Did a later statutory merger and forgiveness of intercompany debt erase sales tax from an earlier booked asset transfer between separate affiliated corporations?

Plain-English summary

An aircraft-component and tooling corporation protested three audited categories: $55,036 of tooling sales, $15,830 of ex-tax tooling consumed, and a $224,413 transfer of assets to its parent. Hearing Officer Robert H. Anderson sustained the audited liability on every category and recommended redetermination with no further adjustment.

For the asset transfer, the separate affiliated corporations recorded an account receivable for the seller and an account payable for the parent. The parent then depreciated the equipment as its capital assets and paid property tax. Anderson found a credit sale at that moment, with tax due on the return for the transfer period and the state becoming a creditor.

The seller later merged into the parent before any rescission, cancellation, or forgiveness. The merger made the survivor both intercompany creditor and debtor, extinguishing that internal debt by operation of law, but it also carried the seller's state tax liability into the survivor. The merger eliminated the separate seller-creditor needed for a bad-debt or returned-merchandise route; it did not eliminate the state's claim.

Affiliation, asserted lack of sale intent, a planned eventual merger, the actual merger, and later forgiveness did not reverse the sale. Anderson said a taxpayer that chose one transactional method had to accept its tax consequences even if another method would have produced less or no tax.

Hearing, tooling items, corporate history, credit sale, authorities, and missing outcome

The hearing occurred January 30 at 10:30 a.m. in Downey, but its year remains 19XX. The close-out audit covered April 1, 1967 through June 30, 1970, and a determination issued December 17, 1971. The PDF identifies the petitioner's controller, Board supervisor, and auditor but supplies no petition, audit schedules, complete workpapers, determination, transcript, exhibits, or later Board order. The signed recommendation is dated February 23, 1973 and marked reviewed for audit March 1, 1973.

The $55,036 tooling-sales measure comprised three items. For G---, $10,771 of claimed rework was treated as additions and therefore fabrication labor constituting a sale under section 6006(b), because no repair-and-restoration evidence was presented. For B--- H---, invoice 4332 charged $16,700 for tooling to produce a specified spar, but no proof established a direct U.S. Army sale or resale to a customer that sold the tooling to the Army. For F--- H---, $27,565 involved a purchase-order letter saying title is or eventually will be vested in the federal government; Anderson found it inconclusive as to title before use. No tooling, work order, repair record, invoice copy, part, contract, purchase order, title evidence, resale certificate, delivery, payment, or government record is included.

The consumed-tooling item began at $185,549 and fell to $72,491 after reaudit. The petitioner did not protest $56,661, leaving $15,830. Its calculation used $327,521 of tooling purchases, including $297,406 from Profile, multiplied by 17.3 percent. It said $508,036 of tooling sales were at selling price and included purchased items, generated labor, expediting, rework, changes, setups, overhead, and profit. Anderson found no support for a use-tax exemption and sustained the balance. The first-page table prints 15,0830; later arithmetic and prose use $15,830. No ledger, Schedule 10C, purchase record, cost allocation, amortization, customer billing, exemption support, or reaudit schedule is included.

People v. Schwartz, 31 Cal.2d 59, supported the presumption that a certificate of delinquency was correct and placed on the taxpayer the burden to show error and produce evidence for a proper replacement determination. That citation resolved to the named case. The source supplies no certificate, records underlying the determination, burden hearing, or alternative computation accepted by the Board.

The corporate narrative begins with M--- D--- merging into the petitioner June 30, 1969, followed by a name change. The petitioner then merged into its parent June 30, 1970 and operated as a division. Plants closed in 1970 and 1971, and management intended equipment to move to a remaining location through a parent gathering account. On July 1, 1970, gathering-account equipment moved to the division through an intercompany charge said to be immediately forgiven into divisional equity. In May 1971 the rental and all other corporate charges were forgiven. No merger agreement or filing, entity chart, plant record, equipment list, gathering account, charge, rental entry, forgiveness, divisional-equity entry, closing schedule, or legal-work record appears.

The source contains an unresolved transfer-year conflict. The auditor's account says the separate corporations made the book transfers in June 1960. A later paragraph says no tax was reported when the assets were transferred in 1969 and describes the tax debt as arising from a sale almost a year before the June 1970 merger. The live annotation likewise says the merger was delayed almost a year. The source provides no ledger or document that permits correction, so both printed years remain disclosed.

