Was a partnership's transfer of assets to a new corporation exempt when outside cash investors reduced the partners' ownership to 25 percent?

Plain-English summary

An existing partnership needed funds. A corporation had been formed, and the plan transferred $15,000 of assets and $8,000 of liabilities to it for $20,000 of stock. The letter says additional stock was for partnership goodwill but supplies no separate goodwill value. The former partners' stock would represent 25 percent of the $80,000 total issue under a permit because cash investors would buy the other $60,000.

The letter concluded that occasional-sale treatment under section 6006.5(b) did not apply. After the complete transaction, the original partners' ownership interest in the business's tangible personal property would fall from 100 percent to 25 percent.

Stock issued by a commencing corporation was not treated as taxable consideration under the letter's historical rule. The corporation's assumption of $8,000 in partnership liabilities was measurable consideration, however, and Tax Counsel E. H. Stetson stated $320 of tax. The source does not state the rate or show the calculation. Notes, cash, or any other consideration would also enter the measure.

Proposed capitalization, goodwill and permit gaps, measure, and missing outcome

The August 13 request is not included, and the addressee appears only as N. The partnership and corporation are unnamed. The source says the existing partnership needed funds but supplies no financial statement, cash-flow record, borrowing attempt, investor solicitation, business description, ownership percentage among partners, or explanation of why incorporation was selected.

The plan used $15,000 of partnership assets, $8,000 of liabilities, and $20,000 of stock. The additional stock was attributed to goodwill. No asset schedule, tangible-property identity or location, valuation, basis, depreciation, goodwill appraisal, liability ledger, creditor, assumption agreement, net-value calculation, purchase or contribution agreement, or closing record appears.

The $20,000 issue to former partners was 25 percent of $80,000 total stock authorized under an unidentified permit. Cash investors would purchase the remaining $60,000. The source gives no permitting agency, permit, stock class, par or fair-market value, share count, subscription, investor identity, cash payment, issuance timing, certificate, shareholder ledger, voting rights, or restriction.

Section 6006.5(b) failed because the complete contemplated transaction reduced the original partners' ultimate interest in the business's tangible personal property from 100 percent to 25 percent. The source does not treat the intermediate moment before investor issuance as controlling or supply a different sequence.

The historical rule treated commencing-corporation stock as no taxable consideration. The assumed $8,000 liability remained the tax measure, producing the letter's stated $320 tax. If the corporation gave notes, cash, or other consideration, those amounts also belonged in the measure. No liability verification, other-consideration search, tax rate, mathematical workpaper, return, payment, audit, assessment, penalty, interest, claim, appeal, or later outcome is included.

The live annotation preserves incorporation, 100-to-25-percent dilution, section 6006.5(b), assets including goodwill, stock, assumed liabilities, tax measure, and date. It omits the funding need; $15,000 assets, $8,000 liabilities, $20,000 partner stock, $80,000 permit total and $60,000 investor cash; stated $320 tax; additional-consideration warning; limited source record; missing permit and valuation evidence; and absence of a completed transaction or later tax outcome.

What this means for you

Partnerships incorporating with new investors

Continuity of ownership can matter. A major outside-investor issuance may prevent an exemption even when the original partners receive stock in the new corporation.

Accountants and tax professionals

Model ownership after the complete linked stock issuance, not only an intermediate step. Preserve the permit, capitalization table, subscriptions, cash receipts, asset and goodwill values, assumed-debt instruments, all other consideration, stock issuance, tax rate and calculation, closing, and actual reporting.

Common questions

Q: What ownership percentage would the former partners retain? A: Twenty-five percent after the full stock issuance.

Q: Why did occasional-sale treatment fail?
A: Their ownership of the tangible business property would be diluted from 100 percent to 25 percent.

Q: Was the new corporation's stock itself treated as taxable consideration? A: No, under the historical commencing-corporation rule described in the letter.

Q: What consideration measured the tax?
A: The $8,000 of partnership liabilities assumed by the corporation, plus any other cash, notes, or consideration if provided.

Q: How much goodwill did the source value?

A: It gives no separate figure. It says additional stock was for goodwill but includes no appraisal or calculation.

Q: What permit authorized the $80,000 total stock issue?

A: The source does not identify or include it.

Q: Does the source show why $8,000 produced $320 of tax?

A: No. It states both numbers but supplies no rate or workpaper.

Q: Did the stock sale and asset transfer occur?

A: The source does not say.

Citations and references

• California Revenue and Taxation Code § 6006.5(b)
• August 13, 1964 request — described but not included
• Partnership, corporation, financing, asset, goodwill, liability, permit, stock, investor, cash, transfer, rate, tax-calculation, return, audit, assessment, payment, claim, appeal, and outcome records — described or implicated but not included

Verbatim support

From the official August 28, 1964 E. H. Stetson opinion:

The $20,000 of stock represents 25 percent of the total stock to be issued under the permit. The other $60,000 of stock will be sold to cash investors.

Since, after the whole transaction is completed, the original partners’ ownership interest in the tangible personal property of the business will have been diluted to a 25 percent interest from their former 100 percent ownership, the transfer is not exempt as an occasional sale under Section 6006.5(b) of the Sales and Use Tax Law.

Since the liabilities assumed are $8,000, the tax would be $320.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.1920
• Original supporting opinion: 395.1920 PDF

Original ruling text

395.1920

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

August 28, 1964

“N”
This is in reply to your letter of August 13 in which you inquire about the sales taxability of the incorporation of a certain partnership. As we understand the facts, your client is an existing partnership in need of funds. You have formed a corporation and would now like to transfer the partnership assets worth $15,000 and liabilities of $8,000 to the corporation in exchange for $20,000 worth of stock. The additional stock is for the goodwill of the partnership. The $20,000 of stock represents 25 percent of the total stock to be issued under the permit. The other $60,000 of stock will be sold to cash investors. Since, after the whole transaction is completed, the original partners’ ownership interest in the tangible personal property of the business will have been diluted to a 25 percent interest from their former 100 percent ownership, the transfer is not exempt as an occasional sale under Section 6006.5(b) of the Sales and Use Tax Law. Because the receipt of stock in a commencing corporation is not regarded as taxable consideration for the transfer, the measure of the tax is, in this case, limited to the amount of the partnership liabilities assumed by the corporation. Since the liabilities assumed are $8,000, the tax would be $320. If the corporation gives any other consideration in exchange for the stock, such as notes or cash, that also would be included in the measure of the tax. We hope this answer is sufficient for your purposes. If it is not, please do not hesitate to write to us again. Very truly yours,

E. H. Stetson
Tax Counsel

PRD:dse

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