Was transferring a manufacturing business to a new wholly owned subsidiary for first-issue stock, then selling the subsidiary's stock, subject to sales tax?

Plain-English summary

An aircraft-hinge manufacturer negotiated a sale of its manufacturing business while retaining real property for lease to the buyer. To address federal employee-notice advice without prematurely disrupting the workforce, it proposed transferring the business assets and employees to a new wholly owned subsidiary, then selling the subsidiary's stock to the unrelated buyer.

The parent would transfer substantially all hinge-business assets, no indebtedness, and receive only 100 percent of the subsidiary's first-issue stock. The letter found both the substantially-similar-ownership exemption and the commencing-corporation stock-only rule applicable.

The later stock sale did not make the asset transfer taxable. The structure also served stated business purposes: labor-law compliance, operational segregation for contingent-price accounting, and limiting the buyer's operating liabilities.

Proposed facts, federal-law rationale, source defects, and missing record

B--- described itself as the world's largest precision aircraft and aerospace hinge manufacturer, serving major airframe and component manufacturers worldwide. It said virtually all hinge acquisitions were for resale, about 80 percent of sales served commercial aircraft and 20 percent military-related aircraft, and it also developed and invested in real estate. These are request facts reproduced by counsel; no customer, sale, invoice, resale certificate, revenue, production, market-share, contract, or business record is included.

The California plant held inventory, machinery, equipment, and tooling, and B--- held a seller's permit for the hinge business. The planned package excluded related real property, which the buyer would lease, but counsel still treated it as substantially all hinge-business assets. No asset schedule, appraisal, lease, title, permit, inventory, machinery, equipment, tooling, value, allocation, or substantially-all calculation appears.

The source's sale sentence lacks a closing parenthesis and reads that the hinge business, other than related real property, which will be leased to K--- for $16.5 million. It does not unambiguously show whether $16.5 million describes the business price, real-property lease, or another term. This page therefore does not repeat the prior unqualified statement that the manufacturing business sold for $16.5 million.

The sale was scheduled by the end of July 19XX, subject to buyer due diligence and other work. B--- expected contingencies to remain until shortly before closing and withheld employee notice because the sale might fail and premature notice could disrupt operations. The source supplies no year completion, contingency list, due-diligence report, notice, employee response, agreement, closing, price, payment, or later outcome.

The request said Hart-Scott-Rodino and Exon-Florio filings affected the sale. It prints the Hart-Scott-Rodino citation as 15 U.S.C.A. §18(a) and identifies Exon-Florio as Defense Production Act section 721. The source contains no agency filing, clearance, investigation, order, or explanation resolving the printed citation. It also summarizes WARN's 60-day notice rule and employee thresholds, but includes no Department of Labor material or independent authority beyond statutory citations.

Labor counsel reportedly advised that an asset sale would trigger an employment loss even if the buyer rehired everyone, while moving assets and employees to a wholly owned subsidiary would not. B--- therefore proposed a closing-date asset transfer with no indebtedness solely for initial subsidiary stock, followed by the stock sale. The labor advice, engagement, employee roster, payroll hours, plant-closing or mass-layoff analysis, notice, and compliance record are absent.

The stock form also segregated operations for post-acquisition profit calculations under contingent-price and consulting provisions and limited K---'s exposure to operating liabilities. No contingent-price term, consulting agreement, accounting method, organizational record, liability schedule, indemnity, or performance record appears.

Assistant Chief Counsel Gary Jugum applied two provisions. Section 6006.5(b) covered substantially all hinge-business assets except real estate because B--- would initially own 100 percent of the subsidiary. Regulation 1595(b)(3), as numbered in the source, covered a commencing entity because the sole consideration was first-issue stock, with no cash, notes, assumed indebtedness, or other benefit. The source gives no stock class, share count, value, certificate, issuance, liability verification, or alternative consideration.

The live annotation preserves the proposed all-assets/no-debt transfer, new subsidiary, stock-only exchange, later stock sale, both exemptions, federal-labor and other purposes, and date. It omits the aircraft-hinge facts; seller's permit and resale profile; retained real property; ambiguous $16.5 million sentence; due-diligence contingency and redacted year; federal citations and labor-counsel premise; 80/20 sales mix; accounting and liability details; missing records; and absence of closing or tax outcome.

What this means for you

Businesses using a new subsidiary in an acquisition

An asset dropdown followed by a stock sale can receive different treatment from a direct asset sale when the dropdown independently satisfies the stock-only and ownership rules.

Accountants and tax professionals

Confirm that no cash, notes, assumed debt, or other consideration enters the dropdown. Preserve asset and real-property schedules, values, seller-permit and resale records, corporate and stock documents, transaction contingencies, federal filings, labor advice, employee-notice analysis, business-purpose evidence, and the actual closing sequence.

