Could a parent assign zero sales-tax value to equipment transferred to a new subsidiary because the subsidiary's assumed liabilities were not tied to specific assets?

Plain-English summary

A corporation spun off one division April 1, 1988 by transferring real property, intangible rights, office equipment, computers, furniture, and other equipment to a new wholly owned subsidiary. In exchange, the parent received first-issue subsidiary stock and the subsidiary's written promise to assume division liabilities.

The taxpayer initially argued no sale occurred, but dropped that contention after Beatrice Co. v. State Board of Equalization, 6 Cal.4th 767. It then argued the tax measure was zero because none of the assumed liabilities was directly attached to the tangible personal property and all consideration should be assigned to transferred real property and intangible rights.

Senior Staff Counsel Stephen A. Ryan rejected that zero allocation. The adjusted $24,650,711 of assumed liabilities was consideration for the entire adjusted $45,821,337 asset package, including California tangible personal property; the law did not limit consideration to debt directly attached to a particular asset.

Because the package also included real property and intangible rights, the Department allocated the consideration rather than taxing all liabilities. Using the Audit Manual formula and a $3,044,027 California tangible-property net book value produced a $1,637,609 taxable measure. With no supported better allocation, Ryan recommended redetermination without adjustment.

Conference posture, $6.903 million dispute, allocation math, authorities, and missing outcome

The Appeals conference occurred February 9 in Hollywood, but the year remains 19XX; the continuation pages show March 8, 1994. The protested period is redacted as April 1, 198X through December 31, 199X, and the first-page liability amount is also redacted. The source says the most recent prior Board audit ended March 31, 1987. No petition, conference transcript, protested schedule, assessment, prior audit, audit history, tax rate, or original tax amount is included.

Exhibit 1 reportedly listed specific assets and liabilities. It showed total assets received of $52,724,337 and total liabilities assumed of $17,747,711, but the exhibit is absent despite the final w/Exhibit 1 notation. No deed, intangible-right schedule, equipment or inventory list, location, invoice, valuation method, depreciation, subsidiary stock certificate or value, assumption agreement, liability ledger, closing, or transfer record is supplied.

The auditor removed a $6,903,000 receivable from CSC from assets and added it to assumed liabilities. According to the auditor, the subsidiary's tax manager said the parent and subsidiary created the receivable at sale as additional consideration. The taxpayer's conference representative questioned the change but had not participated in the transaction and could not explain it. He received time to supplement the record, then submitted the same division and subsidiary records the auditor had used; those April 1 records established neither a preexisting receivable nor whether the tax manager's explanation was correct.

The adjustment yielded $45,821,337 of assets—$52,724,337 less the receivable—and $24,650,711 of consideration—$17,747,711 plus the receivable. No receivable agreement, account history, general ledger, creation entry, payment, tax-manager statement, interview note, post-conference explanation, or independent evidence resolves the disputed $6,903,000.

The taxpayer's representative asserted that no liability was directly attached to transferred tangible property, as a UCC-1 filing might show. But he did not know details of the note payable-affiliate or miscellaneous other liabilities. He used $3,604,783 of accrued payroll for employees who used the equipment as an example of an indirect link he considered insufficient. He also proposed a hypothetical zero measure when assumed liabilities were specifically attached to real estate. The source supplies no UCC search, filing, payroll record, note, affiliate, miscellaneous-liability schedule, real property, lien, debt-purpose tracing, or answer confined to the hypothetical.

Section 6051 imposed sales tax on a retailer's gross receipts from California retail sales of tangible personal property; section 6006(a) defined a sale as transfer of title or possession for consideration; Civil Code section 1605 supplied the quoted benefit-or-prejudice definition of consideration; and section 6012(a), (b)(2) valued gross receipts in money, cash, credit, property, or otherwise. Szabo Food Service, Inc. v. State Board of Equalization, 46 Cal.App.3d 268, supported requiring the receipt to be consideration for the sold property rather than something else. The reporter resolved to the named case.

