued him a $100,000 note dated August 28, and paid him $125,379.25 on September 5. The source does not provide the personal-loan agreement, creditor and liability details, note, interest, repayment allocation, or accounting records.

On August 30, the petitioner's directors approved transferring the assets to wholly owned P--- O--- L---, Inc. as capital. The agreement was effective September 1, stated no consideration, and was signed by L--- as chairman of both entities. Both books recorded a $234,437.54 investment. No board minutes, transfer agreement, asset list, valuation, ownership record, or ledger is reproduced.

Effective September 1, P--- contributed the assets to N--- P---, a joint venture, for a 50-percent interest. The other venturer, A--- P---, contributed a line of credit. Quoted section 4.3 of the joint-venture agreement directed the first $228,000 of loan cash secured by assets listed in an absent Exhibit 3.1 to P---. The source does not provide the complete agreement, exhibit, credit line, security instrument, lender, loan amount, or distribution calculation.

On September 5, the venture distributed $225,379.25 of secured-loan proceeds to P---. P--- immediately issued a check in that amount to the petitioner, and both corporations booked it as a reduction of the petitioner's investment in P---.

The auditor classified tooling, machinery, equipment, furniture, and fixtures as taxable; vehicles and leasehold improvements as nontaxable. A 93.12-percent ratio of taxable asset book value to total transferred asset book value was applied to original proceeds rounded to $234,438. The reaudit paragraph says proceeds were corrected to $225,379.75, fifty cents more than each cash distribution and check stated earlier. It gives no asset-by-asset book values, vehicle or improvement basis, allocation workpaper, reason for the fifty-cent difference, or arithmetic reconciliation.

The petitioner contended that the asset transfer was a contribution to capital and the later payment was a nontaxable dividend. Sections 6006 and 6051 supplied the consideration and retail-sales rules. Regulation 1595(b)(4) and cited Annotation 495.0090 addressed transfers to a commencing corporation, while cited Annotation 495.0725 addressed dividends in kind. The current official 495 collection exposes 495.0725 and its supporting PDF but does not expose 495.0090; the latter remains identified here only as the authority cited in this source.

The recommendation says Cal Metal Corp. v. State Board of Equalization was distinguishable, but the PDF prints 161 Cal.App.3d 579. That reporter page resolves within the unrelated Morse Signal Devices of California, Inc. v. County of Los Angeles, while the named Cal-Metal Corp. opinion is reported at 161 Cal. App. 3d 759. This page preserves the source's printed page rather than silently correcting its original text.

Cohen also compared the transaction with Industrial Asphalt, Inc. and Huntrix, Inc. v. State Board of Equalization, Los Angeles Superior Court docket C696414, saying there was no final decision yet but that the Board had applied tax under almost identical conditions. A later reported opinion with the Industrial Asphalt caption appears at 5 Cal. App. 4th 1237 (1992); it is linked only to reconcile the source's pending-case identity and posture, not to import its later holding into this 1991 recommendation.

The September 25 transmittal recommended redetermination without adjustment except for the June 1 reaudit. It gave the petitioner 30 days to request reconsideration with new evidence or contentions, or to request a Board hearing; absent either request, the recommendation would go to the Board for final consideration and action. The PDF supplies no request, Board calendar item, final decision, assessment, payment, refund, judicial appeal, or later result.

The live annotation preserves the related corporations, stated capital contribution and investment entries, immediate 50-percent joint-venture contribution, secured loan, four-day cash return, reduction of investment, consideration conclusion, final cash/property result, taxable-sale conclusion, and noninventory-property measure. It omits the parties and personnel; hearing nonappearance; audit period and all figures; treasurer's personal loan, note, and repayment; dates other than September 16, 1991; signatures and book value; section 4.3 and Exhibit 3.1; asset classes and 93.12-percent ratio; the fifty-cent proceeds conflict; statutes, regulation, annotations, and cases; reaudit recommendation; procedural options; missing records; and absent final outcome.