When the separate entities recorded reciprocal receivable and payable entries, Anderson found the sale complete and tax due. Parent depreciation and property-tax payment further reflected its treatment of the equipment as its own. Northwestern Pacific Railroad Co. v. State Board of Equalization, 21 Cal.2d 524, supported gross receipts from a wholly owned subsidiary's booked sale to an affiliate; that reporter resolved.

The source next prints Pacific Pipeline Construction Co. v. State Board of Equalization as (1956) 49 Cal. 2d 889 for a taxable affiliated-company asset exchange. Citation verification did not resolve 49 Cal.2d 889. An exact-name search found the named California Supreme Court case at 49 Cal.2d 729, filed February 21, 1958. This page preserves the Board's defective reporter and year rather than rewriting the source.

W. E. Hall Co. v. Franchise Tax Board, 260 Cal. App. 2d 179, and Moline Properties v. Commissioner, 319 U.S. 436, supported the distinction between the government's ability to look through labels and a taxpayer's inability to disregard its chosen entity and transaction form. Both reporters resolved to the named cases. The source supplies no entity-disregard finding beyond treating the corporations as separate.

Former Corporations Code section 4116 made the survivor succeed to constituent rights and properties and take their debts and liabilities as though it had incurred them. Mutual Building & Loan Association of Pasadena v. Wiborg, 59 Cal. App. 2d 325, supported survival of rights, powers, liabilities, and assets through merger. The Board attributes its quotation to page 323, which precedes the reporter's first page; the verified opinion places the quoted merger discussion on pages 328–329. The reporter and named case resolve, but the pinpoint does not.

The seller's intercompany claim against the buyer disappeared when the survivor became both creditor and debtor. The already-due state tax did not: it became the surviving parent's liability. Anderson reasoned that a hypothetical pre-merger tax payment would not become refundable merely because of merger. No return, due date, tax rate, tax amount, state collection record, payment, refund claim, or merger-liability entry is supplied.

The recommendation says the only possible Sales and Use Tax Law routes around the state liability would have been bad debt or returned merchandise. Merger defeated both because the creditor-seller ceased separately and no debt remained. No bad-debt deduction, income-tax treatment, return of equipment, rescission, credit memo, refund claim, or statutory citation for those routes appears.

Freeman v. Commissioner, 303 F.2d 580, supported holding the taxpayer to its chosen method. The citation service returned an ambiguous reporter match but identified the source-named case. Anderson recommended Redetermine; make no further adjustments to the audited liability. No redetermination notice, Board adoption, amount, penalty, interest, collection, payment, refund, claim, judicial appeal, or final outcome is included.

The live annotation preserves the two mergers, separate-entity asset transfer, receivable/payable entries, depreciation and property tax, planned-but-delayed merger, taxable-sale result, cancellation, surviving state debt, and February 23, 1973 date. It omits the hearing and audit period; all four tooling issues and amounts; plant, gathering-account and forgiveness details; June 1960/1969 conflict; statutes and seven cases; defective Pacific Pipeline reporter/year and Wiborg pinpoint; bad-debt and returned-merchandise analysis; recommendation and audit-review date; missing records; and absent final outcome.

What this means for you

Affiliated corporations planning mergers

An asset transfer completed while entities are separate can create tax before a later merger. Booked receivables, payables, depreciation, and property-tax treatment may evidence a completed credit sale.

Accountants and tax professionals

Reconcile the transaction's legal form with every ledger entry, asset record, invoice, depreciation schedule, property-tax payment, merger document, cancellation, and tax return. Separately preserve proof for fabrication, government-sale, resale, consumed-property, bad-debt, or returned-merchandise positions.

Common questions

Q: Why did the book transfer count as a sale?
A: The separate corporations recorded reciprocal receivable and payable entries, and the parent treated the equipment as its own capital asset.

Q: Did common ownership prevent a taxable sale?
A: No. The recommendation treated the affiliated corporations as separate entities when the transfer occurred.

Q: Did the statutory merger extinguish the tax debt?
A: No. The surviving corporation succeeded to the seller's liabilities, including the debt owed to the state.

