Was a partnership-to-corporation asset transfer occasional when partners received different stock classes and one also received corporate notes?

Plain-English summary

Two partners doing business as A--- T--- Company had formed a corporation and planned to move their partnership property into it. They divided earnings equally, but the assumed books showed about $75,500 invested for H--- T. N---, Sr. and about $10,000 for H. T. N---, III.

The senior partner would receive $40,000 of corporate notes, $33,000 of preferred-stock equity, and $2,500 of common-stock equity. The junior partner would receive $10,000 of common-stock equity. Note holders did not count as ultimate owners, while partners and stockholders did.

Legal Counsel Herbert L. Cohen concluded that more than 80 percent of real or ultimate ownership remained unchanged under Regulation 1595. Although stock classes, management rights, and profit-sharing rights differed, immediate liquidation would leave the shareholders with substantially similar rights to the value of the transferred tangible personal property.

The conclusion was expressly conditional. An interest nominally held in the senior partner's wife's name had to be proven to be community property or the senior partner's separate property. The source supplies no evidence, ownership calculation, completed transfer, or later outcome.

Marital-property premise, investment and equity figures, liquidation test, and missing record

Cohen responded to W--- S. M--- on February 26, 1975 after a January 6 letter to the San Diego office asked about client A--- T--- Company. The request is absent, and the source gives no representative role, business activity, property, tax period, seller's permit, or transaction date.

The client was a partnership. One partner's interests were nominally held by his wife, R--- N---. Cohen assumed evidence could show that the wife-named partnership interest was either community property or H--- T. N---, Sr.'s separate property and could rebut former Civil Code section 5110's described presumption that property acquired by a married woman through a written instrument was her separate property.

Cohen cited Commerce Clearing House State Tax Reporter, California volume 3, section 60-242.16, dated October 23, 1953, for treating community property held in one spouse's name as having the same ultimate ownership as community property held in both names. The cited reporter material and marital-property evidence are not included. Cohen said the opinion was valid only if the stated ownership was proved.

The letter assumes H--- T. N---, Sr. and H. T. N---, III were the partners, split earnings equally, and had respective book investments of approximately $75,500 and $10,000. It supplies no partnership agreement, capital accounts, contributions, withdrawals, profits, distributions, liabilities, or actual books.

The partners had created a corporation and planned to transfer their partnership-property interests for corporate common stock, preferred stock, and notes. The source does not identify the corporation, property, tangible assets, values, debt, transfer date, agreement beyond saying one existed, consideration mechanics, capitalization, share counts, voting rights, dividends, preferences, conversion or redemption terms, management rights, or profit rights.

The senior partner's stated package totaled $75,500 by face or equity figures: $40,000 notes, $33,000 preferred equity, and $2,500 common equity. The junior partner would receive $10,000 common equity. Those figures mirror the assumed book investments, but the source provides no fair market values or proof that note face amount and stock equity measure comparable economic value.

Sections 6006.5(b) and 6367 and Regulation 1595 supplied the occasional-sale framework. Partners and stockholders were treated as real or ultimate owners; note holders were not. Regulation 1595 required at least 80 percent of ownership to remain unchanged.

Cohen said the property's ownership after transfer was more than 80 percent unchanged, even though part of the senior partner's investment became a note. He acknowledged the quality of ownership was not identical because the senior partner primarily received preferred stock and the junior partner only common stock. He used a hypothetical immediate liquidation: the two shareholders would retain substantially similar rights, compared with their partnership rights, to the transferred tangible property's value. Differences in stock classification, management, and profit sharing therefore did not alter ultimate ownership on the assumed facts.

The PDF provides no numerator, denominator, percentage computation, liquidation waterfall, preferred or common fair values, asset valuation, note value, creditor priority, tax-paid status, or other calculation supporting the stated more than 80% conclusion.

The live annotation preserves the principle that management and profit-and-loss changes alone do not affect ultimate ownership, the immediate-liquidation comparison, substantially similar result, and February 26, 1975 date. It omits the taxpayer, representative and January 6 request; spouse-named interest and mandatory proof condition; former Civil Code presumption and CCH cross-reference; partner names, equal earnings, investments and assumed books; corporation and planned transfer; every note and equity amount; note-holder exclusion; sections 6006.5(b) and 6367; Regulation 1595's 80-percent threshold and staff's conclusion it was met; missing evidence and calculations; and absent transfer or outcome.

The source supplies no response, marital-property proof, partnership or corporate records, asset schedule, executed transfer, stock or notes, return, audit, assessment, payment, refund, administrative action, appeal, or later result.

What this means for you

Partnerships incorporating a business

Under this opinion, compare ultimate property value before and after, including immediate-liquidation rights. Notes were creditor interests rather than ownership, and marital title had to match the claimed economic ownership.

Accountants and tax professionals

Document partnership books, marital-property title, every stock and note term, asset values, creditor priority, and a supported liquidation waterfall. The letter states an 80-percent result but does not show its calculation.

Common questions

Q: Did corporate note holders count as ultimate owners?
A: No. The opinion said partners and stockholders were regarded as ultimate owners, but note holders were not.

Q: Did preferred versus common stock defeat continuity?
A: No. The projected liquidation rights remained substantially similar as to the transferred tangible property's value.

Q: Did management or profit-sharing changes control?
A: No. The opinion did not treat those changes as altering ultimate ownership on these facts.

Q: Was the result unconditional?
A: No. The opinion required evidence supporting its assumption about the true ownership of the interest held in the spouse's name.

Q: Did equal profit sharing mean equal ownership?

A: Not in the letter's value comparison. The partners divided earnings equally, but the assumed books showed investments of about $75,500 and $10,000.

Q: How did staff calculate more than 80-percent continuity?