What this means for you

Businesses moving assets through related entities

Under this recommendation, calling a transfer a capital contribution or the return payment a dividend did not control when coordinated steps delivered cash back to the transferor for the property.

Accountants and tax professionals

Trace the board authorization, transfer agreement, asset values, secured financing, intercompany entries, cash flow, and timing. Reconcile every amount before allocating consideration among taxable and nontaxable property.

Common questions

Q: Why was the transfer treated as a sale?
A: Staff found consideration because the linked steps left the parent with cash and the subsidiary with the property, even though the transfer agreement stated none.

Q: Did recording the transfer as an investment decide the result?
A: No. The recommendation relied on the actual payment and overall transaction.

Q: Why was the dividend argument rejected?
A: The payment closely matched the asset value, followed within days, and was facilitated by the joint-venture financing terms.

Q: Which property did the audit treat as taxable?

A: Tooling, machinery, equipment, furniture, and fixtures. Vehicles and leasehold improvements were classified as nontaxable, producing a stated 93.12-percent taxable ratio.

Q: Was the returned cash $225,379.25 or $225,379.75?

A: The chronology twice uses $225,379.25 for the venture distribution and subsidiary check. The reaudit paragraph instead calls $225,379.75 the corrected proceeds. The source does not resolve the fifty-cent difference.

Q: What audit result was recommended?
A: Redetermination under the June 1, 1989 reaudit, which applied the 93.12-percent ratio to corrected proceeds.

Q: Did that recommendation become the final Board result?

A: The source does not say. The transmittal offered reconsideration or a Board hearing and contemplated later final Board action, but provides no subsequent record.

Q: Is the printed Cal-Metal reporter page reliable?

A: No. The source prints page 579; that page resolves to a different case, while Cal-Metal is reported at page 759. The original text remains unchanged.

Citations and references

• California Revenue and Taxation Code §§ 6006 and 6051
• California Sales and Use Tax Regulation 1595(b)(4)
• California Sales and Use Tax Annotation 495.0090 (April 19, 1967) — cited by the source but not exposed in the current official 495 collection
• California Sales and Use Tax Annotation 495.0725 (July 22, 1976), with official supporting opinion
• Cal Metal Corp. v. State Board of Equalization, 161 Cal.App.3d 579 — citation as printed; named case record at 161 Cal. App. 3d 759 and different case containing reporter page 579
• Industrial Asphalt, Inc. and Huntrix, Inc. v. State Board of Equalization, LASC C696414 — pending-case posture printed in the source; later reported Industrial Asphalt opinion
• August 30, 1985 board action; transfer agreement; Joint Venture Agreement section 4.3 and Exhibit 3.1; personal loan, August 28 note, checks, books, and June 1, 1989 reaudit — described or quoted in part but not reproduced
• Petition, notice, audit workpapers, asset schedules and valuations, allocation, financing and security records, hearing record, reconsideration or Board-hearing request, final Board action, assessment, payment, refund, appeal, and later outcome — absent

Verbatim support

From the official September 16, 1991 H. L. Cohen Decision and Recommendation:

On September 5, 1985 N--- P--- distributed $225,379.25 in cash to P--- pursuant to Section 4.3 of the Joint Venture Agreement. On September 5, 1985 P--- issued a check in the same amount to petitioner. This payment was shown on the books of both entities as a reduction in petitioner’s investment in P---.

The reaudit adjustment corrected the proceeds of the sale to $225,379.75 which reduced the amount subject to tax in the reaudit.

The final result is that petitioner has cash and P--- has the property. The joint venture agreement was structured so that the payment could be made in this fashion. Since there is consideration the transfer was a sale and that sale was subject to sales tax.