Q: Did later forgiveness of the intercompany debt reverse the sale?
A: No. The recommendation said the taxpayer had to accept the tax consequences of the transaction form it chose.

Q: What other audit items were decided?

A: Three tooling sales totaling $55,036 and a $15,830 consumed-tooling balance were sustained because the claimed repair, federal-government, resale, and use-tax-exemption support was insufficient.

Q: What was the asset-sale measure?

A: The protest table lists $224,413. The source supplies no asset schedule, allocation, rate, or resulting tax.

Q: When did the asset transfer occur?

A: The source conflicts: one passage says June 1960, while another says 1969 and nearly a year before the June 1970 merger.

Q: Could the survivor claim bad debt or returned merchandise?

A: Not under the recommendation, because merger ended the separate creditor-seller and extinguished the intercompany debt.

Q: Did Pacific Pipeline resolve at the printed citation?

A: No. The source prints 49 Cal.2d 889 (1956); the exact named case is reported at 49 Cal.2d 729 (1958).

Q: Is the Wiborg quotation on source-printed page 323?

A: No. The case begins at page 325, and the quoted merger passage appears on pages 328–329.

Q: Was a final Board order or payment supplied?

A: No. The record ends with the hearing officer's no-further-adjustment recommendation and a March 1, 1973 audit-review notation.

Citations and references

• California Revenue and Taxation Code § 6006(b)
• Former California Corporations Code § 4116
• People v. Schwartz, 31 Cal.2d 59
• Northwestern Pacific Railroad Co. v. State Board of Equalization, 21 Cal.2d 524
• Source-printed Pacific Pipeline Construction Co. v. State Board of Equalization, 49 Cal.2d 889 (1956); exact-name case resolves as 49 Cal.2d 729 (1958)
• W. E. Hall Co. v. Franchise Tax Board, 260 Cal. App. 2d 179
• Moline Properties, Inc. v. Commissioner, 319 U.S. 436
• Mutual Building & Loan Association of Pasadena v. Wiborg, 59 Cal. App. 2d 325; source-printed page 323 pinpoint is impossible, and the quoted passage appears at 328–329
• Freeman v. Commissioner, 303 F.2d 580
• Petition, certificate of delinquency, audit schedules and workpapers, tooling and asset records, invoices, contracts, government and resale evidence, ledgers, mergers, plant closings, gathering account, rental and forgiveness entries, returns, determination, reaudit, Board order, payment, claim, appeal, and outcome — described or implicated but not included

Verbatim support

From the official February 23, 1973 Robert H. Anderson recommendation:

When the assets were transferred to the books of M--- – C--- and a receivable and payable recorded on the respective books of the transferor and transferee there was, at that moment, a sale.

The State of California became a creditor as far as the tax was concerned.

However, as pointed out, the liability to the state for tax owed by Petitioner before the merger was not extinguished by the merger. It became a liability of M--- - C---.

Redetermine; make no further adjustments to the audited liability.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.2155
• Original supporting opinion: 395.2155 PDF

Original ruling text

STATE OF CALIFORNIA
BOARD OF EQUALIZATION

In the Matter of the Petition for
Redetermination of State and Local
Sales and Use Taxes:
C--- A--- S--CORPORATION

)
)
)
)
)
)
Petitioner)

395.2155

DECISION AND RECOMMENDATION
OF HEARING OFFICER
Account No. SR -- XX-XXXXXX-010

The above-entitled matter came on regularly for hearing on Tuesday, January 30, 19XX at 10:30 a.m., in Downey, California. Appearances: For Petitioner:

Mr. M. K. J---, Controller
M--- – C--- Corporation
----

For the Board of Equalization:

Mr. Don Farness, Supervisor
Long Beach District
Mr. R. Kamnikar, Auditor
Lon Beach District
Protest

Pursuant to a close-out audit of Petitioner’s records covering the period from April 1, 1967 through June 30, 1970 and a determination issued on December 17, 1971, Petitioner protests the following items: Measure of Tax

Item
Sales of tooling:
Ex-tax purchases of tooling consumed:
Sales of assets to M--- – C---:

$55,036
15,0830
$224,413
Contentions

Petitioner contends that the sales of tooling ($55,036) which included three separate transactions were exempt for the following reasons:

1. G--- tooling, $10,771, amounted to rework on G---’s tooling and amounted to labor only
   which was not taxable

C--- A--- S--- CORP.
SR -- XX XXXXXX

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February 23, 1973
395.2155

2. B--- H--- invoice, $16,700, was an R & D government contract for the U.S. Army and
   therefore not taxable

3. F--- – H---, $27,565, was or involved a U.S. Government prime contract and therefore not
   taxable.
   With respect to the tooling consumed, it was contended originally by Mr. C---, Controller for C--- A--- S---, that it was computed incorrectly and included nontaxable items such as labor rework. It should be noted that originally this item was measured by $185,549 and after a reaudit it was reduced to $72,491. Of the $72,491 Petitioner did not protest $56,661 thus leaving the measure at $15,830. Following is Petitioner’s computation of the amount not protested: “The total tooling sales of $508,036 determined by the auditor on Schedule 10C is at selling price and bears no readily ascertainable relationship to cost. The company, during the period April 1, 1968 through June 30, 1970, purchased tooling of $327,521 per schedule from the general ledgers, of which $297,406 was purchased from Profile. Therefore the tooling consumed should be computed as follows: 327,521 X 17.3% or 56,661 “Part of the problem arises from the fact that the sales invoices not only include purchased tooling, but also C--- generated items such as labor expediting charges, rework, changes and labor set-ups as well as a mark-up for G & A and profit.” Finally, with respect to the sale of assets to the parent corporation, M--- – C---, Petitioner contends this was not a sale, but a bookkeeping transfer that was subsequently reversed. SUMMARY During the period covered by the audit, Petitioner was a corporation engaged in the business of fabricating and selling aircraft component parts and sales of tooling. The three sales described above under Petitioner’s contentions (G---, B--- H--- and F--- H---) were included in the audited determination and deemed taxable sales for the following reasons: G---: The auditor noted that the tooling rework amounted to additions and not repair and restoration of worn tooling. Therefore, the work amounted to fabrication labor which under subsection (b) of Section 6006 of the California Revenue and Taxation Code is a sale. B--- H---: Invoice No. 4332 (copy in work papers) merely indicates the $16,700 was for tooling to produce part No. 625-010-006-1 Spar as identified on OMTR No. 902640. Nothing was

C--- A--- S--- CORP.
SR -- XX XXXXXX

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February 23, 1973
395.2155

produced to support any exemption such as this being a sale to the U.S. Army or a sale for resale to B--- who sold the tooling to the Army. Thus, the auditor had no basis for concluding it was an exempt sale. F--- H---: This item is much the same as the B--- H--- situation. Nothing has been produced to support an exemption except a letter from the F--- people which reads as follows: “Since the terms and conditions as contained in our purchase order has a clause TAXES which reads ‘Unless provided to the contrary hereunder, the price of this Purchase Order includes all Federal, State and Local taxes,’ any Sales Tax which may be applicable would be your liability. “For your information purchase orders which contain the numbers 168P, 169P and 181 were placed under Government Prime Contracts and title to the tooling is or eventually will be vested in the United States Government and therefore may be exempt from California Sales Tax.” The auditor included the self-consumed tooling because he stated it represented tooling not billed to customers but was consumed and amortized over the sales prices of parts. In other words, the Petitioner did not sell the tooling but instead recovered costs by pricing the sales of the parts in such a way that the customer paid for the tooling. Following is Petitioner’s explanation of the sales of assets and the reasons why it should not be deemed taxable: Corporate History: At June 30, 1969, M--- D--- Corporation was merged into C--- M--- Co., Inc. (Petitioner herein) and the name was changed to C--- A--- S--- Corporation. At June 30, 1970 (the close of the audit under consideration) C--- A--- S--- Corporation was merged into the parent, M--- – C--- Corporation and operated from that date on as a division of M--- – C---. C--- M--- Co., Inc., originally operated two plants (--- and ---, Washington) while M--- D--Corporation had one plant (---) until 1969 when a plant was opened at ---, California.
--- and --- were closed on June 30, 1970, and the --- plant was closed on June 30, 1971. Thus, everything was conducted at --- after the closings. It was the intention of management to transfer equipment from the closing plants to ---, as the opportunity arose. In order that the books would not reflect a chaotic situation because of the corporate and divisional change, it was decided that the equipment transfers from the closed plants to --- (all equipment belonging to Petitioner) would be handled through a gathering account on the M--- – C--- Corporation books and a rental charge for depreciation would be billed Petitioner at ---. As of July 1, 1970, all equipment from the corporate gathering account was transferred to the division through an intercompany charge which was immediately forgiven and became part of the divisional equity. (Petitioner on June 30 was merged into M--- and became a division of that entity.)

