Were two contractors' asset transfers to a new joint venture exempt when liabilities moved and their overlapping owners held different post-transfer interests?

Plain-English summary

Two California construction corporations proposed contributing substantially all assets and liabilities, except Corporation A's real estate, to a new joint venture. A would receive an assumed 75-percent venture interest and B 25 percent, based on stated net property-and-debt values of $3 million and $1 million. Shareholder 1 owned all of A and 60 percent of B; shareholders 2 and 3 each owned 20 percent of B.

Staff first explained that liabilities are consideration. Tangible personal property transferred subject to any liability, including debt secured by real property, is a sale unless another exemption applies. If taxable, the measure includes all consideration, not only assumed liabilities.

Retaining real property did not prevent Corporation A from transferring substantially all relevant property. The 80% scope test under Regulation 1595(b)(2) concerned tangible personal property held or used in seller-permit activities and excluded real estate.

Ownership continuity had to be tested separately for each transferor. Corporation A's transfer qualified because 90 percent of ultimate ownership remained common after the transfer. Corporation B's transfer did not: only 70 percent remained common, below the 80-percent threshold. A's tangible-property transfer was therefore exempt, while B's was taxable—not taxable at 70 percent.

General-comment posture, property and liability rules, ownership math, and missing record

Corporation A had existed about 40 years, owned real and tangible property, operated as a California general engineering contractor, and held a required seller's permit. Corporation B was incorporated March 23, 1998, operated the same kind of California business, held a required seller's permit, owned tangible property, and had no real property. The source supplies no articles, permits, contracts, customers, construction projects, asset schedules, values, locations, returns, or business histories.

For unspecified valid business reasons, both corporations would continue their construction operations in a joint venture. Each would receive interests in capital and profits or losses, but the income/loss allocation was still undetermined and would depend on factors mostly unrelated to contributed value. The requester believed that allocation would not affect tax. The source does not decide that point or supply the venture agreement, factors, percentages, governance, distributions, or business reasons.

The $3 million and $1 million were described net values of tangible personal property and indebtedness, not gross asset appraisals. Those amounts produced an assumed 75/25 capital split. No property value, debt amount, creditor, lien, assumption agreement, appraisal, denominator, final value, or closing adjustment appears.

A transfer to a commencing venture solely for an interest was not a sale. Regulation 1595(b)(4) made any assumption of debt a consideration even if the transferor retained joint liability. Regulation 1595(b)(1) included cash, notes, property, and any assumed indebtedness, regardless of whether it arose from tangible property, other property, or both. Real-estate-secured debt counted. If no exemption applied, Regulation 1595(b)(4) allocated all consideration by tangible property sold for use rather than resale over all transferred property. The source supplies no actual consideration or tax measure.

Retaining A's real property did not defeat substantially all. Regulation 1595(b)(2) defined the pool as 80 percent or more of tangible personal property held or used in permit-requiring activities, including out-of-state tangible property but excluding real property. Regulation 1595(c) carried that scope and ownership rule into the relevant analysis. No 80-percent asset calculation is supplied, although counsel accepted that each corporation transferred all or substantially all tangible property.

Shareholder 1's post-transfer property interest was 90 percent: 100 percent of A times A's 75-percent venture interest, plus 60 percent of B times B's 25-percent interest, or 75 plus 15. Shareholders 2 and 3 each held five percent through B. The request incorrectly reasoned that B's owners collectively remained at 100 percent by looking only through B and also printed Section 1565(b)(2); the opinion uses Regulation 1595(b)(2) and compares each transferor's owners with the entire transferee.

For A, only shareholder 1's common interest counted: 100 percent before and 90 percent after, yielding 90 percent. For B, the common amounts were shareholder 1's 60 percent plus five percent each for shareholders 2 and 3, totaling 70 percent. Counsel also quoted the regulation's 86 2/3-percent example and gave a 100-transferor hypothetical showing that equal post-transfer interests do not preserve a transferor's former 100-percent ownership.