Common questions

Q: What did the parent receive for the assets?
A: Only 100 percent of the new subsidiary's first-issue stock.

Q: Did the subsidiary assume the parent's debt?
A: No. The letter expressly states that none of the manufacturing business's indebtedness transferred.

Q: Why was the real estate excluded?
A: The buyer was to lease it; the transferred package still represented substantially all of the hinge manufacturing business for the opinion's analysis.

Q: Did the later sale to an unrelated buyer change the conclusion?
A: No. The legal staff treated the stock sale as compatible with the exemptions under the proposed facts.

Q: Was $16.5 million clearly the hinge-business sale price?

A: No. The source sentence is missing punctuation and associates that figure with the retained real property, its lease, and the business sale without resolving which term it measures.

Q: Was the scheduled closing year disclosed?

A: No. The source prints the expected end-of-July year as 19XX and supplies no completed closing.

Q: Did the source include the federal filings or labor counsel's analysis?

A: No. It reproduces the request's legal account but supplies no filings, advice, agency materials, or employment records.

Q: Did the proposed stock and asset transfers occur?

A: The source does not say.

Citations and references

• California Revenue and Taxation Code § 6006.5(b)
• California Sales and Use Tax Regulation 1595(b)(3), as numbered in the source
• Hart-Scott-Rodino Antitrust Improvements Act citation 15 U.S.C.A. §18(a), as printed without correction
• Exon-Florio Amendment, Defense Production Act § 721, as identified in the source
• Worker Adjustment and Retraining Notification Act, 29 U.S.C. §§ 2101 et seq., including § 2101(a)(1), (2), (3), and (6)
• June 1, 1990 request — described and quoted but not separately included
• Taxpayer, customer, permit, resale, plant, asset, real-property, lease, value, agreement, due-diligence, federal-filing, labor-advice, employee, stock, liability, accounting, closing, return, audit, assessment, payment, claim, appeal, and outcome records — described or implicated but not included

Verbatim support

From the official June 4, 1990 Gary Jugum opinion:

Based on the facts set forth above, it is the opinion of the Board’s legal staff that the proposed transfer of all of the assets and none of the indebtedness of the hinge business operated by B--- to a newly-created subsidiary solely in exchange for the stock of such subsidiary, followed by the sale of such stock to K--- will not be a taxable transaction for purposes of the California Sales and Use Tax Law.

B--- will be receiving no other consideration and the subsidiary will be assuming no indebtedness of B---.

Thus, the proposed structure is supported by substantial and valid business purposes.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.1892
• Original supporting opinion: 395.1892 PDF

Original ruling text

395.1892

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION
1020 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) 445-3723

June 4, 1990
D--- S. B---, Esq.
J---, D---, R--- & P--XXX S. --- Avenue, Suite XXXX
--- ---, CA XXXXX
Re: G. W. B---, Inc., Sales Tax Opinion
Dear Mr. Boyce:
In your June 1, 1990 letter to me, you request a ruling from the Board’s legal staff concerning the application of the California sales and use tax to the proposed transfer of the hinge manufacturing business of G. W. B---, Inc., (“B---”) to a newly-created subsidiary and subsequent sale of the stock of such subsidiary to an unrelated party based on facts described in your letter and as set forth below. FACTS B--- is the world’s largest manufacturer of precision aircraft and aerospace hinges. B---’s customers include all major airframe and many component manufacturers throughout the world. Virtually all acquisitions of hinges from B--- are purchases for resale, and, consequently, are not subject to sales tax. Approximately eighty percent of its sales are for commercial aircraft and twenty percent are for military-related aircraft. In addition to its hinge manufacturing business, B--is a real estate developer and investor. B--- is located in ---, California in a manufacturing plant which houses its inventory, machinery, equipment, and tooling. B--- has a seller’s permit with respect to its hinge manufacturing business. B--- has recently entered negotiations with K--- Industries Inc. (“K---”) with respect to the sale of its hinge manufacturing business (other than related real property, which will be leased to K--- for $16.5 million. The sale is scheduled to occur by the end of July 19XX, but is contingent upon the outcome of due diligence and other work to be done by K---. It is expected that the contingencies will not be removed until very shortly before closing. Pending the removal of contingencies, B--- has chosen not to notify any of its employees of the possible sale. B---’s decision not to notify its employees is based on the business judgment that there is substantial possibility that the sale will not be consummated and that a notice of the proposed sale would unnecessarily disrupt the business operations of B---.

Mr. D--- S. B---, Esq.

