Could first-issued stock remain excluded when a bankrupt company transferred assets to Newco over several weeks before receiving all acquisition shares?

Plain-English summary

NGC proposed transferring assets, including California tangible personal property, to New NGC under a bankruptcy reorganization. In return, New NGC would give common acquisition shares, common-stock warrants, senior notes, assumption of specified NGC obligations, and a commitment to fund an asbestos-claims settlement payment. Because the assets were numerous and dispersed, assignments might begin in the weeks before the prescribed acquisition date.

The letter treated the staggered transfers as part of one integrated bankruptcy reorganization. The plan had court approval, the time between the first transfers and closing was expected to be only a few weeks, and all acquisition shares would issue in one transaction after the transfers were completed.

Under those circumstances, counsel treated the acquisition shares as qualifying first-issue stock and not taxable consideration. The nonstock items still were consideration. Their value had to be allocated by relative fair market value, with both property and consideration totals covering every plan transfer before and at the acquisition.

Formation, nominal capitalization, integration, tax measure, and missing record

New NGC had been incorporated in March 1993 but had issued no shares. Tax Counsel Elizabeth Abreu said delayed stock issuance does not automatically prevent commencing-corporation status; the Board would apply a facts-and-circumstances test when property was later exchanged for stock.

SEC Form 10 or Form S-1 timing might require an audited balance sheet before the acquisition. The request proposed a $1,000 contribution from NGC for 1,000 New NGC shares so an audit could be prepared, with those nominal shares canceled at acquisition. During a June 30 telephone call, the representative said the SEC likely would not require that step. The source contains no SEC demand, filing, balance sheet, contribution, share issuance, cancellation, audit, or later confirmation.

Abreu concluded that even if the nominal shares were issued and canceled as integral plan steps, they would not prevent later acquisition shares from qualifying as first-issue stock. Nor would asset assignments before stock issuance defeat that status if all acquisition shares issued in one transaction after all transfers were complete.

The integration conclusion depended on a single court-approved bankruptcy plan exchanging acquisition shares and other items for all transferred assets, plus an assumed interval of only a few weeks. The request said any early-transferred assets would return to NGC absent favorable federal income-tax rulings. The June 30 call reported a favorable IRS ruling, and the opinion's closing refers to favorable IRS rulings; neither the request, ruling nor rulings are included. No court plan, approval order, transfer list, assignment, return condition, federal-tax analysis, or closing record appears.

The acquisition shares were excluded from taxable consideration, but warrants, senior notes, assumed NGC obligations, and New NGC's asbestos-settlement funding obligation were included. The source supplies no instrument terms, values, liability amounts, settlement agreement, payment amount, beneficiary, or performance record.

The measure was all plan consideration multiplied by the ratio of California tangible personal property other than resale inventory to all transferred property. The letter's hypothetical uses $5 million of consideration, $2 million of relevant California tangible personal property, and $10 million of total property, producing a $1 million measure. These are expressly example figures, not NGC's values. The analysis also assumes no tangible personal property would be brought into California to create use-tax liability.

Because acquisition shares qualified and the IRS had issued favorable rulings, the letter declined to address the representative's last two questions. Their text is absent with the June 8 request. The source also supplies no actual transfer date, June 30 closing, capitalization, issued shares, property or consideration valuation, allocation, return, tax measure, tax paid, audit, assessment, claim, appeal, or later outcome.

The live annotation preserves the integrated court-approved bankruptcy plan, several-week interval, first-issue-stock result, other consideration, section 1595(b)(4), and date. It omits the March incorporation without shares; facts-and-circumstances test; SEC Forms 10 and S-1; possible $1,000 capitalization, 1,000 nominal shares and cancellation; IRS ruling; asset-return condition; one-transaction acquisition-share condition; senior notes and asbestos funding; allocation formula and example; no-property-import assumption; unaddressed questions; missing records; and absent completion or tax outcome.

What this means for you

Businesses with complex closings

Assets need not always move at the exact instant stock is issued, but the steps must form one tightly integrated transaction supported by the governing plan and a short, documented timeline.

Accountants and tax professionals

Preserve the plan, court approval, sequence, stock issuance and cancellation, asset assignments, consideration instruments, locations, fair-market values, resale-inventory exclusion, and source of every ratio input. Do not substitute the opinion's hypothetical figures for transaction values.

Common questions

Q: Why were the early transfers necessary?
A: The company had many assets in different locations and needed several weeks to complete assignments before the prescribed closing date.

