Was a parent's transfer of one division to a new subsidiary for initial stock and assumed division liabilities exempt as a commencing-corporation contribution?

Plain-English summary

Corporation S had produced and sold agricultural chemicals through its C Division for years. In 1968 the division became SA Company; late that year SA was organized as a Delaware corporation. Under an S board resolution and bill of sale, all division assets moved to the new corporation for all its authorized capital stock and assumption of division liabilities.

Lawrence A. Augusta recommended denying S's redetermination petition. Section 6006.5(b) required all or substantially all property of the parent, not merely one division's assets. The transaction also was not a statutory merger or consolidation: one corporation divided into two rather than corporations combining into one.

Initial stock of a commencing corporation alone was described as lacking measurable valuable consideration because incorporators set its arbitrary value. Assumed liabilities were different; they supplied measurable consideration, making the partial asset transfer taxable despite ultimate shareholder continuity.

Assessment, separate-entity analysis, merger wording, procedure, and missing record

The internal memorandum went to Board staff member J. D. Dotson before his eastern trip. S's tax-department representative had requested an informal hearing with a hearing officer at the Chicago district office, and Dotson proposed meeting there with local staff. Augusta wrote internally rather than to the taxpayer because of that scheduled meeting.

Augusta called the facts undisputed and the issues clear-cut, but the source does not include S's petition, exhibits, audit, determination, prior legal-staff opinion, correspondence, hearing request, staff policy, meeting notice, transcript, or taxpayer response. He described a legal-staff policy against one hearing officer reversing another staff opinion unless clearly erroneous and said S's next step after Chicago, if disagreement remained, was a Board hearing. No informal hearing, Board hearing or final action is supplied.

The determination assessed tax on the ratable portion of California assets based on liabilities the new corporation assumed. The source gives no asset identity or location, California fraction, liability, creditor, debt document, stock value, total consideration, tax measure, rate, tax, penalty, interest, or payment.

S argued from section 6006.5(b), Regulation 1595(b)(3) governing statutory mergers and consolidations, and Regulation 1595(b)(4) governing commencing corporations. It asserted that assumed liabilities should not be taxed because the parent owned all new-corporation stock and ultimate responsibility remained with the same shareholders.

Augusta rejected the occasional-sale argument because S transferred only some property; all or substantially all of the parent's property would have had to move. He said the first-issue-stock treatment rested not on occasional sale but on no measurable valuable consideration when incorporators place an arbitrary value on new stock. Publicly traded stock and assumed old-corporation liabilities were measurable.

The parent and subsidiary remained separate corporations and separate persons even though the same S shareholders were the real and ultimate owners. Ultimate liability mattered only within the statutory occasional-sale definition. Augusta treated separate entity status as the essence of incorporation.

The transaction divided one corporation into two, while a statutory merger combines corporations into one survivor or new corporation. One sentence prints, no tax liability would arise were this a statutory merger or consideration; the surrounding discussion refers instead to a statutory merger or consolidation. The source does not resolve the apparent word error, so this page does not silently replace it.

Augusta concluded that a taxpayer's ability to avoid tax by selecting another legal arrangement, such as a statutory merger, did not change tax when the taxpayer chose a different form. He said the Board had consistently held similar transactions taxable but cited no ruling, case, or example.

The live annotation preserves the new corporation, stock, assumed parent liabilities, partial-property failure, measurable-consideration result, and date. It calls the transfer one of a corporation's assets rather than identifying the agricultural-chemicals division. It omits the 1968 history; Delaware organization; resolution and bill of sale; assessment and California allocation; redetermination recommendation and hearings; separate-person analysis; first-stock arbitrary-value theory; merger and tax-planning analysis; source wording defect; missing records; and absent final outcome.

What this means for you

Corporations placing divisions into subsidiaries

Moving one division does not necessarily satisfy an all-or-substantially-all test, and liabilities assumed by the new entity can create a taxable measure.

Accountants and tax professionals

Separate initial stock from every assumed liability, identify whose full property pool controls the statutory fraction, document California asset sourcing and the chosen legal form, and do not equate a divisive reorganization with a formal statutory merger or final staff recommendation with a Board decision.

Common questions

Q: Why did the occasional-sale argument fail?
A: The parent transferred only the division's assets, not all or substantially all of the parent's property.

Q: Was initial stock itself measurably valuable under the memorandum's theory?
A: No. Its value was described as arbitrary when fixed by the incorporators.

Q: What supplied measurable consideration?
A: The new corporation's assumption of the parent's division liabilities.

Q: Why was the transaction not a merger?
A: It left two corporations after dividing assets, rather than combining corporations into one survivor.

Q: What had the determination taxed?

A: The ratable portion of California assets based on liabilities assumed. The source gives no inputs or tax amount.

Q: Did common ultimate shareholders erase the separate corporations?

A: No. The memorandum treated parent and subsidiary as separate persons and said ultimate ownership mattered only when the occasional-sale statute applied.

Q: Did the memorandum decide that a Chicago or Board hearing occurred?

A: No. It discusses the proposed informal hearing and possible next Board hearing but supplies neither record nor result.

Q: What does statutory merger or consideration mean in the source?