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June 4, 1990
395.1892

The proposed sale by B--- is affected by several Federal laws. For example, the sale requires filings to comply with the Hart-Scott-Rodino Antitrust Improvements Act of 1976, 15 U.S.C.A. §18(a), and the Exon-Florio Amendment, Section 721 of Title VII of the Defense Production Act of 1950. In addition, the proposed sale is impacted by the Worker Adjustment and Retraining Notification Act ((“Warn”), 29 U.S.C. §§ 2101, et seq., which requires every “employer” to give at least 60 days advance notice of a “plant closing” or “mass layoff.” For purposes of WARN, an “employer” is a business enterprise, such as B---, that employs 100 or more employees (excluding part-time employees) or 100 or more employees who in the aggregate work at least 4,000 hours per week (exclusive of hours of overtime). 29 U.S.C. § 2101(a)(1). A “plant closing” is the permanent or temporary shutdown of a single site of employment or one or more facilities or operating units within a single site of employment, if the shutdown results in an “employment loss” at the single site of employment during any 30-day period for 50 or more employees excluding any part-time employees. 29 U.S.C. § 2101(a)(2). A “mass layoff” is a reduction in force which is not the result of a plant closing and results in an “employment loss” at the single site of employment during any 30-day period for (1) at least 33% of the employees (excluding any part-time employees) and at least 50 employees (excluding any part-time employees), or (2) at least 500 employees (excluding any part-time employees). 29 U.S.C. § 2101(a)(3). For this purpose, an “employment loss” is an employment termination (other than a discharge for cause, voluntary departure, or retirement), a layoff exceeding 6 months, or a reduction in hours of work of more than 50% during each month of any 6-month period. 29 U.S.C. § 2101(a)(6). B--- has been advised by its labor counsel that the Department of Labor has indicated that a sale of a business, if structured as an asset sale, will be viewed as an “employment loss” triggering notice requirements under WARN notwithstanding the fact that the purchaser will hire all the employees of the business. On the other hand, a transfer of the assets and employees to a whollyowned subsidiary should not be deemed an “employment loss” triggering notice requirements. Consequently, in order for B--- to postpone notification of its employees and still be in compliance with WARN, B--- has structured the sale as a transfer of its assets (and none of its indebtedness) to a newly-created subsidiary on the closing date solely in exchange for the initial issuance of stock by such subsidiary. Thereafter, B--- will sell the stock to K---. Such a sale of stock will also satisfy the requirements of the sale to K--- that the hinge business be physically segregated from the remainder of B---’s operations and operated post-acquisition in a separate legal entity to facilitate calculation of profits for certain contingent price and consulting provisions. In addition, isolation of the hinge business in a separate corporation will provide K--- with a method of limiting its exposure to liabilities of operating the hinge business. OPINION Based on the facts set forth above, it is the opinion of the Board’s legal staff that the proposed transfer of all of the assets and none of the indebtedness of the hinge business operated by B--- to a newly-created subsidiary solely in exchange for the stock of such subsidiary, followed by the sale of such stock to K--- will not be a taxable transaction for purposes of the California Sales and Use Tax Law.

Mr. D--- S. B---, Esq.

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June 4, 1990
395.1892

DISCUSSION
In general, the sale of tangible personal property associated with the business of a retailer for which a seller’s permit is held constitutes a taxable sale for California sales tax purposes. However, among the exceptions to taxable treatment are two provisions which apply to the B--- transaction. Section 6006.5(b) of the California Revenue and Taxation Code exempts 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 the transfer the “real or ultimate ownership” of the property is substantially similar to that which existed before the transfer. In addition Section 1595(b)(3) of the Sales Tax Regulations exempts transfers of property to a commencing corporation in exchange solely for the first issue of stock of the corporation, except to the extent the transferor receives consideration such as cash, notes, or assumption of indebtedness. Each of the foregoing exemptions should apply to the proposed transfer of assets by B--- to a newly-created subsidiary. In the case of the asset transfer by B---, B--- is receiving 100% of the stock of the newly-created subsidiary in exchange for substantially all of its hinge manufacturing business (exclusive only of real property), and consequently, will meet the requirements of Revenue and Taxation Code Section 6006.5(b). In addition, the transfer constitutes a transfer to a commencing entity and the exemption of Sales and Use Tax Regulation Section 1595(b)(3) should apply because the sole consideration being received by B--- will be the stock of the commencing corporation; B--will be receiving no other consideration and the subsidiary will be assuming no indebtedness of B---. Moreover, the transfer to the subsidiary is being undertaken for the valid business purposes of (i) maintaining compliance with federal labor laws in a manner to minimize the potentially disruptive impact on the B--- labor force of premature notice of a possible sale, and (ii) separating the B--- business into a distinct legal entity to facilitate accounting segmentation and to limit K---’s exposure to liabilities. Thus, the proposed structure is supported by substantial and valid business purposes. Under such circumstances, it is clear that the exemptions to the sales tax are applicable and that no sales tax should be owed as a result of the transfer of the hinge business to a commencing corporation followed by the sale of such stock to K---. Please feel free to contact me if you have any questions or would like additional information. Very truly yours,

Gary Jugum
Assistant Chief Counsel