Q: What connected the separate transfers?
A: One court-approved bankruptcy plan, a short transfer period, and a single later issuance of all acquisition shares.

Q: Were the acquisition shares taxable consideration?
A: No, under the stated integrated-plan facts they qualified as first-issued stock.

Q: What consideration remained taxable?
A: Warrants, senior notes, assumed obligations, and the settlement-fund payment commitment.

Q: Did forming New NGC in March without shares prevent commencing-corporation status?

A: No. Counsel said a delay in stock issuance called for a facts-and-circumstances test.

Q: What was the proposed nominal-capitalization step?

A: If SEC timing required it, NGC would contribute $1,000 for 1,000 shares, then cancel those shares when the acquisition closed. The June 30 update said that step likely would not be required.

Q: Was the $1 million measure NGC's tax?

A: No. It was a hypothetical calculation using $5 million of consideration, $2 million of California tangible personal property other than resale inventory, and $10 million of all property.

Q: Did the opinion decide every question in the request?

A: No. It expressly left the last two questions unaddressed, and the source does not reproduce them.

Q: Did the acquisition close on June 30 or at another time?

A: The source gives an expected June 30 date but no completed closing or later outcome.

Citations and references

• California Sales and Use Tax Regulation 1595(b)(4)
• June 8, 1993 request and its last two questions — described but not included
• June 30, 1993 telephone update reporting an IRS ruling and likely SEC treatment — described in the opinion
• Bankruptcy plan, court approval, federal ruling, SEC filings, audited balance sheet, assets, valuations, assignments, consideration instruments, liabilities, settlement, capitalization, shares, cancellation, closing, return, audit, assessment, payment, claim, appeal, and outcome records — described or implicated but not included

Verbatim support

From the official July 15, 1993 Elizabeth Abreu opinion:

A corporation may be considered a "commencing corporation" within the meaning of the regulation even though shares of the corporation are not immediately issued upon its formation.

We also assume that the time between the transfer of the first $1,000 and the Acquistion will be short, only a few weeks.

Accordingly, the Acquisition Shares will not be regarded as taxable consideration.

The value of the consideration must also include any consideration given pursuant to the plan.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.1795
• Original supporting opinion: 395.1795 PDF

Original ruling text

395.1795

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

MEMBER
First District

450 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) 324-8208

BRAD SHERMAN
Second District, Los Angeles
ERNEST J. DRONENBURG, JR.
Third District, San Diego
MATTHEW K. FONG
Fourth District, Los Angeles

July 15, 1993

GRAY DAVIS
Controller, Sacramento

BURTON W. OLIVER
Executive Director

Mr. M--- R. F--H---, E---, W--- & M--XXX --- Street
--- ---, CA XXXXX-XXXX

Re:

N--- G--- Company
SY -- XX-XXXXXX

Dear Mr. F---:
This is in response to your letter dated June 8, 1993 regarding the plan of reorganization of N--- G--- C--- ("NGC"). Specifically, you state: "Under the proposed plan of reorganization (the 'Plan'), NGC will transfer certain of its assets (including tangible personal property located in California) to a newly-formed corporation ('New NGC') in exchange for (i) certain shares of New NGC common stock ('Acquisition Stock'), (ii) warrants to purchase additional shares of New NGC common stock, (iii) New NGC senior notes, (iv) the assumption by New NGC of certain of NGC's obligations, and (v) New NGC's obligation to fund a payment to a settlement fund established by NGC for the payment of certain asbestos-related claims made against NGC (the 'Acquisition'). New NGC was incorporated in March 1993, but has issued no shares. It is anticipated that New NGC will be capitalized upon the consummation of the Acquisition, which is expected to occur on or about June 30, 1993, unless (as described below) New NGC is required by the Securities and Exchange Commission (the 'SEC') to be capitalized earlier." You then explain that New NGC may be required to obtain an audited balance sheet in order to comply with SEC filing requirements for the registration statement on Form 10 and for