Because A exceeded 80 percent, sections 6006.5(b), 6367 and 6281 exempted its tangible-property transfer. B's 70 percent failed and its transfer was taxable. The source does not identify any vehicle, vessel or aircraft, actual asset, transfer date, invoice, return, rate, tax measure, tax payment, audit, assessment, claim, appeal, or later outcome.

The taxpayer was unidentified. Counsel said the letter was not specific written advice, was not a Board opinion, and did not qualify under section 6596. Section 6596 and Regulation 1705 were said to be attached, but the official PDF includes no attachments.

The live annotation publishes the shareholder percentages, assumed 75/25 venture split, 90/5/5 post-transfer interests, transferor tables, 90-percent exemption and 70-percent failure. It calls the $3 million and $1 million contributions assets, while the source calls them net values of tangible property and indebtedness. It also adds (2000–2) without a supporting amendment in the PDF. It omits the reliance denial; contractors, dates and permits; retained real estate; undetermined profit/loss allocation; debt and allocation rules; regulatory examples and requester error; missing attachments and records; and absent outcome.

What this means for you

Businesses forming a joint venture

Do not combine all owners and assets into one continuity calculation. Each contributing entity must independently satisfy the 80% property and ownership tests.

Companies retaining land or buildings

Retained real estate did not count against the historical substantially-all test, which measured tangible personal property used in permit-requiring activities.

Accountants and tax professionals

Trace each transferor's owners into the entire transferee and sum only common interests. Separately document the 80-percent property pool, out-of-state assets, retained real estate, venture capital and profit/loss rights, every assumed liability, all consideration, use-versus-resale allocation, actual transfers, and tax reporting.

Common questions

Q: Did transferring debt automatically make the contributions taxable?

A: It made each contribution a sale, but a sale could still qualify for a separate occasional-sale exemption.

Q: Did Corporation A's retained real estate defeat the exemption?

A: No. The regulation's substantially-all calculation excluded real property.

Q: Why was Corporation A's transfer exempt?

A: Staff calculated that 90% of ultimate ownership remained unchanged, exceeding the 80% threshold.

Q: Why was Corporation B's transfer taxable?

A: Only 70% of ultimate ownership remained unchanged after B exchanged its property for a 25% venture interest.

Q: Does 70 percent describe a tax rate or taxable percentage?

A: No. It is the common-ownership result. Because it fell below 80 percent, B's entire described transfer failed that exemption; the source gives no tax amount.

Q: Why was the requester's 100-percent analysis wrong?

A: It looked only through B's same shareholders. The regulation compares each transferor's pre-transfer ownership with each owner's interest in the whole joint venture.

Q: Were $3 million and $1 million gross asset values?

A: The source calls them net values of tangible personal property and indebtedness and supplies no gross assets or liability amounts.

Q: Did profit-and-loss percentages match 75/25?

A: The source says they were not yet determined and does not decide whether a different allocation would affect the result.

Q: Could the taxpayer rely under section 6596?

A: No. The client was unidentified and the letter expressly says it offers general comments, not specific written advice or a Board opinion.

Q: Did the transfers and tax outcome occur?

A: The source does not say.

Q: Could the unidentified taxpayer claim section 6596 reliance relief?

A: No. The letter said the unidentified request produced general comments, not specific written advice under section 6596.

Citations and references

• California Revenue and Taxation Code §§ 6006(a), 6006.5(b), 6051, 6201, 6281, 6367, 6401, and 6596
• California Sales and Use Tax Regulations 1595(b)(1), 1595(b)(2), 1595(b)(4), 1595(c), and 1705
• Request-printed Section 1565(b)(2), corrected within the opinion's analysis to Regulation 1595(b)(2)
• May 3, 1999 request and stated section 6596 and Regulation 1705 attachments — described but not included
• Taxpayer, corporations, permits, venture, profit/loss allocation, business purpose, assets, out-of-state property, real estate, values, liabilities, consideration, computations, transfers, returns, audit, assessment, payment, claim, appeal, and outcome records — described or implicated but not included

Verbatim support

From the official August 6, 1999 Janice L. Thurston comment letter:

Since you did not identify the taxpayer, this letter does not constitute specific written advice to the taxpayer and does not come within the provisions of Revenue and Taxation Code section 6596.

