Did a sole proprietor's asset contribution qualify as occasional when a creditor also received half the new corporation's stock and both parties received notes?

Plain-English summary

In an absent December 17 request, advisers proposed that A--- contribute all assets and liabilities of A---'s sole-proprietor retail business to a new corporation. B--- would contribute notes and accounts payable that A--- owed B---. Each party would receive 200 shares of $50 par-value stock and five $2,000 corporate notes due at variable times.

Associate Tax Counsel J. J. Delaney concluded the transfer would not qualify as an occasional sale under section 6006.5(b). He expressly presumed A--- and B--- would be the only shareholders. On that assumption, A---'s ownership interest in the transferred tangible personal property would fall from 100 percent to 50 percent. That substantial change defeated the exemption even if the notes were treated as an ownership interest.

The letter separately offered general information on bonds. It distinguished a bond representing corporate ownership from an ordinary creditor claim and listed features staff associated with bond treatment. It treated the proposed notes as nonownership consideration.

Counsel nevertheless said the proposed transfer would be only partly taxable under an uncited administrative exemption for property contributed to a commencing entity solely for an ownership interest. His formula divided consideration other than shares by total consideration, then multiplied that ratio by the taxable assets' sales price. If stock replaced A---'s $10,000 of notes, only liabilities assumed by the corporation would remain in the numerator. The source supplies no completed transaction, inputs, calculation, tax, or later outcome.

Proposed structure, ownership assumption, bond discussion, allocation, and missing record

Delaney sent the December 23, 1959 letter to redacted addressees, for the attention of a redacted person. It responds to their December 17 ruling request and later calls A--- your client. The request, adviser identities, client engagement, and enclosed pamphlet copy of the Sales and Use Tax Law are not included.

The proposal had two contributors. A--- would move every asset and liability of a sole-proprietor retail business. B--- would contribute A---'s notes and accounts payable owed to B---. The source does not identify the business, property, inventory, debt, creditors, locations, values, tax-paid status, or how contributing obligations owed to B--- would be documented or extinguished.

Each party would receive 200 shares of stock with $50 par value and five corporate notes of $2,000 each. Thus, the face figures stated for each party were $10,000 of stock par value and $10,000 of notes. The source does not provide fair market value, issue price, voting or economic rights, maturity dates beyond variable times, interest, security, transfer terms, or capitalization records.

The occasional-sale conclusion rested on an express factual presumption: A--- and B--- would be the only shareholders. Before the transfer A--- held 100 percent of the tangible personal property; afterward A--- would hold a 50-percent corporate interest. Delaney called that a substantial ownership change. He said the same result followed even if the notes represented ownership, so the bond question did not decide section 6006.5(b) on these facts.

For general information, Delaney described an ownership-type bond as distinct from a creditor-debtor instrument. His feature list included serial form, attached interest coupons, payment at a date certain, registrability, ready transferability, optional stock conversion, acceleration after default, and a lien on corporate property superior to prior and later creditor claims. The rendered PDF visibly says the security must be kept in provisions which provide for acceleration; the live annotation restates that item as containing certain acceleration provisions. The page preserves the source wording rather than silently rewriting it.

Delaney said an instrument without its own superior lien would probably be considered a debenture similar to notes ordinarily issued to general creditors. He then treated the proposed corporate notes as not representing an ownership interest. The source provides no indenture, note form, coupon, registration, transfer, conversion, acceleration, lien, priority, or creditor record supporting that characterization.

The uncited administrative commencing-entity rule excluded property contributed solely for ownership interests, but other consideration formed the sales-tax measure. The letter prints the formula as Consideration other than shares / Total consideration × the sales price of taxable assets = taxable measure. It does not define every denominator component or supply any asset sales price, liability amount, numerator, denominator, ratio, rate, jurisdiction, or tax.

The final hypothetical says the above remarks would apply if A--- and B--- received corporate stock instead of serial notes, but A---'s measure would fall because converting A---'s five notes into $10,000 of additional stock would remove that amount from the numerator. Only liabilities assumed by the corporation would remain there. The letter does not quantify those liabilities or explain B---'s corresponding instrument replacement beyond the plural premise.

The source uses future-tense proposal language throughout and invites correction if counsel misunderstood. It supplies no response, revised facts, executed formation, transfer, stock or notes, return, audit, determination, assessment, payment, refund, administrative action, appeal, or later outcome.

The live annotation preserves only the bond-versus-creditor distinction and staff's feature list, plus the December 23, 1959 date. It omits the request, parties, proposed incorporation, sole proprietorship, assets and liabilities, equal shares and notes, express sole-shareholder assumption, 100-to-50-percent ownership change, denial of section 6006.5(b), general-information limitation, proposed notes' actual classification, administrative exemption, allocation formula, stock-replacement hypothetical, assumed liabilities, qualified invitation, missing records, and absent outcome.

What this means for you

Sole proprietors incorporating with another owner

Under this letter, equal issuances to a second contributor reduced the sole proprietor's ownership from 100 to 50 percent and defeated the historical continuity requirement.

