Who owed tax when property bought ex-tax was contributed to a new corporation, leased to another company, and later used after the companies merged?

Plain-English summary

W--- bought property ex tax for resale and incorporated it into an amusement-park attraction that remained tangible personal property rather than real property. Instead of reselling, W--- contributed the attraction to IJR in a nontaxable commencing-corporation transfer. IJR leased it to W2, collected rental tax, and reported and paid that tax to the Board. IJR and W2 later merged.

The original buyer owed use tax on its purchase price because its nontaxable contribution was a use rather than a resale. It apparently underreported that liability and remained responsible for the full tax on cost plus interest.

The new corporation had not purchased the attraction and therefore did not owe use tax merely for its own use. Its lease was taxable as a continuing sale because no California tax had been paid on a purchase price. When the lease ended through merger, the survivor stood in the constituent corporations' place and could use the property without an additional use tax; there was no longer a lease sale and no purchase by the user.

The memorandum also said Tax Counsel Kelly Ching's earlier unidentified-client response did not qualify for reasonable-reliance protection under section 6596, though Supervising Tax Counsel David H. Levine found its substantive analysis correct.

Earlier advice, distinct taxpayer roles, analogies, underreporting, and missing outcome

The August 15, 1997 Audit, Evaluation, Planning and Settlement memorandum is not included. It concerned transactions an adviser now said matched his February 28, 1995 unidentified-client request. Kelly Ching had answered April 26, 1995, and district staff questioned whether she had considered annotation principles later incorporated into Regulation 1595. None of those three writings is supplied.

Because the original adviser did not identify the clients, Ching's response did not qualify under section 6596, and she reportedly said so. Levine therefore addressed correct tax only, not reasonable reliance. The source supplies no taxpayer identity in the earlier writings, complete facts, disclosure, reliance act, detriment, penalty, interest claim, request, response, or section 6596 determination beyond this statement.

W--- purchased for resale and used the property by making a nontaxable contribution instead. Ching required W--- to report use tax on purchase price. District staff said W--- later did so except for an unspecified deficiency. Levine closed by saying W--- apparently underreported and owed full tax on cost plus late-payment interest. No vendor, invoice, purchase date, cost, resale certificate, attraction components, contribution date or value, return, reported tax, shortfall, rate, interest computation, assessment, payment, claim, appeal, or outcome appears.

The attraction remained tangible personal property. The source gives no name, location, design, construction record, component list, fixture analysis, owner, use, value, customer, admission, or real-property interest supporting that classification.

IJR acquired the attraction through a nontaxable commencing-corporation transfer and therefore did not purchase it. IJR's own use was not taxable, but its lease was a taxable continuing sale because it had paid no California tax on purchase price. IJR collected, reported and paid rental tax. No articles, stock, ownership, formation, transfer agreement, title, lease, W2 identity, rent, invoices, tax reimbursement, returns, payment, audit, or balance is supplied.

Regulation 1660(c)(6) and 1595(b)(3), plus live Annotations 330.3650 and 395.2150, applied when the disappearing lessor itself bought property ex tax for resale or lease, then survivor use triggered purchase-price tax with rental-tax credit. Here, disappearing/lessor IJR never purchased the property, so that carried purchase obligation did not exist.

Levine used two analogies. A person buying equipment outside California and using it there for one year before California entry could use it tax free, while a later lease would be taxable and own use after the lease would again be nontaxable. And if he gave Joe a computer, Joe could use it tax free, while Levine would owe tax if he had bought it for resale before gifting it; Joe's lease would be taxable, followed by nontaxable own use. These are examples, not facts about the attraction.

For this analysis, the commencing-corporation transfer was like a gift: W--- owed use tax as the ex-tax buyer making the contribution; IJR was a nonpurchasing transferee free to use the property; its lease was taxable; and survivor use after the merger was not tax because the lease sale ended and the user made no purchase. The source supplies no merger agreement, parties' survivor identity, effective date, filing, property succession, lease termination, post-merger use, return, audit, assessment, payment, claim, appeal, or outcome.

The live annotation preserves the ex-tax purchase, contribution, lease, merger, W--- purchase-price tax, IJR rental tax, post-lease and post-merger no-tax result, distinctions from 330.3650 and 395.2150, and date. It adds (M98–3) without supporting amendment text in the opinion. It omits the 1995 advice chain and section 6596 denial; identified party names; amusement attraction and tangible-property classification; collection and payment of rental tax; gift and out-of-state-use analogies; W--- underreporting and interest; missing records; and absent final audit outcome.

