Was a partnership's transfer of substantially all business assets to a new corporation exempt even though outside investors bought stock shortly afterward?

Plain-English summary

An individual sold business assets to a limited partnership, which assumed business debt. Associate Tax Counsel John H. Knowles recommended sustaining tax on that retail sale because a limited partner was a separate person under section 6005. The auditor allocated the assumed liability according to the ratio of taxable tangible personal property to total assets; no figures or calculation are supplied.

The limited partnership then transferred substantially all business assets to a commencing corporation for stock. A group of doctors purchased stock for cash several weeks later. The Corporations Commissioner's permit required the partners to receive their stock before any cash stock sale to the doctors.

The recommendation treated the partnership-to-corporation transfer as an exempt occasional sale because substantially all business assets moved and ultimate ownership remained substantially the same at that transfer. Timing alone probably would not establish the exemption, but the regulator-required order supplied a good business reason. Knowles offered a Board hearing or hearing waiver; the source supplies no final action.

Two recommendations, dated wording conflict, live additions, and missing record

The letter concerns redetermination petitions for a sole proprietor whose identity, business, account and permit numbers are redacted. It recommends that tax was properly assessed on the individual's business-asset sale to the limited partnership but improperly assessed on the limited partnership's sale to the commencing corporation. No petition, notice, audit workpaper, assessment, tax period, asset schedule, invoice, entity agreement, closing document, return, payment, or refund record appears.

For the first sale, the partnership's assumption of business indebtedness was consideration. The auditor prorated that liability using taxable tangible personal property over total assets. The source supplies no debt amount, creditor, loan, assumed-liability document, tangible-property value, total-asset value, fraction, tax measure, rate, tax, penalty, or interest.

For the second sale, Board staff said it had examined Corporations Commissioner records in detail. The permit required stock to issue to all limited-partnership owners for the business assets before any cash stock sale to the doctors. Neither the permit, application, Commissioner file, business-purpose evidence, partner list, doctor list, stock authorization, share count, price, subscription, certificate, nor cash record is included.

The source then says The sale to the partnership occurred on December 16, 1961, even though its surrounding analysis concerns stock to limited-partnership owners and its opening separately identifies the earlier individual-to-partnership sale. It says the cash stock sale to doctors occurred January 8, 1962. The record does not resolve whether the December wording refers to the first sale, the partnership asset sale, or the partner stock issuance. This page preserves that ambiguity rather than silently relabeling the event.

Knowles cited historical section 6006(b), with the source's bracketed direction to current section 6006.5(b). He concluded the business-asset sale qualified because substantially all assets were sold while ultimate ownership remained substantially the same. Different timing for stock issuances probably was not enough alone; the permit-required order was the important good business reason.

The live annotation says the procedure was not used to avoid sales tax and did not constitute a step transaction. Those express findings do not appear in the supporting March 1 letter, which states only the required ordering and good business reason. The live entry also prints 3/1/66; 7/28/86; the supporting PDF contains no July 28, 1986 opinion, amendment, author, or explanation. The page therefore uses the formal source-body issue date and reports the unexplained live date separately.

The live entry accurately preserves the partnership-assets-for-stock transaction, section 6006.5(b), contemplated cash stock sale, substantial later ownership change, Commissioner-required sequence, and good-business-reason conclusion. It omits the taxable first sale; section 6005; liability-allocation formula; December 16, 1961 and January 8, 1962 dates; detailed file review; recommendation posture; hearing and waiver option; wording conflict; missing records; and absent final outcome.

What this means for you

Partnerships incorporating before bringing in investors

A later ownership change did not automatically invalidate an earlier qualifying asset contribution when the steps were genuinely separate and the sequence had a regulatory purpose.

Accountants and tax professionals

Test each sale separately, preserve the debt and asset-value ratio, obtain the actual regulatory permit, reconcile every event date and label, document stock issuance and cash-sale timing, and distinguish a staff recommendation from final Board action.

Common questions

Q: Was the individual's transfer to the limited partnership taxable?
A: Yes. The partnership assumed business debt as consideration.

Q: Was the partnership's transfer to the new corporation taxable?
A: No. It transferred substantially all business assets while ownership remained substantially the same.