As you can see, the analysis required by 1595(b)(2) is on a transferor by transferor basis, not on a shareholder by shareholder basis.

Corporation A’s transfer of tangible personal property to the joint venture would not be subject to tax.

The real or ultimate ownership of the property that corporation B transferred to the joint venture is not substantially similar to that which existed before the transfer, and corporation B’s transfer of tangible personal property to the joint venture would be subject to tax.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.2025
• Original supporting opinion: 395.2025 PDF

Original ruling text

395.2025

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

JOHAN KLEHS
First District, Hayward

LEGAL DIVISION (MIC:82)
450 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0082)
Telephone: (916) 324-2588
FAX: (916) 323-3387

DEAN F. ANDAL
Second District, Stockton
CLAUDE PARRISH
Third District, Torrance
JOHN CHIANG
Fourth District, Los Angeles
KATHLEEN CONNELL
Controller, Sacramento
_______

August 6, 1999

E. L. SORENSEN, JR.
Executive Director

--Re:

Unidentified Taxpayer

Dear Mr. ---:
This letter is in response to your letter of May 3, 1999 requesting an opinion from the Board of Equalization as to whether or not proposed transfers of assets are subject to the California sales tax. We apologize for the delay in our response. Our understanding of the transaction you pose in your letter may be summarized as follows: 1.

Corporation A, a California corporation that has been in existence for about forty years, is a general engineering construction contractor operating in the State of California, which is required to and does hold a seller’s permit from the Board. Corporation A is owned 100% by shareholder #1. Corporation A owns real property and tangible personal property.

2.

Corporation B, incorporated on March 23, 1998 in the State of California, is also a general engineering construction contractor operating in the State of California, which is required to and does hold a seller’s permit from the Board. Corporation B is owned 60% by shareholder #1, 20% by shareholder #2 and 20% by shareholder #3. Corporation B owns tangible personal property, but owns no real property.

3.

For valid business reasons, corporation A and corporation B desire to form a joint venture and continue the construction operations of both corporations within the joint venture. To accomplish this, substantially all of the assets and liabilities of each corporation, excluding the real property owned by corporation A, are to be transferred to the joint venture. In exchange, each corporation will receive an interest in the capital and in the profits or losses of the joint venture

Mr. ---

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August 6, 1999
395.2025

4.

Each corporation’s percentage ownership of the total initial capital of the joint venture will be based on the ratio of the final value of the net assets contributed by each respective corporation to the total value of the net assets contributed by both corporations. As we understand your example, corporation A will transfer tangible personal property and indebtedness with a net value of $3,000,000 and corporation B will transfer tangible personal property and indebtedness with a net value of $1,000,000.

5.

The allocation of the net income or loss of each corporation has yet to be determined and will be based on a number of factors, most of which are unrelated to the value of the contributed property. However, you do not believe the issue of the percentage allocation of profits and losses will impact the ultimate determination of whether or not this proposed transaction is subject to sales tax.

6.

Based on the above, we assume that corporation A has 75% interest in the joint venture and corporation B has 25% interest in the joint venture.

