Could a subsidiary transfer all operating property and liabilities to Newco, then spin Newco through the corporate chain to the same public-company shareholders without tax?

Plain-English summary

A Virginia telecommunications subsidiary with its executive office in California proposed transferring its facsimile-and-telecommunications business property and liabilities to a new wholly owned subsidiary for first-issue stock. It would retain 339,300 Class A shares of the public ultimate parent and an intercompany receivable. The Newco stock would then move up the corporate chain, into another new subsidiary, and finally be distributed to the public parent's Class A and closely held Class B shareholders in the same proportions as their parent-company ownership.

Tax Counsel Elizabeth Abreu concluded that the proposed property transfer met the all or substantially all test because every item of tangible personal property used in the business would transfer; the two retained items were intangible. Ultimate ownership also appeared substantially similar because the same shareholders would own Newco indirectly in the same proportions. That conclusion assumed only routine public Class A trading immediately before distribution, no unusual stock transactions immediately afterward, and independent business purposes other than avoiding California sales or use tax.

Sections 6367 and 6281 therefore appeared to exempt the tangible property and vehicles. Newco's assumption of every liability was consideration and entered gross receipts, but the conditional exemptions sheltered those receipts. Stock transfers within the reorganization would not undo the exemptions on the stated business-purpose assumptions.

If section 6006.5(b) failed, first-issue stock would not independently protect the transfer because Newco also assumed liabilities and T--- sold and leased tangible property under a seller's permit. The starting consideration would be all assumed liabilities—including accounts payable, accrued employee benefits, and real-property-secured debt—allocated by California tangible-property value over total transferred-property value. The letter's illustration applies $5 million of liabilities × ($2 million of California tangible property ÷ $10 million of all property) to reach a $1 million tax measure.

The letter also directs Newco to seek BT-111 vehicle exemption certificates from a local Board Compliance Supervisor or Tax Compliance Specialist and present the certificates to DMV. It supplies no completed reorganization, federal ruling, clearance, actual value, allocated measure, return, assessment, or outcome.

Proposed property, six questions, assumptions, and missing outcome

The opinion answers the correspondent's November 24, 1992 letter, which is not included. T--- was a Virginia corporation with a California executive office, conducted its facsimile and other telecommunications development, sales, leasing, and servicing business in all 50 states, and held a California seller's permit. It was wholly owned through two Delaware corporations. The ultimate parent's Class A stock traded on NASDAQ/NMS and had more than 2,800 holders; approximately 13 persons held its Class B stock.

T--- proposed keeping only 339,300 ultimate-parent Class A shares and an intercompany receivable. It would move all other business tangible and intangible property plus every liability to Newco. The listed assets were cash; notes, accounts, and contract receivables; inventory; prepaid expenses; buildings and improvements; machinery and equipment; equipment regularly leased to customers; leaseholds and improvements; motor vehicles; subsidiary stock; deferred income taxes; and other assets. The listed liabilities were trade accounts payable, accrued liabilities, and deferred service, interest, and rent.

No request, organization chart, seller's permit, shareholder list, stock-market record, plan, asset or liability schedule, intercompany account, agreement, stock certificate, vehicle record, title, valuation, accounting record, or transfer document is included. The source gives no asset or liability values for the actual transaction.

Immediately after receiving first-issue Newco stock, T--- would own all of Newco. Under a plan adopted for valid business purposes, T--- would distribute Newco stock to its parent, which would distribute it to the public ultimate parent. That parent would contribute Newco stock to newly formed Industries for all Industries stock. It then would distribute Industries Class A shares one-for-one to its Class A holders other than T--- and Class B shares one-for-one to its Class B holders. Industries would become independent of the public parent, its owners would hold it in the same proportions as the parent, and its principal asset would be Newco stock.

The requester said this would qualify federally under Internal Revenue Code sections 368(a)(1)(D) and 355, but also said an IRS ruling was pending. Abreu did not give a federal opinion, and the source supplies no IRS request, ruling, reorganization plan, corporate approval, distribution, closing, or evidence that the proposed steps occurred.

Question one asked whether sections 6006.5(b), 6367, and 6281 exempted the property transfer. Section 6367 covered occasional transfers of tangible personal property but not vehicles; section 6281 supplied a similar vehicle exemption. Regulation 1595(b)(2) defined substantially all as at least 80 percent of all activity property, including out-of-state tangible property, without real or intangible property in the denominator. It also defined substantially similar ownership as at least 80 percent unchanged. The source cites Business Taxes Law Guide Annotations 395.1260 and 395.1500 on excluding real and intangible property from that test.

Because T--- would transfer all business tangible property and retain only intangible assets, the property limb was satisfied. Abreu also found the ultimate owners before and after to be the public parent's Class A and Class B shareholders. But the Board would scrutinize a quick subsidiary-stock transfer to outsiders and disregard it as a direct taxable property sale when the only business purpose was sales-or-use-tax avoidance. Routine trading in publicly traded parent stock would not alone defeat occasional-sale treatment.