Q: Why did the later doctor stock purchase not change the result?
A: A regulatory permit required the partners' stock issuance to occur first, providing a good business reason for the order.

Q: Why is the page dated 1966 rather than the annotation's later date?
A: The supporting recommendation is formally dated March 1, 1966. The live annotation adds July 28, 1986, but supplies no corresponding opinion or explanation.

Q: What happened on December 16, 1961?

A: The source says the sale to the partnership occurred then, but the surrounding paragraph concerns the corporation transaction and partner stock. The source does not resolve that wording.

Q: Did the supporting letter expressly find no tax avoidance or no step transaction?

A: No. Those statements appear on the live annotation. The letter says the permit-required sequence supplied a good business reason.

Q: Did the Board adopt the recommendations?

A: The source does not say. It offers a hearing or enclosed waiver forms and provides no later action.

Citations and references

• California Revenue and Taxation Code § 6005
• California Revenue and Taxation Code § 6006(b) (historical), with the source's bracketed direction to § 6006.5(b)
• Corporations Commissioner permit and records — described as examined but not included
• Redetermination petitions, audit, assets, debt, values, liability allocation, permit, stock, cash sale, hearing, waiver, Board action, return, payment, claim, appeal, and outcome records — described or implicated but not included

Verbatim support

From the official March 1, 1966 John H. Knowles recommendation:

It is our recommendation that tax was properly assessed on the sale of the taxpayer’s business assets to the limited partnership but that it was improperly assessed on the sale by the limited partnership to the commencing corporation.

The auditor properly measured the tax by a formula method of prorating the liability assumed by the amount the taxable tangible personal property bore to the total assets.

The fact that the sale and issuance of stock to the two groups occurred at different times probably is not sufficient to establish the exemption by itself.

The important fact is that the transaction took place in this order because of the requirement of the Corporations Commissioner, and this was a good business reason for it.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.1840
• Original supporting opinion: 395.1840 PDF

Original ruling text

STATE OF CALIFORNIA

395.1840

STATE BOARD OF EQUALIZATION

March 1, 1966

Mr. W--- P. C--Attorney at Law
XXX S. --- St., Suite XXX
--- ---, California XXXXX
Dear Mr. C---:
Re:

E--- J. B--E. J. B. E--SR -- XX XXXXXX
SN -- XX XXXXXX

This is to inform you of our recommendation in the matter of the petitions for Redetermination of the above-named taxpayer. It is our recommendation that tax was properly assessed on the sale of the taxpayer’s business assets to the limited partnership but that it was improperly assessed on the sale by the limited partnership to the commencing corporation. A limited partner is a separate person under the Sales and Use Tax Law, (Revenue and Taxation Code Section 6005). The sale by an individual to a limited partnership in consideration of an assumption by the partnership of the business indebtedness constitutes a sale, and since in this case the sale was at retail, it is subject to the sales tax. The auditor properly measured the tax by a formula method of prorating the liability assumed by the amount the taxable tangible personal property bore to the total assets. We have examined, in some detail, the records of the Corporations Commissioner concerning the issuance of stock to members of the limited partnership and to the group of doctors. The permit requires the sale and issuance of stock to all the owners of the limited partnership in consideration of the business assets prior to any sale of stock for cash. The sale to the partnership occurred on December 16, 1961, while the sale of stock to the doctors did not occur until January 8, 1962. This being the case, the sale of business assets comes within Section 6006(b) of the Revenue and Taxation Code [now see §6006.5(b)], and is an exempt occasional sale. It qualifies in that substantially all of the business assets were sold while the ultimate ownership of the assets remained substantially the same. The fact that the sale and issuance of stock to the two groups occurred at different times probably is not sufficient to establish the exemption by itself. The important fact is that the transaction took place in this order because of the requirement of the Corporations Commissioner, and this was a good business reason for it.

Mr. W--- P. C---

-2-

March 1, 1966
395.1840

You are entitled to a Board hearing on your petition for Redetermination of E. J. B. E---, E--- J. B--as sole proprietor. If you disagree with our recommendations and desire a hearing before the Board, it will be granted on request. If you no longer desire the hearing, please sign and return two of the enclosed waiver of Board hearing forms. The third copy is for your file. Very truly yours,

John H. Knowles
Associate Tax Counsel

JHK:md
Enclosure