Redetermine in accordance with the reaudit report dated June 1, 1989.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.1530
• Original supporting opinion: 395.1530 PDF

Original ruling text

395.1530

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

WILLIAM K. BENNETT
First District, Kentfield

1020 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) 920-7445

BRAD SHERMAN
Second District, Los Angeles
ERNEST J. DRONENBURG, JR.
Third District, San Diego

September 25, 1991

MATTHEW K. FONG
Fourth District, Los Angeles
GRAY DAVIS
Controller, Sacramento

Mr. A--- J---. K---, President
N--- Corporation
XXX E. --- Way
--- ---, CA XXXXX

CINDY RAMBO
Executive Director

Dear Mr. K---:
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 the determination be redetermined without adjustment except as provided in the reaudit report dated June 1, 1989 as explained in the Decision and Recommendation. There are three options available to you at this point. 1. If, after reading the Hearing Decision and Recommendation, you believe that you have new evidence and/or contentions, you should file a Request for Reconsideration. No special form is required to file the Request for Reconsideration, but it must be filed 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. Direct any such request directly to me, with a copy sent to the State Board of Equalization, P.O. Box 942879, Sacramento, CA 94279-0001, Attn: Principal Tax Auditor. 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 you of the procedure you can follow to request an oral hearing before the Board. 2. If, after reading the Hearing Decision and Recommendation, you find that there is no basis for filing a Request for Reconsideration, but nevertheless desire to have an oral hearing before the Board, a written request must be filed within 30 days with Ms. Janice Masterton, Assistant to the Executive Director, Board of Equalization, P.O. Box 942879, Sacramento, CA 94278-0001.

Mr. A--- J--- K---, President
SR -- XX XXXXXX-010

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September 25, 1991
395.1530

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,

H. L. Cohen
Senior Staff Counsel
HLC:te
Enc.
cc:

Ms. Janice Masterton
Assistant to the Executive Director (w/enclosure)
Mr. Glenn Bystrom
Principal Tax Auditor (file attached)
--- ---e – District Administrator (w/enclosure)
Petition Unit (w/enclosure)

STATE OF CALIFORNIA

395.1530
BOARD OF EQUALIZATION
BUSINESS TAXES APPEALS REVIEW SECTION

In the Matter of the Petition
for Redetermination Under the
Sales and Use Tax Law of:
N--- CORPORATION

Petitioner

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DECISION AND RECOMMENDATION

No. SR -- XX XXXXXX-010

The above-referenced matter came on regularly for hearing before H. L. Cohen on June 19, 19XX in --- ---, California. Appearing for Petitioner:

No appearance
(No response to Notice of
Hearing)

Appearing for the
Sales and Use Tax Department:

Mr. J. Huk
Supervising Tax Auditor
--- --- District
Mr. G. Ellis
Tax Auditor
--- --- District
Protested Item

The protested tax liability for the period January 1, 1984 through March 31, 1987 is measured by:

Item
C.

Unreported sales of capital assets
Less reaudit adjustment

State, Local
and County
$ 218,318
8,444
Total $ 209,874

N--- CORPORATION
SR -- XX XXXXXX-010

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September 16, 1991
395.1530

Contentions of Petitioner
Petitioner contends that the transfer of assets to its subsidiary was a contribution of capital and therefore not subject to tax. Summary Petitioner is a corporation which is engaged in the manufacture and sale of lenses. It also makes substantial sales of tooling. The last previous audit was for the period through December 31, 1983. Subsequent to the issuing of the deficiency determination a reaudit was conducted. In a reaudit report dated June 1, 1989 the amount subject to tax was reduced by
$68,102 to $252,745. This included the above noted reduction in the protested item. On August 25, 1985, Mr. F--- L---, then treasurer of petitioner, obtained a personal loan and paid the liabilities related to the capital assets owned by petitioner. This was treated as a loan by L--- to petitioner. Petitioner executed a note dated August 28, 1985 for
$100,000 to Lodato. On September 5, 1985 petitioner issued a check for $125,379.25 to L--- in repayment of the loan. On August 30, 1985, petitioner’s Board of Directors voted to transfer the assets in question to a wholly-owned subsidiary, P--- O--- L---, Inc. (P---), as a contribution to capital. The transfer was to be effective September 1, 1985. The transfer agreement did not mention consideration and was signed by L--- as Chairman of both petitioner and P---. The transfer was shown on the books of both entities as an investment in the amount of $234,437.54. On September 1, 1985, P--- contributed the assets received from petitioner to N--P---, a joint venture, in exchange for 50% interest in the joint venture. The other joint venturer was A--- P---. A--- contributed a line of credit to the joint venture. The Joint Venture Agreement provides in Section 4.3 as follows: “Cash available for distribution arising from any loans to the partnership which are secured by any of the assets described on Exhibit 3.1 shall be distributed as follows: A.