A: The source does not explain. Its surrounding sentences discuss statutory merger or consolidation; the printed wording remains preserved below.

Citations and references

• California Revenue and Taxation Code § 6006.5(b)
• California Sales and Use Tax Regulation 1595(b)(3) and (b)(4)
• Redetermination petition, prior staff opinion, Chicago informal-hearing request, determination, board resolution, bill of sale, assets, liabilities, stock, values, California allocation, tax calculation, returns, hearings, Board action, payment, claim, appeal, and outcome records — described or implicated but not included

Verbatim support

From the official June 5, 1970 Lawrence A. Augusta memorandum:

It is my recommenation that the petition be denied.

To be an occasional sale, all of the property of “S”, the parent, would have to be transferred to the subsidiary.

Likewise, when liabilities of the old corporation are assumed by the new corporation, there is measurable consideration.

Here we had a single corporation and now have two corporations.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.1880
• Original supporting opinion: 395.1880 PDF

Original ruling text

State of California

Board of Equalization

Memorandum

To:

Mr. J. D. Dotson

From:

Lawrence A. Augusta

395.1880
Date:

June 5, 1970

You requested that I review the petition for redetermination of “S” prior to your trip to the East. Mr. “B” of “S” tax department, in writing the petition, requested an informal hearing with a hearing officer at our Chicago district office. You propose to hold that hearing along with representatives of our Chicago office during your trip. It is my recommenation that the petition be denied. It seems to me, as I will explain hereinafter, that the issues are clear-cut and that there is no dispute as to the facts. I understand it to be the legal staff’s policy that once one member of the legal staff has rendered an opinion on a particular matter, a legal staff hearing officer will not reverse that opinion unless it is clearly erroneous. Consequently, I would say that the next step for “S” after your hearing in Chicago, if they still disagree, is to appear at a Board Hearing. I am stating my opinion in a memo to you rather than a letter to the taxpayer, as would normally be done, because of your scheduled meeting with the taxpayer. As I understand the facts, “S” for some years had been engaged in the production and sale of agricultural chemicals through their “C” Division. In 1968, the “C” Division was renamed the “SA” Company, and in late 1968, the “SA” was organized as a Delaware corporation. By resolution of the board of Directors of “S”, all of the assets of the “SA” were transferred to the new corporation pursuant to a bill of sale. The new corporations transferred to “S” all of their authorized capital stock, and the new corporation assumed the liabilities of “S” identified with the agricultural chemicals division. A determination was issued assessing tax on the ratable portion of California assets based on the amount of the liabilities assumed. Mr. “B” cites Section 6006.5(b) relating to occasional sales; Regulation 1595(b)(3) relating to statutory mergers and consolidations; and Regulation 1595(b)(4) relating to contributions to commencing corporations, and argues that since no tax would be due on an assumption of liabilities in connection with a statutory merger, no tax should be due when an existing corporation incorporates one of its divisions. Referring to Section 6006.5, he argues this should be the result because the ultimate responsibility for payment of the liabilities is unchanged since all the stock of the new corporation is owned by the parent corporation. First, the transfer is not an occasional sale because Section 6006.5(b) defines such a sale as including only transfers of all or substantially all of the property held by a person. To be an occasional sale, all of the property of “S”, the parent, would have to be transferred to the subsidiary.

Mr. J. D. Dotson

-2-

June 5, 1970
395.1880

Further, our position that transfers to a commencing corporation in exchange solely for stock of the new corporation is not based on the theory that it is an occasional sale as “B” assumes. Rather, it is based on the theory that though there is a sale, there is no measurable valuable consideration received since the value of the stock is an arbitrary value placed on it by the incorporators. If the stock is traded on the exchange, as is the case with an existing corporation, there is measurable consideration. Likewise, when liabilities of the old corporation are assumed by the new corporation, there is measurable consideration. Despite the fact that the two “S” corporations are related, and the stockholders of “S” are the real and ultimate owners of “SA” the fact remains they are separate corporations and separate “persons” under the law. In fact, the separate entity is the essence of creating a corporation. Since “S” would undoubtedly assert the entity when it is to their benefit, we will not allow them to deny it here. It is true that no tax liability would arise were this a statutory merger or consideration; however, the fact remains that it is not a statutory merger or consolidation. In point of fact, it seems quite the opposite of a merger as it is a division of an existing corporation. In a statutory merger, one or more corporations combine into a singe corporation, which may have a new name or carry on the name of one of the pre-existing corporations. The new corporation assumes the liablities of the old corporations. Here we had a single corporation and now have two corporations. The old corporation transferred some of its assets to the new corporation. This transfer was a sale, and the consideration received was the first issues of stock and the assumption of liabilities of “SA”. While these are related companies, they are nevertheless separate and distinct corporate entities. While the real or ultimate liability is that of “S” shareholders, that is immaterial under the Sales and Use Tax Law, except where there is an occasional sale as defined under Section 6006.5(b). As a general proposition, the fact that a taxpayer may avoid tax by arranging his affairs in a certain manner, as, for example, by choosing to follow the statutory merger scheme, has no bearing on the application of tax if he does not so arrange his affairs. We have consistently held transactions, such as the one involved here, to be subject to tax. LAA:ph [1b]