You believe that corporation A’s transfer of tangible personal property to the joint venture is not subject to tax because corporation A transferred substantially all its tangible personal property without a substantial change in ownership. You believe the same with respect to corporation B, and in your letter you state: “Turning to corporation B, the stock ownership is not as simple as corporation A, but we believe the end result will be the same as corporation A. By applying the exact same rules to corporation B, here’s the results. Corporation B transferred tangible personal property with a fair value of $1,000,000. In exchange, corporation B received an ownership interest in the capital of the joint venture of $1,000,000. Looking through corporation B to the shareholders, shareholder #1 owns 60%, shareholder #2 owns 20% and shareholder #3 owns 20% of the outstanding stock of corporation B before and after the transfer. Therefore, under Sections 6006.5(b) and 6281, shareholder #1 is considered to own 60%, shareholder #2 is considered to own 20% and shareholder #3 is considered to own 20%, of the tangible personal property both before and after the transfer. Since each of the three shareholders of corporation B own the exact same interest in the tangible personal property both before and after the transfer, which collectively equals 100% of the ownership of the property, the real or ultimate ownership of the tangible personal property meets the definition of ‘substantially similar’ referred to in Sections 6006.5(b) and 6281 and further defined in Section 1565(b)(2) as being 80% or more unchanged after the transfer.

Mr. ---

-3-

August 6, 1999
395.2025

You ask for our opinion on the following three matters:
“A.

Whether or not, under Section 1595(b)(4), the transfer of tangible personal property that is subject to any type of liability to a commencing joint venture subjects the transfer to California sales tax to the extent of the liabilities assumed.

“B.

Whether or not, in the fact pattern presented for corporation A, the retention of the real property within corporation A prevents corporation A from meeting the requirement that ‘substantially all’ of corporation A’s assets be transferred to the joint venture to avoid the imposition of the California sales tax on our proposed transactions.

“C.

Whether or not, in the detailed fact pattern presented related to the ownership of both corporation A and corporation B, [Rev. & Tax. Code] sections [6367,] 6006.5[b] and 6281 would exempt the transfer of assets from corporations A and B to the joint venture from California sales tax because there would be a transfer of substantially all of the assets of corporation A and corporation B and the real or ultimate ownership of the tangible personal property both before and after the transfer would be substantially similar as required by, and in accordance with the rules of, both of those sections.”

General Discussion:
I initially note that Revenue and Taxation Code section 6596, as interpreted by Regulation 1705 (both of which are attached), sets forth the circumstances under which a taxpayer may rely on a written response to a written request for an opinion. In order to come within the provisions of section 6596, all relevant facts, including the identity of the taxpayer, must be disclosed. You should provide us with the identity of your client (as well as all relevant facts) in your initial letter to us if you wish an opinion letter coming within the provisions of section 6596. Since you did not identify the taxpayer, this letter does not constitute specific written advice to the taxpayer and does not come within the provisions of Revenue and Taxation Code section 6596. This letter is not an “opinion” of the Board; rather, it constitutes general comments regarding the applicability of the California Sales and Use Tax Law to the transaction you describe. Sales tax is imposed on a retailer’s retail sale of tangible personal property in this state, measured by a percentage of gross receipts, unless the sale is specifically exempt by statute. (Rev. & Tax. Code § 6051.) When sales tax does not apply, use tax applies to the storage, use or