A: The source states the result and invokes immediate-liquidation rights but supplies no numerator, denominator, percentage, stock valuation, or liquidation schedule.

Q: Were the notes worth $40,000 for ownership purposes?

A: The notes had a stated $40,000 amount but did not count as ownership. The source gives no fair market value or terms.

Q: Did the planned incorporation occur?

A: The source does not say. It supplies no transfer, issued stock or notes, return, audit, assessment, payment, appeal, or later outcome.

Citations and references

• California Revenue and Taxation Code §§ 6006.5(b) and 6367
• California Sales and Use Tax Regulation 1595
• Former California Civil Code § 5110 — marital-property presumption as described in the source
• Commerce Clearing House State Tax Reporter, California volume 3, section 60-242.16 (October 23, 1953) — cited but not included
• January 6, 1975 request and partners' transfer agreement — identified but not included
• Marital-property, partnership, books, capital, asset, valuation, corporate, stock, note, liquidation, transfer, return, tax, audit, assessment, payment, appeal, and outcome records — described or implicated but not included

Verbatim support

From the official February 26, 1975 Herbert L. Cohen letter:

The opinion stated herein is valid only if the partnership interest is shown to be either community property or separate property of H--- T. N---, Sr.

Partners and stockholders are regarded as having the real or ultimate ownership of the property of partnerships and corporations. Note holders are not so considered.

However, if the corporation were to liquidate immediately after transfer of the assets, the ownership rights of the two shareholders would be substantially similar to their ownership rights in the partnership as to the value of the tangible personal property transferred.

The ownership interests are more than 80% unchanged. The transfer is therefore an occasional sale and as such is exempt from tax.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.1650
• Original supporting opinion: 395.1650 PDF

Original ruling text

395.1650
STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION
1020 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)

February 26, 1975

Mr. W--- S. M--P.O. Box XXX
--- ---, Calif. XXXXX

Dear Mr. M---:
Re:

A--- T--- Company
XXXX --- Street
--- ---, California
Account SR – XX-XXXXXX

Your letter dated January 6, 1975, and addressed to our San Diego office has been referred to the undersigned for reply. You inquire as to the application of sales and use tax to a transaction involving your client, A--- T--- Company. You state that your client is a partnership and that the interests of one partner, H--- T. N---, Sr., are “nominally held by his wife”, R--- N---. For purposes of this reply we assume that evidence is available to show that the partnership interest in R---’s name is in fact community property or separate property of H--- T. N---, Sr., and that the presumption created by Civil Code Section 5110, that any interest in property acquired by a married woman by an instrument in writing is her separate property, can be effectively rebutted. For purposes of qualifying as an occasional sale under the Sales and Use Tax Law community property held under the name of one of the spouses is considered to have the same ultimate ownership as community property held under both names (Commerce Clearing House (CCH) State Tax Reporter, California Vol. 3, Section 60-242.16, October 23, 1953). The opinion stated herein is valid only if the partnership interest is shown to be either community property or separate property of H--- T. N---, Sr. As stated above, we assume that H--- T. N---, Sr., and H. T. N---, III, are partners doing business as A--- T--- Company. Earnings are divided equally, however H--- T. N---, Sr., has an investment of approximately $75,500 in the business and H. T. N---, III has an investment of approximately $10,000 in the business. We assume that the books of the partnership show these amounts in the accounts of the two partners. The partners created a corporation and plan to transfer their interests in the property of the partnership to the corporation in exchange for common stock, preferred stock and notes of the

Mr. W--- S. M---

-2-

February 26, 1975
395.1650

corporation. H--- T. N---, Sr., is to receive notes in the amount of $40,000, preferred stock representing $33,000 of owners’ equity in the corporation, and common stock representing $2,500 of owners’ equity in the corporation. H. T. N---, III is to receive common stock representing $10,000 of equity in the corporation. You inquire as to the sales and use tax consequences of the transfer from the partners to the corporation. It is our opinion that this transfer is exempt from sales or use tax. Section 6367 of the Revenue and Taxation Code provides an exemption from sales or use tax for transfers that are occasional sales. Section 6006.5(b) defines an occasional sale as any transfer of all or substantially all the property held or used by a person in the course of activities for which he is required to hold a seller’s permit when after such transfer the real or ultimate ownership of such property is substantially similar to that which existed before such transfer. Partners and stockholders are regarded as having the real or ultimate ownership of the property of partnerships and corporations. Note holders are not so considered. Sales and Use Tax Regulation 1595 interprets “substantially similar” ownership to mean that 80% or more of that ownership is unchanged after the transfer. The agreement between the partners provides for the transfer to the corporation of the partner’s respective partnership assets in exchange for the stock and notes of the corporation. The ownership of the property after the transfer is substantially similar to that prior to the transfer since more than 80% of that ownership is unchanged, even though a part of H--- T. N---’s partnership investment was exchanged for a note of the corporation. The quality of ownership of the property after the transfer is not identical as between the partners because one partner’s interest is manifested primarily in preferred stock of the corporation and the other partner’s interest is manifested solely in common stock. However, if the corporation were to liquidate immediately after transfer of the assets, the ownership rights of the two shareholders would be substantially similar to their ownership rights in the partnership as to the value of the tangible personal property transferred. Therefore, neither the difference in classification of stock nor the changes in management rights or rights to share in the profits are considered to affect the ultimate ownership of the assets of the corporation. The ownership interests are more than 80% unchanged. The transfer is therefore an occasional sale and as such is exempt from tax. If you have any further questions regarding this transfer please contact us again. Very truly yours,

Herbert L. Cohen
Legal Counsel

HLC RW
cc:

--- --- – Principal Auditor (WLW)