The answer depended on two timing assumptions: immediately before the Industries distribution, ownership changes would arise only from routine public trading in Class A shares; immediately after it, no unusual stock transaction would occur. The source provides no trading window, shareholder register, transaction, later stock disposition, business-purpose document, or completed ownership calculation.

Question two asked whether assumed liabilities were nontaxable consideration if section 6006.5(b) applied. Abreu answered that the liabilities were consideration included in gross receipts, but sections 6367 and 6281 appeared to exempt those gross receipts.

Question three asked whether Regulation 1595(b)(4)'s first-issue-stock rule would exempt the sale if section 6006.5(b) failed. Abreu answered no: T--- sold and leased tangible property, held a seller's permit, did not qualify under section 6006.5(a), and received additional consideration through Newco's liability assumption.

Question four asked which liabilities entered the measure if the occasional-sale exemption failed. The starting point was every liability Newco assumed, including accounts payable, accrued employee benefits, and debt secured by real property. The allocation fraction was California tangible-personal-property value divided by total value of all property transferred. In the hypothetical, $5 million of liabilities multiplied by $2 million over $10 million yielded a $1 million tax measure. No source shows those illustrative amounts were T---'s values or supplies an actual allocation, taxable measure, rate, or tax.

Question five asked how to clear the transferred vehicles. Newco was to call a local Board office for the Compliance Supervisor or Tax Compliance Specialist handling BT-111 Forms, obtain the Board-issued exemption certificates and required-document list, present the forms to DMV, and provide the local office a copy of the opinion. No BT-111 form, office, vehicle list, application, certificate, DMV registration, fee, approval, rejection, or later procedure is supplied.

Question six asked whether the internal stock transfers created California sales or use tax consequences. The source's final answer is narrower than the live annotation's standalone no-tax conclusion: if the Newco-stock transfers had an independent business purpose and were not part of a plan whose sole purpose was transferring tangible property tax-free, they would not affect the exemptions or make the property transfer taxable.

That answer refers to the sections 6006.5(b) and 6387 exemption, although the opinion had relied repeatedly on section 6367 and the live annotation says no tax under the stated conditions. The record contains no correction or other explanation for 6387, so both source wordings are preserved rather than silently reconciled.

The live annotation preserves the ownership chain, proportional distribution, three headline conclusions, business-purpose condition, and January 15, 1993 date. It omits the retained intercompany receivable; business and seller's-permit facts; detailed asset and liability lists; pending IRS ruling; 80-percent tests; disregard rule; routine-trading and no-unusual-transaction timing assumptions; liability-as-consideration analysis; fallback allocation and $1 million example; BT-111 process; 6387 wording; missing records; and absent transaction and tax outcome.

What this means for you

Corporate groups planning a spin-off

Track each property and stock transfer, ultimate shareholder ownership, trading around the distribution, and a contemporaneous independent business purpose. This was a conditional prospective answer, not proof that a completed spin-off qualified.

Accountants and tax professionals

Verify both 80-percent tests, document every retained and transferred asset and liability, and preserve vehicle-clearance support. If the exemption fails, allocate all assumed liabilities using California tangible-property value and the value of the complete transferred-property pool.

Common questions

Q: What property had to transfer?
A: At least 80 percent of all tangible personal property used in the business, including out-of-state property. The proposal moved all of it and retained only ultimate-parent shares and an intercompany receivable, both intangible.

Q: Why did the later shareholder distribution not break continuity?
A: The same Class A and Class B shareholders would own Newco indirectly in the same proportions, assuming only routine Class A trading immediately before distribution and no unusual stock transaction immediately afterward.

Q: Did assumed liabilities count as consideration?
A: Yes, but the applicable occasional-sale and vehicle exemptions made the resulting gross receipts exempt.

Q: Would first-issued stock alone save the transfer if continuity failed?
A: No. The assumed liabilities were additional consideration under Regulation 1595(b)(4).

Q: How would the measure be calculated if the exemption failed?

A: Start with all assumed liabilities and multiply by California tangible-property value divided by total transferred-property value. The hypothetical was $5 million × ($2 million ÷ $10 million) = $1 million.

Q: Did real-property-secured debt enter the starting liabilities?

A: Yes. The letter expressly included it, along with accounts payable and accrued employee benefits, before allocation.

Q: How were transferred vehicles to be cleared?

A: Newco was to obtain Board BT-111 exemption certificates through the responsible local-office compliance staff, present them to DMV, and show the local office this opinion.

Q: Did the IRS confirm the federal reorganization and spin-off treatment?

A: The requester said a ruling was pending. No IRS ruling is included.

Q: Does the source cite section 6367 or 6387?

A: It repeatedly cites 6367, but the last substantive paragraph prints 6387. No supplied record resolves that apparent conflict.

Q: Did the proposed reorganization close or produce a tax result?

A: The source does not say. It gives no completed transfer, actual allocation, clearance, return, assessment, or later outcome.