Mr. ---

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August 6, 1999
395.2025

other consumption of tangible personal property purchased from any retailer for the storage, use or other consumption in this state, measured by a percentage of the sales price, unless that use is specifically exempt by statute. (Rev. & Tax. Code §§ 6201, 6401.) The term “sale” includes any transfer of title or possession of tangible personal property for a consideration. (Rev. & Tax Code §§ 6006(a).) Revenue and Taxation Code section 6367 exempts from tax the transfer of tangible personal property (other than the transfer of vehicles, vessels, or aircraft) that qualifies as an occasional sale. Revenue and Taxation Code section 6006.5(b) defines an occasional sale as any transfer of all or substantially all of the property held or used by a person in the course of those activities for which the seller is required to hold a seller’s permit or permits (or would be required to hold a permit or permits if the activities were conducted in California) where, after the transfer, the real or ultimate ownership of the property is substantially similar to that which existed before the transfer. Revenue and Taxation Code section 6281 exempts from tax the sale or use of vehicles when they are included in a transfer of all or substantially all of the property held or used in the course of business activities of the person selling the property where, after such transfer, the real or ultimate ownership of such property is substantially similar to that which existed before the transfer. Regulation 1595(b)(2) explains that (1) “substantially all the property” means 80 percent or more of all tangible personal property held or used by the person in the course of the activities requiring the holding of a seller’s permit, including tangible personal property located out of the state but excluding any real property, and further explains that a simultaneous transfer of all or substantially all of its assets to more than one entity, will qualify for the exemption if the ownership remains substantially similar, and (2) stockholders or other persons holding an ownership interest, not a security interest, in a corporation or other entity are regarded as having the real or ultimate ownership of the property of the corporation or other entity, and the real or ultimate ownership is “substantially similar” to that which existed before the transfer if 80 percent or more of the ownership of tangible personal property is unchanged after the transfer.

Mr. ---

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August 6, 1999
395.2025

Response to Inquiries:
We will respond to your specific requests in items A, B and C above in the order requested: “A. Whether or not, under Section 1595(b)(4), the transfer of tangible personal property that is subject to any type of liability to a commencing joint venture subjects the transfer to California sales tax to the extent of the liabilities assumed.” A transfer of tangible personal property to a commencing joint venture in exchange solely for an interest therein is not a sale of tangible personal property. Regulation 1595(b)(4) explains: “[s]uch a transfer is a sale if the transferor receives any consideration, such as . . . an assumption of indebtedness (whether or not the transferor retains any joint liability with respect to the indebtedness assumed by the transferee), and tax applies to that sale unless it otherwise qualifies for exemption.” Regulation 1595(b)(1) describes consideration to include: “. . . cash, notes, and any other property as well as any indebtedness assumed by the transferee. It is irrelevant that the indebtedness assumed may have arisen solely in connection with the transferor's acquisition of the tangible personal property transferred, the other property transferred, or some combination thereof. . . .” The transfer to a commencing entity of tangible personal property subject to any type of liability, as well as any other indebtedness assumed by the transferee (including indebtedness secured by real property), or other consideration, constitutes consideration for the sale of tangible personal property and unless otherwise specifically exempt, the sale is subject to sales tax, as further described in Regulation 1595(b)(4): “The gross receipts from that sale is allocated among the taxable portion and the non-taxable portion by dividing the selling price of the tangible personal property transferred to the purchaser for use rather than resale by the selling price of all property transferred and then multiplying that amount by the total gross receipts (i.e. all consideration) received by the transferor.”

Mr. ---

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Therefore, the transfer of tangible personal property that is subject to any type of liability to a commencing joint venture is a sale of tangible personal property and unless specifically exempt is subject to sales tax measured not only by the liabilities assumed, but by all other consideration (if any). “B. Whether or not, in the fact pattern presented for corporation A, the retention of the real property within corporation A prevents corporation A from meeting the requirement that ‘substantially all’ of corporation A’s assets be transferred to the joint venture to avoid the imposition of the California sales tax on our proposed transactions.” The definition of “occasional sale” in 6006.5(b) is conditioned on a transfer of substantially all tangible personal property. This is explained in 1595(b)(2). The transfer or retention of real property is irrelevant to the question of whether a transfer of tangible personal property qualifies as an occasional sale. Regulation 1595(c) explains that “the rules set forth in 1595(b)(2) of this regulation are applicable in determining under this paragraph whether a transfer is of substantially all the property and whether the ownership is substantially similar.” These rules define “substantially all the property” as 80 percent or more of all the tangible personal property held or used in the course of activities requiring the holding of a seller’s permit. The retention of the real property by a transferor of substantially all of its tangible personal property will not affect the determination of whether the transfer of tangible personal property qualifies as an occasional sale. “C. Whether or not, in the detailed fact pattern presented related to the ownership of both corporation A and corporation B, [Rev. & Tax. Code] sections [6367,] 6006.5[b] and 6281 would exempt the transfer of assets from corporations A and B to the joint venture from California sales tax because there would be a transfer of substantially all of the assets of corporation A and corporation B and the real or ultimate ownership of the tangible personal property both before and after the transfer would be substantially similar as required by, and in accordance with the rules of, both of those sections.” If, as we have assumed, corporation A owns a 75 percent interest in the joint venture and corporation B owns a 25 percent interest in the joint venture, then for purposes of the occasional sale exemption, shareholder #1 has a real or ultimate interest in 90 percent of the tangible personal property of the joint venture derived (derived through its ownership in corporation A: 100 percent x 75 percent = 75 percent, and through its ownership in corporation B: 25 percent x 60 percent = 15 percent). For the purposes of the occasional sale exemption, shareholders #2 and #3 each have a real or ultimate ownership interest in 5 percent of the property of the joint venture (derived through their ownership interests in corporation B: 25 percent x 20 percent = 5 percent).