Beatrice, 6 Cal.4th 767, addressed a parent division spin-off for first-issue stock plus assumed liabilities and valued the assumption at the cost of paying debts or fulfilling obligations. Cal-Metal Corp. v. State Board of Equalization, 161 Cal.App.3d 759, treated assumed liabilities as sale consideration and rejected a partial allocation where the buyer assumed all liabilities. United States Lines, Inc. v. State Board of Equalization, 182 Cal.App.3d 529, treated a separate leaseback agreement itself as consideration for crane transfers. All three reporters resolved to the named cases. The source reproduces none of the opinions and does not say its facts matched every detail of those transactions.

The Department applied Board Audit Manual section 1005.10 to comply with Regulation 1595(b)(4). It excluded property merely leased by the taxpayer. The formula divided taxable California tangible personal property by total transferred assets, then multiplied by taxable consideration. No Audit Manual page, regulation text, list of excluded leased assets, classification schedule, or workpaper is included.

The later unredacted explanation identifies $3,044,027 as California taxable-property net book value. Dividing it by $45,821,337 of adjusted assets and multiplying by $24,650,711 of adjusted consideration yields the recommended $1,637,609 measure. The Department could have used the $3,044,027 net book value but used the lower formula amount. No rounding convention, depreciation support, fair-market-value evidence, asset-level situs, inventory classification, county, district, local component, rate, or resulting tax is supplied.

Ryan found one sale of $45,821,337 of assets for first-issue stock plus the promise to assume $24,650,711 of liabilities. The parties had not allocated particular debts to particular assets, and the subsidiary assumed all division liabilities for all assets. Direct attachment to the California equipment was not required. With no more reasonable allocation, he accepted $1,637,609 and said an adjustment required satisfactory supporting evidence.

The live annotation preserves the spin-off asset classes, wholly owned commencing subsidiary, first-issue stock, assumed liabilities, no-direct-attachment position, all-assets consideration rule, allocation requirement, and March 8, 1994 date. But it presents None of the liabilities ... was attributable as an unqualified fact, while the source says the taxpayer's representative contended and represented this, lacked knowledge of two categories, and did not rebut the $6.903 million reclassification. It omits all amounts, disputed receivable, incomplete post-conference submission, Audit Manual formula, four cases, statutory definitions, recommendation, evidence condition, missing Exhibit 1 and records, and absent final outcome.

Ryan signed the recommendation w/Exhibit 1, but no exhibit follows in the official PDF and the signature-date line is blank. No redetermination, taxpayer response, final Board action, notice, payment, claim, appeal, or later outcome is supplied.

What this means for you

Companies spinning off a division

Moving assets to a new subsidiary for stock plus assumed liabilities can create taxable consideration. Debt need not be secured by or directly attached to a specific equipment item.

Accountants and tax professionals

Support each asset and liability classification, value, location, and allocation with contemporaneous agreements and ledgers. Reconcile intercompany receivables and tax-manager explanations, direct and indirect liability relationships, leased-property exclusions, and formula inputs; a zero allocation needs evidence.

Common questions

Q: Why did assumed liabilities count as consideration?
A: The subsidiary's promise relieved the parent of obligations and was given in exchange for the complete asset transfer.

Q: Was the entire $24,650,711 taxed?
A: No. The Department allocated consideration because the transfer included real property and intangible rights outside the sales-tax base.

Q: How did the Department calculate the measure?

A: It multiplied $24,650,711 of adjusted consideration by the ratio of $3,044,027 of California taxable tangible property to $45,821,337 of adjusted total assets, producing $1,637,609.

Q: What taxable measure was upheld?
A: $1,637,609 for the California tangible personal property.

Q: What happened to the parent's zero-measure argument?
A: It was rejected because the parties transferred all assets for stock and the assumption of all liabilities without allocating particular debts to particular assets.

Q: Why was $6,903,000 moved from assets to liabilities?

A: The auditor said the subsidiary's tax manager identified the intercompany receivable as sale-created additional consideration. The taxpayer's representative could not rebut or confirm that explanation with the records submitted.

Q: Did the source establish that no liability related to tangible property?

A: No. That was the taxpayer's position. Its representative lacked details for the affiliate note and miscellaneous liabilities, and no UCC or debt-tracing record is supplied.