C--- A--- S--- CORP.
SR -- XX XXXXXX

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February 23, 1973
395.2155

On May 1971, the rental charge as well as all other corporate charges were forgiven. Therefore, at this time, the situation existed as if all the equipment transactions had gone directly to the division in the first place. The delays ensued because the plants could not be closed as quickly as projected and the corporate and divisional legal work took more time than anticipated. Petitioner contends that, however, only book entries were made with no payments, and even these entries were reversed through the forgiveness technique. The auditor noted that when Petitioner was a corporation and therefore a separate legal entity separate and apart from M--- – C--- Corporation, assets were transferred to the books of M--- and the transfers were recorded by setting accounts receivable (Petitioner) and payable (by M---). The transfers were made in June 1960. Following the transfers, M--- depreciated the equipment as its own capital asset and paid the property tax on it. In June 1970 there was a statutory merger wherein Petitioner was merged into M---. At the time of the merger nothing had been paid to Petitioner for the assets transferred and no sales tax had been reported and paid by Petitioner to the state when the assets were transferred in 1969. Presumably, no tax was paid because the corporate officials did not consider the transaction taxable or that they did not consider that any sale was intended since there was to ultimately be a statutory merger of the two entities. CONCLUSIONS Sales of tooling: G---. No evidence was presented to support a conclusion that the labor was to repair and restore worn-out tooling. Accordingly, it is presumed that the audited liability is correct. B--- H---. No evidence was produced to support a conclusion that the sale to B--- should be exempt from sales tax. Accordingly, it is presumed that the audited liability is correct. F--- H---. The letter from the purchaser, F---, contains inconclusive statements and is not evidence to support a conclusion that the title to the tooling passed to the United States before any one made use of it. Thus, it is presumed that the audited liability is correct. Consumed tooling. Nothing was offered to support an exemption from use tax on the tooling in question. Again, it is presumed that the audited liability is correct. Presumption of Correctness. A certificate of delinquency carries with it the presumption that the Board’s determination is correct. The taxpayer has the burden of proving not only that the determination, based upon his records, is incorrect, but also of producing evidence from which another and proper determination may be made. People v. Schwartz (1947) 31 Cal.2d 59.

C--- A--- S--- CORP.
SR -- XX XXXXXX

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February 23, 1973
395.2155

Sale of assets to M--- – C---. When the assets were transferred to the books of M--- – C--- and a receivable and payable recorded on the respective books of the transferor and transferee there was, at that moment, a sale. Tax was due and payable on that transaction with the return that covered the period when the transfer occurred. The State of California became a creditor as far as the tax was concerned. No tax was reported and paid with the return that covered the period when the sale occurred. Subsequently, the seller was merged into the buyer, and this happened before any rescission of the sale or cancellation and forgiveness of the debt occurred. The sales price at which a wholly owned subsidiary corporation sold property to its parent or to another subsidiary constituted “gross receipts” of the wholly owned subsidiary where the buyer and seller were operated as separate corporate entities and the buyer gave the seller credit on its books for the amount of the sales price. Northwestern Pacific Railroad Co. v. State Board of Equalization (1945) 21 Cal. 2d 524. The exchange of assets between two affiliated corporations to effect a territorial division of a business is a retail sale. Pacific Pipeline Construction Co. v. State Board of Equalization (1956) 49 Cal. 2d 889. Petitioner appears to believe that no sale occurred because the transferor was a wholly owned subsidiary of the transferee, and no sale was intended even if one did occur. Further it appears that Petitioner feels that the whole thing became a nullity because of the statutory merger and subsequent reversal or forgiveness of the debt created when the transfer was made. In interpreting a business transaction for tax purposes the taxing authority is not necessarily bound by the language the taxpayer chose to describe it or by the bookkeeping entries chosen to record it; but a taxpayer does not have the same freedom to disregard the form he has chosen for a business transaction as does the government in applying taxing statutes to the transaction. W.E. Hall Co. v. Franchise Tax Board (1968) 260 Cal. App. 2d 179; Moline Properties v. Commissioner of Int. Rev., 319 U.S. 436 (87 L.Ed. 1499, 63 S.Ct. 1132.) In summary the transfer of the C--- A--- S---’ assets to M--- – C--- Corporation was a credit sale notwithstanding the relationship of the two entities. This brings up the second issue which relates to the effect of a statutory merger on the creditor-debtor relationship when the creditor is merged into the debtor. Section 4116 of the California Corporations Code provides that upon merger or consolidation pursuant to this article (Title 1, Div. 1, Part 8, Chapter 3, Article 1) the separate existence of the constituent corporation (merged corporation) ceases, and the consolidated or surviving corporation shall succeed, without other transfer, to all the rights and properties of each of the constituent corporations, and shall be subject to all of the debts and liabilities of each, in the same manner as if the consolidated or surviving corporation had itself incurred them.