What this means for you

Corporate reorganization teams

Separate each party and step. The original purchaser's tax liability did not become the transferee's purchase-price basis merely because the transferee later leased and used the asset.

Equipment lessors

Property acquired without a taxable purchase can still produce taxable rental receipts. Ending the lease and resuming own use is a different tax event.

Accountants and tax professionals

Track who purchased, intended resale, used by contribution, received without purchase, leased, collected and paid rental tax, merged, survived, and later used. Preserve cost, resale certificates, stock and transfer documents, lease and rent, merger filings, rental credits, returns, underpayment, interest, assessment, and payment.

Common questions

Q: Why did the original buyer owe use tax?
A: It bought the property ex-tax for resale but used it by making a nontaxable contribution to a commencing corporation instead of reselling it.

Q: Why was the new corporation's lease taxable?
A: It had not paid California tax on a purchase price, so its lease was a continuing sale subject to tax on rentals.

Q: Why was post-merger use not taxed again?
A: The transferee and survivor were not purchasers of the property, and after the lease ended there was no continuing sale.

Q: Did underpayment by the original buyer change the transferee's liability?
A: No. The memorandum says it was irrelevant to the transferee, while the original buyer still owed full tax and interest.

Q: Why was section 6596 reliance unavailable?
A: The earlier request did not identify the clients, so the response did not satisfy that provision's requirements.

Q: Did W--- fully pay the purchase-price use tax?

A: District staff said it later reported tax, but Levine says it apparently underreported and owed full cost tax plus late interest. No amount or outcome is supplied.

Q: Did IJR actually pay tax on rentals?

A: The memorandum says IJR collected tax from W2 and reported and paid it to the Board, but supplies no invoices or returns.

Q: Why did the parallel annotations produce a different merger result?

A: Their disappearing corporations had bought property ex tax, so the purchase-price obligation carried into survivor use. IJR was not a purchaser.

Q: Were the one-year outside-California equipment and Joe's computer real transaction facts?

A: No. They were explanatory examples.

Q: What did (M98–3) change?

A: The live annotation shows that notation, but the supporting opinion contains no amendment text or explanation.

Q: Was W--- finally assessed or paid the remaining tax and interest?

A: The source does not say.

Citations and references

• California Revenue and Taxation Code § 6596
• California Sales and Use Tax Regulations 1595(b)(3) and 1660(c)(6)
• February 28, 1995 request, April 26, 1995 Kelly Ching response, and August 15, 1997 district memorandum — described but not included
• Live Annotation 330.3650 and Live Annotation 395.2150
• Party, attraction, purchase, cost, resale certificate, formation, stock, contribution, lease, rent, rental tax, merger, survivor use, return, underpayment, interest, audit, assessment, payment, claim, appeal, and outcome records — described or implicated but not included

Verbatim support

From the official August 25, 1997 David H. Levine memorandum:

Thus, the only question before us now is the correct application of tax, not a question of reasonable reliance on Ms. Ching’s letter.

For purposes of this analysis, the nontaxable commencing corporation transfer is the same as a gift.

Thus, once the lease ended and IJR used the property itself (i.e., used by the survivor of the merger), no further tax was due since there was no longer a sale (the lease) and there was no purchase by the user of the property.

Of course, W--- owes the full tax on cost, and interest thereon for any late payment of such tax.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.2110
• Original supporting opinion: 395.2110 PDF

Original ruling text

State of California

Board of Equalization
Legal Division-MIC: 82

Memorandum

395.2110
August 25, 1997

To :

Mr. Vic Anderson, Supervisor
Audit, Evaluation, Planning and Settlement
Section

Date:

From :

David H. Levine
Supervising Tax Counsel

Telephone: (916) 445-5550

Subject:

CalNet 485-5550

W--SR -- XX-XXXXXX

This is in response to your memorandum dated August 15, 1997 regarding the application of tax to the use of property involved in a merger. By letter dated February 28, 1995, Mr. W--V--- W--- inquired, on behalf of his unidentified clients, about the application of tax to a series of transactions which he now represents as being the transactions currently under review. Tax Counsel Kelly Ching responded by letter dated April 26, 1995. The --- --- District office believes that Ms. Ching’s response may have failed to consider the implications of certain annotations (whose principles have now been incorporated into Regulation 1595). Since Mr. V--- W--- did not identify his clients, Ms. Ching’s letter did not come within the provisions of Revenue and Taxation Code section 6596, and she so advised him. Thus, the only question before us now is the correct application of tax, not a question of reasonable reliance on Ms. Ching’s letter. As explained below, Ms. Ching’s analysis was correct. W--- purchased property for resale to incorporate into an amusement park attraction that maintained its identity as tangible personal property (as opposed to becoming real property). W--- then contributed that attraction to IJR in a nontaxable commencing corporation transfer, and IJR leased the attraction to W--- 2 (W2). As relevant here, Ms. Ching advised that W--improperly purchased the property for resale since W--- was transferring the property to IJR in a nontaxable commencing corporation transaction and was not reselling it. (Although the parties were not identified in Mr. V--- W---’s letter or in Ms. Ching’s response, when referring to these letters I will use the appropriate names now that they have been identified.) Thus, she concluded that W--- was required to report use tax on its purchase price of such property. District office advises that W--- thereafter did so, except as noted below. Ms. Ching then advised that IJR’s lease to W---2 was subject to tax since IJR did not pay tax on purchase price (nor could it since it did not purchase the property). IJR did collect tax from W---2 on rentals and reported and paid the tax to the Board. In response to Mr. V--- W---’s question as to how tax would apply if IJR and W---2 thereafter merged, Ms. Ching explained

Mr. Vic Anderson

-2-

August 25, 1997
395.2110

that “only [IJR’s] sale of the property (e.g., in a continuing sale) is taxable; its own use is not. Thus, any use by [IJR] of the fixtures and machinery and equipment after leasing the property will be nontaxable, without regard to whether such use occurs upon termination of the lease to
[W---2] or after merging into [W---2].”
District office cites two annotations, 330.3650 (12/11/86) and 395.2150 (9/23/71), that it believes are “parallel” to the subject merger and conflict with Ms. Ching’s analysis. Unlike the situation here, both these annotations relate to property purchased by the disappearing corporation extax for resale. When a person purchases property extax for resale and then uses the property, it owes tax on such use. The application of this rule in the context of property purchased extax for lease, leased, and then used by the lessor is subdivision (c)(6) of Regulation 1660. The lessor owes tax on purchase price with a credit for any tax already paid on rentals payable. Subdivision (b)(3) of Regulation 1595, also cited by District office, applies this rule to mergers, incorporating the annotations cited above. It is the disappearing corporation’s purchase price of property purchased for resale that is subject to tax if, after the merger, the surviving corporation uses the property rather than reselling, as is often the case when one of the parties to a merger was making a taxable lease of property to the other party to a merger. A person who does not purchase property for resale, and who otherwise does not owe tax on its use of property, may use such property without use tax liability. For example, a person who purchases equipment outside California and who uses it outside California for one year prior to bringing it into California does not owe tax on the use of the property in California. That person may use the property in any manner it wishes without payment of use tax. However, if it leases the property, the lease is a continuing sale subject to tax because the person would not have paid California tax or tax reimbursement on purchase price. If the person thereafter stops leasing the property and starts using it again, the person would obviously not owe tax on that use because the person would still not be regarded as having purchased the property for use in California. If that person then merged with another person, the survivor would stand in the place of the constituent corporations. Thus, the survivor is also not regarded as having purchased the property for use in California and may use the property tax free. This is true even if the survivor had been leasing the property from the disappearing corporation in a taxable continuing sale prior to the merger. The same analysis applies to the use of property acquired by gift. If I make a gift of a computer to Joe, Joe may use that computer tax free because he did not acquire the computer by purchasing it from a retailer. (If I had purchased the computer for resale, I would be the person owing tax on the use of the computer, that is, the making of a gift of it.) Of course, since he would not have paid tax on purchase price, any lease of the computer by Joe would be taxable. If he thereafter starts using it again, no tax is due on that use. For purposes of this analysis, the nontaxable commencing corporation transfer is the same as a gift. That is why Mr. V--- W--was advised that W--- owed tax on purchase price, since W--- purchased the property for resale and then used it by way of a nontaxable transfer to a commencing corporation. IJR, as the transferee in a nontaxable commencing corporation transfer, was not a purchaser who owed tax on its use of the property. IJR was free to use the property in any manner it wished tax free.

Mr. Vic Anderson

-3-

August 25, 1997
395.2110

Thus, once the lease ended and IJR used the property itself (i.e., used by the survivor of the merger), no further tax was due since there was no longer a sale (the lease) and there was no purchase by the user of the property. I believe the analysis above answers all the questions asked by District office. I note that W--- apparently underreported tax on its purchase price of the property and District office asks how this relates to IJR’s tax basis in the property. For sales and use tax purposes, it is irrelevant to IJR’s liability. Of course, W--- owes the full tax on cost, and interest thereon for any late payment of such tax. If you have further questions, feel free to write again.

DHL/cmm
cc:

Mr. Dennis Fox (MIC:92)
Mr. Brian S. Ishimaru (MIC:40)