Q: Was the $3,044,027 equipment book value used as tax measure?

A: No. Counsel says the Department could have used it but instead accepted the lower $1,637,609 allocation.

Q: Is Exhibit 1 included?

A: No. The source repeatedly relies on it and says it accompanied the recommendation, but the published PDF ends without it.

Q: Was the no-adjustment recommendation finally adopted or paid?

A: The source does not say.

Citations and references

• California Civil Code § 1605
• California Revenue and Taxation Code §§ 6006(a), 6012(a) and (b)(2), and 6051
• California Sales and Use Tax Regulation 1595(b)(4)
• Board Audit Manual § 1005.10 — formula described; manual text not included
• Beatrice Co. v. State Board of Equalization, 6 Cal.4th 767
• Szabo Food Service, Inc. v. State Board of Equalization, 46 Cal.App.3d 268
• Cal-Metal Corp. v. State Board of Equalization, 161 Cal.App.3d 759
• United States Lines, Inc. v. State Board of Equalization, 182 Cal.App.3d 529
• Exhibit 1, petition, audit records, agreements, assets, liabilities, intercompany receivable, tax-manager statement, UCC records, stock, calculations, post-conference evidence, redetermination, Board action, notice, payment, claim, appeal, and outcome — described or implicated but not included

Verbatim support

From the official March 8, 1994 Stephen A. Ryan decision and recommendation:

The law in the case of an assumption of liabilities given in exchange for assets does not limit the taxable consideration only to those liabilities, if any, which were directly attached to the specific tangible personal property asset(s) in question.

The parties did not allocate any particular debt amount to any specific asset.

In the absence of any other more reasonable allocation under these circumstances, we find that $1,637,609 is the consideration paid for the assets in question and, thus, constitutes the measure of petitioner's resulting sales tax liability.

Redetermine without adjustment.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.2158
• Original supporting opinion: 395.2158 PDF

Original ruling text

STATE OF CALIFORNIA

395.2158

BOARD OF EQUALIZATION
BUSINESS TAXES APPEALS REVIEW SECTION
In the Matter of the Petition
for Redetermination Under the
Sales and Use Tax Law of:

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C--- S--- CORPORATION
Petitioner

DECISION AND RECOMMENDATION

No. SY – XX XXXXXX-010

The Appeals conference in the above-referenced matter was held by Staff Counsel Stephen A. Ryan on February 9, 19XX in Hollywood, California. Appearing for Petitioner:

Ms. S--- R--Senior Accounting Specialist
Mr. D--- L--Manager, State & Local Taxes

Appearing for the
Sales and Use Tax Department:

Mr. Raul Gonzales
Supervising Tax Auditor
Protested Item

The protested tax liability for the period April 1, 198X through December 31, 199X is measured by:

State, Local
and County

Item

A.

Unreported gross receipts from the
sale of furniture and equipment
to I--- I--- N--Services, Inc.

$X,XXX,XXX

Petitioner's Contentions

1. The measure of tax is zero; thus, there is no sales tax.
2. If tax applies, the measure is too high.

C--- S--- CORPORATION
SY – XX XXXXXX-010

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March 8, 1994
395.2158

Summary
Petitioner designs, integrates, installs, and operates computer and communications systems, plus makes some sales of tangible personal property. The most recent prior Board audit covered a period which ended on March 31, 1987. On April 1, 1988, petitioner performed a "spin off" of one of its many divisions by transferring the real property, intangible rights, office equipment, computers, furniture and other equipment, from petitioner's I--- division to a commencing wholly owned subsidiary corporation in exchange for first issue stock in that subsidiary plus the subsidiary's written agreement promising to assume petitioner's liabilities that were associated with that division. Attached hereto as Exhibit 1 is a copy of petitioner's statement of the specific assets transferred and liabilities assumed. The Department imposed sales tax against petitioner measured by $X,XXX,XXX as the estimated portion of the tangible personal property assets located in California at the time of the sale. Petitioner initially contended that the transfer was not a sale and, thus, not taxable. However, since the recent decision in Beatrice Company v. State Board of Equalization (1993) 6 Cal.4th 767, Mr. L--- said that petitioner has dropped that contention. He represented that petitioner now only disputes the tax measure, although he still stated several times at the Appeals conference that there was no consideration paid for the property in question. The Department found that on the date of sale, petitioner's total net book value of the California tangible personal property assets transferred was $X,XXX,XXX. The total value of all assets then transferred was $XX,XXX,XXX. The Department calculated the
$X,XXX,XXX tax measure pursuant to a Board Audit Manual formula (see section 1005.10) which was intended to comply with Regulation 1595(b)(4) in order to establish a tax measure consisting of the portion of the liabilities assumed which is attributable to the California noninventory tangible personal property transferred. No assets merely leased by petitioner were included. That formula computes the sales tax measure as follows: Taxable tangible personal property transferred Total assets transferred

