Could a corporation still be 'commencing' if it was formed months before the reorganization and might issue nominal shares before receiving the assets?

Plain-English summary

NGC proposed transferring assets, including California tangible personal property, to New NGC under a bankruptcy reorganization. New NGC would provide common acquisition shares, common-stock warrants, senior notes, assumption of specified NGC obligations, and a commitment to fund an asbestos-claims settlement payment. New NGC had been incorporated in March 1993 without issuing shares.

The letter said formation without immediate stock issuance did not automatically end commencing-corporation status; the Board would use a facts-and-circumstances test. A possible $1,000 capitalization and 1,000 nominal shares, canceled when the acquisition closed, also would not prevent the later acquisition shares from being first-issued stock.

Because the proposed staggered asset transfers and stock issuance were integral parts of one court-approved plan and counsel assumed only a few weeks between the first $1,000 transfer and acquisition, the acquisition shares would not be taxable consideration. Other consideration—warrants, notes, assumed obligations, and the settlement-fund commitment—had to be allocated across all transferred assets by fair market value.

Facts-and-circumstances rule, conditional plan, duplicate opinion, and missing record

Tax Counsel Elizabeth Abreu said a corporation may remain commencing even when shares do not issue immediately upon formation. A delayed issuance triggers a facts-and-circumstances test at the time stock is issued for property. The source provides no general safe harbor, maximum delay, completed formation, or final status beyond its transaction-specific conditional analysis.

SEC Form 10 or Form S-1 requirements might have demanded an audited balance sheet before acquisition. The proposed workaround was a $1,000 NGC contribution for 1,000 New NGC shares, with those shares canceled at acquisition. A June 30 telephone update reported that the SEC likely would not require the step. No SEC request, filing, audited balance sheet, contribution, stock certificate, cancellation, or later determination appears.

One sentence says Since NGC has no assets and has not issued stock, even though NGC is elsewhere described as transferring many assets and New NGC as the formed corporation without issued shares. The source does not resolve whether NGC there is a referent error for New NGC; this page preserves the wording conflict and does not use it to assert that the transferor lacked assets.

Abreu concluded that an integral nominal issue and cancellation would not prevent later acquisition shares from being first-issue stock. Pre-issuance asset assignments also would not defeat the result if all acquisition shares issued in one transaction after all transfers. The source gives no assignment dates, assets, stock issue, cancellation, or closing.

The integration analysis depended on one court-approved bankruptcy plan exchanging shares and other items for all transferred assets and an assumed interval of only a few weeks. Early assets would return to NGC absent favorable federal income-tax rulings. The June 30 update reported a favorable IRS ruling; the close refers to favorable IRS rulings. No request, ruling, plan, approval order, return condition, transfer record, or federal-tax analysis is included.

Only the acquisition shares were excluded from consideration. Warrants, senior notes, assumed NGC obligations, and the asbestos-settlement funding obligation remained. The letter allocated all consideration among assets by relative fair market value and measured tax by all plan consideration times California tangible personal property other than resale inventory divided by all transferred property. Its $5 million, $2 million, and $10 million example produces a $1 million measure; those are hypothetical figures, not NGC's values. Counsel also assumed no tangible personal property would be brought into California to create use tax.

The letter declined to address the last two request questions because it found first-issue status and favorable IRS rulings. Their text is absent. The source also supplies no actual capitalization, transfer, acquisition, allocation, tax calculation, return, payment, audit, assessment, claim, appeal, or outcome.

CDTFA publishes this complete opinion at both 395.1841 and 395.1795. Fresh text extraction differs only in the four annotation-number stamps. The 395.1841 live entry publishes only the delayed-issuance facts-and-circumstances rule. It omits every transaction fact and conditional result; Regulation 1595(b)(4)'s full rule; nominal capitalization; SEC and IRS developments; integrated plan; consideration and allocation; internal wording conflict; unaddressed questions; duplicate publication; missing records; and absent outcome.

What this means for you

Companies forming an acquisition entity

Commencing-corporation treatment can survive a brief pre-closing period and nominal capitalization when the steps are integrated and the facts support one formation transaction.

Accountants and tax professionals

Document the entire formation timeline and facts supporting commencing status. Do not exclude nonstock consideration: value warrants, notes, liabilities, and funding commitments, include every plan asset and item, and preserve the California noninventory tangible-property ratio and no-import assumption.

Common questions

Q: Did incorporation months before closing automatically disqualify Newco?
A: No. The Board said delayed stock issuance required a facts-and-circumstances analysis.

Q: What about the possible $1,000 initial capitalization?
A: The nominal shares would not prevent later acquisition shares from qualifying because they were an integral short-term step and would be canceled at closing.

Q: Was all consideration excluded?
A: No. Only qualifying first-issued stock was excluded; warrants, senior notes, assumed obligations, and the settlement-fund commitment remained consideration.

Q: How was the taxable measure determined?
A: By allocating total taxable consideration based on California noninventory tangible property's fair-market-value share of all transferred property.

Q: Was the nominal $1,000 capitalization actually required or completed?

A: The June 30 update said the SEC likely would not require it. The source supplies no completed capitalization or share issuance.

Q: Why does one sentence say NGC had no assets?

A: The source does not explain. That conflicts with its description of NGC as the asset transferor and likely intended New NGC, but the official text is preserved rather than corrected.

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

A: No. It was a mathematical example using hypothetical $5 million, $2 million, and $10 million values.

Q: Is this the same opinion used for Annotation 395.1795?

A: Yes. CDTFA publishes separate PDFs whose extracted text changes only the 395.1841 and 395.1795 stamps.

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
• Separate official publication as Annotation 395.1795
• Bankruptcy plan, court approval, IRS ruling, SEC filings, audit, assets, values, assignments, consideration instruments, liabilities, settlement, capitalization, shares, cancellation, closing, return, tax, 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.

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.

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 395.1841
• Original supporting opinion: 395.1841 PDF

Original ruling text

395.1841

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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395.1841

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