Mr. ---

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August 6, 1999
395.2025

Regulation 1595(b)(2) uses the following table to illustrate how to determine whether 80 percent of the real or ultimate ownership of the tangible personal property of a transferee remains unchanged after the transfer:

Stockholders
A
B
C

Interests in
Transferor
Corporation

Interests in
Transferee
Corporation

Interests Common
Before and After
Transfer

40%
40%
20%
100%

33 1/3%
33 1/3%
33 1/3%
100%

33 1/3%
33 1/3%
20%
86 2/3%

As you can see, the analysis required by 1595(b)(2) is on a transferor by transferor basis, not on a shareholder by shareholder basis. The transfer by 100 persons of $100 of tangible personal property to a single entity for which each transferor receives a 1% interest in the transferee valued at $100 is not a transfer in which the ownership interest is substantially similar to that which existed before the transfer – before the transfer, each transferor had a 100% ownership interest and after the transfer had only a 1% ownership interest. In other words, the ownership in each transferor must be substantially similar before and after the transfer for the transfer of that transferor’s assets to qualify as an occasional sale. The real or ultimate ownership of the tangible personal property before and after the transfers by corporation A to the joint venture may be shown as follows:

Stockholders
1
2
3

Interests in
Transferor
Corporation A
100%
100%

Interests in
Transferee
Joint Venture
90%
5%
5%
100%

Interests Common
Before and After
Transfer by Corporation A
90%
90%

The real or ultimate ownership of the tangible personal property before and after the transfers by corporation B to the joint venture may be shown as follows: Interests in

Interests in

Interests Common

Mr. ---

-8-

Stockholders
1
2
3

Transferor
Corporation B
60%
20%
20%
100%

Transferee
Joint Venture

August 6, 1999
395.2025
Before and After
Transfer by Corporation B

90%
5%
5%
100%

60%
5%
5%
70%

Although corporation A and corporation B each transferred all or substantially all of their tangible personal property to the joint venture, the real or ultimate ownership of the property is substantially similar to that which existed before the transfer only for the transfer of tangible personal property by corporation A, in which 90 percent of the real or ultimate ownership of the property is unchanged after the transfer. Corporation A’s transfer of tangible personal property to the joint venture would not be subject to tax. On the other hand, only 70 percent of the real or ultimate ownership of the tangible personal property of that corporation B is unchanged after its transfer to the joint venture. The real or ultimate ownership of the property that corporation B transferred to the joint venture is not substantially similar to that which existed before the transfer, and corporation B’s transfer of tangible personal property to the joint venture would be subject to tax. If you have any further questions, please do not hesitate to write. Very truly yours,

Janice L. Thurston
Senior Tax Counsel
JLT/cmm
cc:

Sacramento District Administrator (KH)