C--- A--- S--- CORP.
SR -- XX XXXXXX

-6-

February 23, 1973
395.2155

In Mutual Building & Loan Association of Pasadena v. Wiborg (1943) 59 Cal. App. 2d 325, the court, in considering the above referenced section, said at page 323: By virtue of the merger, the separate corporate existence of Title Guarantee suffered the fate of all merged corporations, to wit, they became a part of the muscle and the bloodstream of the mergee corporation transfusing into the mergee all of its (their) rights and privileges.

While the Title Guarantee merger with Title Insurance caused it to lose its identity as to its separate existence, yet it became an integral part of Title Insurance, and carried with it all of its rights, powers, liabilities, and assets except the indicia and attributes of a corporate body, distinct from that into which it is merged. When Petitioner was merged into M--- - C---, M--- C--- acquired all of the liabilities of Petitioner. One of them was a debt for tax owed to the State of California as a result of the sale that occurred almost a year earlier, and on which no tax had been reported and paid. That debt was not extinguished by reason of the merger as far as the state is concerned. Suppose, for example, that the principals of C--- A--- S--- had recognized the transfer as a sale and had reported and paid the sales tax on it. Then, in the course of events the statutory merger occurred as it did; it goes without saying that the surviving corporation would not be entitled to a refund of that sales tax paid to the state. As far as the creditor (Petitioner herein) and the debtor (M--- - C---) is concerned, liability for the debt was extinguished by operation of law the instant Petitioner was merged into M--- - C--because the surviving corporation became both a creditor and a debtor. However, as pointed out, the liability to the state for tax owed by Petitioner before the merger was not extinguished by the merger. It became a liability of M--- - C---. The only way, under the Sales and Use Tax Law, to get around the liability for the tax owed the state (M--- – C---’s ;liability after the merger) would be via the bad debt or returned merchandise routes, and the merger wiped out both possibilities because the creditor-seller ceased to exist as a separate legal entity. In other words, there was no longer a debt (after the merger) and without it there could not be a bad one. M--- - C--- could not declare it as a bad debt for income tax purposes when the creditor also became a part of the muscle and bloodstream of the mergee corporation. Finally, in answer to Petitioner’s explanation as to why the transfers were made when they were and were handled as they were we refer to the case of Freeman v. Commissioner (1962) 303 F.2d 580, wherein the court said:

C--- A--- S--- CORP.
SR -- XX XXXXXX

-7-

February 23, 1973
395.2155

In matters of tax liability, substance is generally preferred to form and is often determinative of tax consequences; however, if a taxpayer having a choice of methods of accomplishing an economic or business result pursues a particular method he must abide the tax consequences of his choice even though another method would have resulted in less severe or nonexistent tax consequences. In sum, it is concluded that the transfer of assets from Petitioner to M--- – C--- Corporation was a sale giving rise to sales tax liability, a debt owed to the State of California, which was not extinguished by reason of the merger wherein Petitioner was merged into the purchaser. RECOMMENDATIONS Redetermine; make no further adjustments to the audited liability.

Robert H. Anderson, Hearing Officer

FEB 23 1973
Date

REVIEWED FOR AUDIT:
3-1-73
Principal Tax Auditor

Date