Accountants and tax professionals

Verify the shareholders, voting and economic interests, instrument terms, assumed liabilities, asset values, and every formula input. Do not apply this historical bond checklist or allocation method without current authority.

Common questions

Q: What ownership did Party A retain?
A: Fifty percent on counsel's express assumption that A--- and B--- would be the only shareholders, down from A---'s full ownership of the transferred tangible property.

Q: Did the bond definition decide the exemption?
A: No. The ownership dilution defeated it either way.

Q: How were the five notes treated?
A: As creditor claims rather than ownership interests.

Q: What measured the partially taxable transfer?
A: The ratio of nonshare consideration to total consideration, applied to the taxable assets' sales price.

Q: Did the source provide the formula inputs or tax due?

A: No. It states stock par values and note face values but gives no asset sales price, liabilities, total consideration, ratio, rate, jurisdiction, or computed tax.

Q: Was the five-note package worth $10,000?

A: Its stated face amount was $10,000 for each party—five $2,000 notes—but the source gives no fair market value or terms sufficient to value the notes.

Q: Did the proposed transfer occur?

A: The source does not say. It gives prospective advice and supplies no execution, return, audit, assessment, payment, appeal, or outcome.

Citations and references

• California Revenue and Taxation Code § 6006.5(b)
• Administrative exemption for property contributed to a commencing entity solely for an ownership interest — described but not otherwise cited in the source
• December 17 ruling request and enclosed Sales and Use Tax Law pamphlet — identified but not included
• Business, entity, shareholder, asset, liability, note, bond, stock, valuation, transfer, capitalization, return, tax, audit, assessment, payment, appeal, and outcome records — described or implicated but not included

Verbatim support

From the official December 23, 1959 J. J. Delaney letter:

In arriving at this conclusion, we presume that “A” and “B” will be the sole shareholders in the new corporation. If this is the case, “A’s” former ownership interest of 100% in the tangible personal property transferred to the corporation will be reduced to a 50% interest.

Here, however, the answer to this question is of no assistance in determining if the occasional sale exemption applies since, even if they do represent an ownership interest, a substantial change in ownership will occur as stated above.

Consideration other than shares / Total consideration X the sales price of taxable assets = taxable measure.

The result would be that only the liabilities assumed by the corporation would be included in the above-mentioned formula.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.1560
• Original supporting opinion: 395.1560 PDF

Original ruling text

395.1560
December 23, 1959
--- --- ----- --- ----- --- --Attention: Mr. --- --Gentlemen: Your letter of December 17 requested a ruling on the following factual situation. Party “A” is to contribute to a new corporation all of the assets and liabilities of his sole-proprietor retail business. Party “B” is to contribute notes and accounts payable due him by party “A”. In exchange for these contributions, each party shall receive 200 shares of $50.00 par value capital stock and five $2,000.00 notes due at variable times. It is our opinion that the transfer by “A” does not qualify as an exempt occasional sale under part (b) of Section 6006.5 of the Sales and Use Tax Law, pamphlet copy enclosed. In arriving at this conclusion, we presume that “A” and “B” will be the sole shareholders in the new corporation. If this is the case, “A’s” former ownership interest of 100% in the tangible personal property transferred to the corporation will be reduced to a 50% interest. The question of whether the notes to be issued constitute “bonds” or “an interest in the corporation” as mentioned in Section 6006.5 might be important under different factual situations. Here, however, the answer to this question is of no assistance in determining if the occasional sale exemption applies since, even if they do represent an ownership interest, a substantial change in ownership will occur as stated above. For your general information, it is our opinion that the reference to bonds in the occasional sale exemption means bonds of the type which will be an ownership interest in a corporation rather than merely a creditor-debtor relationship. In order that any security qualify as a bond for sales tax purposes it must be issued in serial form with interest coupons attached, payable at a date certain, registerable, readily transferable, convertible to stock if desired, and kept in provisions which provide for acceleration of payment in case of default. A “bond” which does not under its own term create a lien against corporate property superior to prior and subsequent creditor’s claims would probably be considered debentures similar to notes ordinarily issued general creditors. Even though the occasional sale exemption is not applicable, we believe that “A’s” transfer is only partially taxable. As you are probably aware, there is an administrative exemption for property contributed to a commencing entity solely in exchange for an ownership interest therein. However, any consideration tendered the transferor of the property except an ownership interest therein will constitute the measure of his sales tax liability. Being that the notes tendered by the corporation do not

395.1560
represent an ownership interest in the corporation, we believe that your client’s tax liability should be computed by use of the following formula: Consideration other than shares Total consideration

X the sales price of taxable assets = taxable measure.

The above remarks would apply even if “A” and “B” were to receive corporate stock instead of serial notes. However, the measure of “A’s” tax liability would be reduced since the $10,000.00 notes would then be converted to an additional $10,000.00 in stock and would not be included in computing the taxable measure. The result would be that only the liabilities assumed by the corporation would be included in the abovementioned formula. We trust that this answers your question. If we have misinterpreted your situation or can be of any additional service, please so inform us. Very truly yours,

J. J. Delaney
Associate Tax Counsel