x

taxable consideration

The Department used the following calculations for this particular transfer to reach the $X,XXX,XXX result:
$X,XXX,XXX
($52,724,337 - $6,903,000)

x

($17,747,711 + $6,903,000)

The $52,724,337 amount represents the "total assets transferred/ received" as shown on Exhibit

1. The $17,747,711 is also from Exhibit 1 as the "total liabilities transferred/assumed". The
   Department deleted the $6,903,000-Exhibit 1 "receivable from CSC [petitioner]" from the assets

C--- S--- CORPORATION
SY – XX XXXXXX-010

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March 8, 1994
395.2158

and included it in the liabilities assumed because the auditor represented that Mr. G--- B---, as the tax manager of the subsidiary, told the auditor that such receivable had only been created by petitioner and the subsidiary at the time of the sale as additional consideration for this transfer. At the conference, Mr. L--- questioned this $6,903,000 change by the auditor. Mr. L--- was asked to explain, but could not since he had not been involved in the transaction. He was allowed time to submit information after the conference, but he merely submitted the records used by the auditor. These various records of the division and of the subsidiary, each dated April 1, 1988, do not by themselves clarify either that there had been an existing receivable of petitioner prior to April 1, 1988, or that Mr. B---'s explanation was right or wrong. Mr. L--- contends that none of the liabilities which the subsidiary assumed was attributable to any tangible personal property transferred. He argues that although there was consideration for the sale, such consideration is all attributable to the intangible rights also transferred. He thus believes that the measure of sales tax on the transfer of the tangible personal property is zero. Mr. L---'s position is that there must be a direct relation between a particular liability and a specific asset in order to be "attributable". He believes that any indirect connection, such as the $3,604,783 "accrued payroll" liability for the employees who used the computers, furniture, etc., is insufficient to be "attributable". Mr. L--- represented that there were no specific liabilities attached to any of the transferred tangible personal property assets in question, such as would be evidenced by a UCC1 filing with the California Secretary of State. However, he did not know the details of the "note payable-affiliate" or "miscellaneous other liabilities" obligations assumed by the subsidiary. A zero sales tax measure was suggested by Mr. L--- in the following hypothetical case: a retailer transfers equipment to a person, in exchange for the transferee's assumption of the retailer's liabilities which were specifically attached to a nontangible personal property asset such as real estate. Analysis and Conclusions What is the measure of the sales tax? Sales tax is imposed upon a retailer measured by the gross receipts which he or she derived from California retail sales of tangible personal property (Revenue and Taxation Code section 6051). "Sale" is defined as the transfer of title or possession of that property for consideration (Rev. & Tax. Code § 6006(a)). "Consideration" for Sales and Use Tax Law purposes is defined in Civil Code section 1605 as follows: "Any benefit conferred, or agreed to be conferred, upon the promisor, by any other person, to which the promisor is not lawfully entitled, or any prejudice suffered, or agreed to be suffered, by such person, other than such as he is at the time of