The first $228,000 of such cash shall be distributed to P--and …”

N--- CORPORATION
SR -- XX XXXXXX-010

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September 16, 1991
395.1530

N--- P--- obtained a loan on the assets. On September 5, 1985 N--- P--distributed $225,379.25 in cash to P--- pursuant to Section 4.3 of the Joint Venture Agreement. On September 5, 1985 P--- issued a check in the same amount to petitioner. This payment was shown on the books of both entities as a reduction in petitioner’s investment in P---. The auditor regarded the series of transactions as a sale of assets by petitioner to P---. The auditor calculated a ration of the book value of taxable assets transferred to book value of total assets transfered. Taxable assets were tooling, machinery, equipment, furniture and fixtures. Non-taxable assets were vehicles and leasehold improvements. This ration was 93.12% taxable. This ration was multiplied times the sale proceeds of $234,438 to arive at the taxable amount in the original audit. The reaudit adjustment corrected the proceeds of the sale to
$225,379.75 which reduced the amount subject to tax in the reaudit. Petitioner contends that the transfer of the assets was a contribution to the capital of P--- and that the payment from P--- to petitioner was a dividend which is not subject to tax. Petitioner cited Cal Metal Corp. v. State Board of Equalization, 161 Cal.App.3d 579. Analysis and Conclusions Section 6051 of the Revenue and Taxation Code imposes a sales tax on retailers based on the gross receipts from the retail sale of tangible personal property. Section 6006 defines “sale” to include any transfer of title to or possession of tangible personal property for a consideration. The question here is whether petitioner received consideration for its transfer of assets to Plastar. The transfer of assets to a commencing corporation is not regarded as a sale unless the transferor receives consideration in the form of cash, notes, or an assumption of indebtedness (see Sales and Use Tax Regulation 1595, Subdivision (b)(4)). See also Business Taxes Law Guide [BTLG] Annotation 495.0090, (4/19/67). Similarly, dividends in kind are not regarded as a sale because there is no consideration. See BTLG, Annotation 495.0725 (7/22/76). Here there is no dispute as to the receipt of cash by petitioner from P---. The dispute regards the nature of this payment: was it a dividend or consideration for the property transfered? I conclude that it was consideration for the property transfered. The amount is equivalent to the book value of the property. The payment was made within a few days of the transfer of the property. The final result is that petitioner has cash and P--- has the property. The joint venture agreement was structured so that the payment could be made in this fashion. Since there is consideration the transfer was a sale and that sale was subject to sales tax. The cases cited by petitioner are distinguishable. Both deal with transfers to subsidiaries or partnerships where the transferee assumed liabilities of the transferor as a condition of the transfer of the property. The case here is similar to Industrial Asphalt, Inc. and Huntrix, Inc. v. State Board of Equalization, LASC C696414 in which there is no final decision yet. In that case the Board held that tax applied under almost identical conditions.

N--- CORPORATION
SR -- XX XXXXXX-010

-4-

September 16, 1991
395.1530

Recommendation
Redetermine in accordance with the reaudit report dated June 1, 1989.
__________
H. L. Cohen, Senior Staff Counsel

____
9-16-91
Date