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the registration statement on Form S-1. Since NGC has no assets and has not issued stock, an audited balance sheet cannot be prepared. You further explain that: "Whether an audited balance sheet is required for the Form 10 or the Form S-1, the only way that New NGC will be able to meet the time constraints under the Plan and the SEC's requirements is to capitalize New NGC with nominal capitalization and issue at least one share of stock before the Acquisition, which will allow Ernst & Young to prepare an audit within this time frame. If such an initial capitalization of New NGC is required, New NGC will be capitalized with
$1,000 contributed by NGC and will issue 1,000 shares of New NGC stock to NGC, with the stock issued to NGC upon the initial capitalization being canceled in connection with the consummation of the Acquisition. "Finally, whether or not it may become necessary to capitalize and issue nominal shares of New NGC for purposes of the Form 10 or Form S-1 before consummation of the Acquisition, in order to complete the Acquisition by the prescribed date it may be necessary as a practical matter (because of the large numbers and different locations of the assets to be transferred) to begin assigning assets to New NGC in the weeks preceding consummation of the Acquisition. If the Internal Revenue Service does not issue favorable rulings with respect to the federal income tax consequences of the Plan, however, any assets transferred to New NGC will be returned to NGC." During our telephone conversation on June 30, 1993, you stated that since you wrote your letter, you have received a favorable ruling from the Internal Revenue Service and you have learned that it is likely that the SEC will not require the $1,000 initial capitalization. Regulation 1595(b)(4) reads: "CONTRIBUTION TO COMMENCING CORPORATION OR COMMENCING PARTNERSHIP. Tax does not apply to a transfer of property to a commencing corporation or commencing partnership in exchange solely for first issue stock of the commencing corporation or an interest in the commencing partnership. Tax does apply, however, if the transferor receives consideration such as cash, notes, or an assumption of indebtedness, and the transfer does not otherwise qualify for exemption. The tax is measured by the amount of such consideration attributable to the tangible personal property transferred." With respect to this regulation and the transactions you describe, you ask for the following opinions:

1. The formation of New NGC in March 1993 without issuance of shares of New
   NGC does not preclude the proposed transfer of assets to New NGC from

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qualifying as a transfer of assets to a "commencing corporation" pursuant to Regulation 1595(b)(4). A corporation may be considered a "commencing corporation" within the meaning of the regulation even though shares of the corporation are not immediately issued upon its formation. Where there is a delay in the issuance of such stock, we will apply a facts and circumstance test to determine whether a corporation is regarded as a "commencing corporation" when it issues stock in exchange for property.

2. The issuance of 1,000 New NGC shares to NGC for $1,000 as an integral step
   in consummation of the Plan (which shares will be canceled, also as part of consummation of the Plan) will not preclude the Acquisition Shares issued in exchange for NGC assets from qualifying as "first issue stock" of New NGC within the meaning of Regulation 1595(b)(4); nor will the transfer of assets to New NGC before actual issuance of the Acquisition Shares affect the qualification of the Acquisition Shares as "first issue of stock" so long as the Acquisition Shares are issued in one transaction after the completion of all transfers; and, accordingly, the value of the Acquisition Shares issued to NGC will not be included in the measure of the sales tax. It is our understanding from your description of the transactions that even though some of the assets will not be transferred simultaneously in exchange for the Acquisition Shares, the transfers of the assets are part of a single, integrated bankruptcy plan of reorganization in which the Acquisition Shares and other items are being exchanged for all of the transferred assets. This plan has been approved by the bankruptcy court. We also assume that the time between the transfer of the first $1,000 and the Acquistion will be short, only a few weeks. Under these circumstances, we will regard the transfers of the assets to New NGC as transfers to a commencing corporation partly in exchange for first issue stock of a commencing corporation. Accordingly, the Acquisition Shares will not be regarded as taxable consideration.
3. The amount of each type of consideration received by NGC from New NGC
   (such as the Acquisition Shares) will be allocated among the assets transferred to New NGC in proportion to those assets' respective fair market value. The total consideration for the property transferred to New NGC will include the warrants, the New NGC senior notes, the assumption by New NGC of certain of NGC's obligations, and New NGC's obligation to fund a payment to a settlement fund. To determine the measure of tax for these sales, you multiply the value of all the consideration given to NGC by the ratio of the total value of the tangible personal property located in California (other than resale inventory) to the total value of all property transferred to New NGC. For example, if the total value of consideration is $5,000,000, the total value of the tangible personal property located in California is $2,000,000, and the total value of all property

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transferred is $10,000,000, the measure of tax is $1,000,000. [$5,000,000 X ($2,000,000/$10,000,000).] We assume, however, that no tangible personal property will be brought into California which would give rise to a use tax liability. The values used must include the values of all of the property transferred pursuant to the plan, including the tangible personal property and other property transferred before the Acquisition and at the time of Acquisition. The value of the consideration must also include any consideration given pursuant to the plan. Since we conclude that the Acquisition Shares qualify as "first issue stock" and since the IRS issued favorable rulings, your last two questions need not be addressed. 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