C--- S--- CORPORATION
SY – XX XXXXXX-010

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March 8, 1994
395.2158

consent lawfully bound to suffer, as an inducement to the
promisor, is a good consideration for a promise." (Emphasis added.) "Gross receipts" is defined to mean the total amount of the sale price of the retail sales of retailers, valued in money, whether received in money, cash, credit, property, or otherwise (Rev. & Tax. Code § 6012(a), (b)(2)). However, gross receipts must be provided as consideration for the property sold, rather than be provided for some other reason (Szabo Food Service, Inc. v. State Board of Equalization (1975) 46 Cal.App.3d 268, 272-273). The California Supreme Court has recently held that there is a measurable valuable consideration which is subject to sales tax as the result of the California retail sale of tangible personal property assets from a parent corporation's spin-off of one of its divisions to a commencing wholly owned subsidiary corporation in exchange for the subsidiary's first issue stock plus the subsidiary's assumption of the liabilities of that division (Beatrice, supra). The assumption was held to have "value equal to the cost to the promisor of paying its debts or fulfilling its obligations" (Beatrice, at p. 783). Further, the court in Cal-Metal Corp. v. State Board of Equalization (1984) 161 Cal.App.3d 759, 764-765, opined generally as follows regarding a similar situation: "The assumption of liability owed by a transferor of property can constitute the consideration for the transfer. That consideration is the measure of the sales price and thus the measure of the ultimate tax liability." However, in that situation, the liabilities which were assumed were "the liabilities on the equipment" (Cal-Metal, supra, p. 762). Petitioner believes this factor is critical. On the basis that the purchaser had assumed "all" the liabilities, the Cal-Metal court rejected that taxpayer's argument to allocate only 50 percent of the liabilities (pp. 768-769). In United States Lines, Inc. v. State Board of Equalization (1986) 182 Cal.App.3d 529, the court upheld the sales tax on the transfer of cranes in exchange for the full value of the purchaser's execution of a separate lease agreement whereby the purchaser leased those cranes back to the seller. Thus, the consideration for the sale was a separate agreement itself. Here, the Department has not used as the measure of sales tax the full
$24,650,711 ($17,747,711 plus $6,903,000) amount of liabilities which were assumed by the subsidiary. This is because petitioner also then sold real property and intangible rights, and the Board does not impose sales tax on consideration paid for those rights. The Department has merely attempted to make a reasonable allocation of that $24,650,711 total to the total
$45,821,337 assets transferred such that California sales tax is only imposed upon an amount representing the valuable consideration paid for the tangible personal property assets located in California when transferred. The Department could have used the $3,044,027 net book value of

C--- S--- CORPORATION
SY – XX XXXXXX-010

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March 8, 1994
395.2158

such taxable assets, but did not. It reasonably used only a $1,637,609 measure as a result of its Audit Manual formula. We reject petitioner's proposed method of establishing the sales tax measure. Petitioner desires an unreasonable allocation which would attribute zero to those tangible personal property assets which were located in California when transferred. The substance of petitioner's contention is that there was no consideration attributed to such property because all the consideration involved in the transfer was attributable to the other property (nontangible) also transferred. This analysis ignores both the substance of what took place and the applicable laws. Petitioner and the subsidiary made an agreement and then acted in accordance with it. They made one sale of $45,821,337 worth of assets in exchange for the subsidiary's first issue stock plus the subsidiary's promise to assume $24,650,711 of petitioner's liabilities. The parties did not allocate any particular debt amount to any specific asset. As in Cal-Metal, the subsidiary assumed all the liabilities in consideration for receipt of all the assets. That amount is consideration for all the assets transferred, including the tangible personal property assets located in California. The law in the case of an assumption of liabilities given in exchange for assets does not limit the taxable consideration only to those liabilities, if any, which were directly attached to the specific tangible personal property asset(s) in question. In the absence of any other more reasonable allocation under these circumstances, we find that $1,637,609 is the consideration paid for the assets in question and, thus, constitutes the measure of petitioner's resulting sales tax liability. Without evidence to support Mr. L---'s allegations about the $6,903,000 amount, we uphold the auditor's findings and conclusions based upon his actual examination of petitioner's records and specific explanations from the subsidiary's tax manager. To obtain an adjustment, petitioner will need to submit satisfactory evidence to support its position.

Recommendation

Redetermine without adjustment.

Stephen A. Ryan, Senior Staff Counsel

w/Exhibit 1

Date