Citations and references

• California Revenue and Taxation Code §§ 6006.5(a), 6006.5(b), 6281, and 6367
• California Revenue and Taxation Code § 6387 — source-printed once in the final answer, where the record otherwise identifies § 6367
• California Sales and Use Tax Regulation 1595(b)(2) and (b)(4)
• Internal Revenue Code §§ 355 and 368(a)(1)(D) — requester's expected federal treatment; IRS ruling pending
• Business Taxes Law Guide Annotations 395.1260 and 395.1500 — cited by the opinion on excluding real and intangible property from the tangible-property test
• BT-111 Forms — Board vehicle-exemption certificates described but not included
• November 24, 1992 request; IRS submission and ruling; organization, shareholder and trading records; business-purpose evidence; property and liability schedules; agreements; stock, receivable, vehicle, value and allocation records; returns; audit; assessment; payment; claim; appeal; and outcome — described or implicated but not included

Verbatim support

From the official January 15, 1993 Elizabeth Abreu opinion:

According to your letter, T--- will transfer all of its tangible personal property to Newco. The only property T--- will retain is intangible property. Therefore, the "all or substantially all of the property" requirement is met.

We are assuming that the only changes in ownership interests in A--- immediately before distribution of the Industries stock to its shareholders will be due to routine public trading of its Class A shares. We are also assuming that immediately after the transfer of the Industries stock to the shareholders of A--- there will be no other unusual stock transactions.

Assumption of liabilities is consideration and is included in the gross receipts from the sale of tangible personal property. However, since the exemptions under sections 6367 and 6281 appear to apply to the sale of the tangible personal property to Newco, the gross receipts from this sale are exempt from tax.

If the transfer to Newco is not an occasional sale under section 6006.5(b), the starting point for determining the measure of tax is the total amount of liabilities assumed by Newco, including accounts payable, accrued employee benefits, and indebtedness secured by real property.

Newco should call a local Board office and ask for the Compliance Supervisor or Tax Compliance Specialist who handles the BT-111 Forms.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.2161.010
• Original supporting opinion: 395.2161.010 PDF

Original ruling text

395.2161.010

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

MEMBER
First District

1020 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) 324-8208

BRAD SHERMAN
Second District, Los Angeles
ERNEST J. DRONENBURG, JR.
Third District, San Diego
MATTHEW K. FONG
Fourth District, Los Angeles

January 15, 1993

GRAY DAVIS
Controller, Sacramento
────────
BURTON W. OLIVER
Executive Director

Ms. R--- N. H--S---, B---, G---, S--- & M--XXXX --- ---, Suite XXX
--- ---, CA XXXXX
Re:

SY -- XX-XXXXXX

Dear Ms. H---:
This is in response to your letter dated November 24, 1992 in which you state: "A.

Introduction

"The facts of the transaction are as follows. T--- Corporation ('T---') is a Virginia corporation with its executive office located in --- ---, California. The principal business of T--- involves the development, sale, leasing and servicing of facsimile and other telecommunications equipment and supplies. T--- conducts business in all 50 states. T--holds California sales tax permit number SY -- XX-XXXXXX in connection with its business. T--- is a presently a wholly owned subsidiary of A--- - M---, Inc. ('A--- M---'), a Delaware corporation, which is a wholly-owned subsidiary of A--- G---, Inc. ('A---'), a Delaware corporation. Shares of A---'s Class A Common Stock are traded over the National Market System of the National Association of Securities Dealers, Inc. Automated Quotation System ('NASDAQ/NMS') and are held by more than 2,800 persons. Shares of A---'s Class B Common Stock are held by approximately 13 persons. "B.

The Transaction

"The assets of T--- consist of (a) tangible and intangible property located within and without California used in the course of its facsimile and telecommunications business, and (b) 339,300 shares of Class A common stock of A--- (the 'A--- Shares') and an intercompany receivable due from A--- (the 'A--- Receivable'). T--- proposes to transfer all of its assets other than the A--- Shares and the A--- Receivable, i.e., all of the

Ms. R--- N. H---

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395.2161.010

tangible and intangible property used in the course of its facsimile and telecommunications business, together with all of its liabilities, to a newly formed subsidiary hereafter referred to as 'Newco', in exchange for first issue stock of Newco. Immediately after the transfer, T--- will own 100% of the issued and outstanding shares of stock of Newco. "The assets to be transferred by T--- to Newco consist of the following: Cash Notes, accounts and contracts receivable Inventories Prepaid expenses Buildings and improvements Machinery and equipment Leasing Equipment (1) Leaseholds and improvements Motor vehicles Stock of subsidiaries Deferred income taxes Other assets (1)

Leased to customers in the regular course of
business.

"The liabilities to be transferred from T--- to Newco consist of the following items: Accounts payable, trade Accrued liabilities Deferred service, deferred interest, deferred rent "C.

The Reorganization After the Transaction

"Immediately after T--- transfers the above-described assets and liabilities to Newco and receives the shares of Newco stock, and pursuant to a plan of reorganization adopted by A--- for valid business purposes, T--- will distribute the shares of Newco to its parent, A---Mayfair, who will in turn distribute the shares of Newco to its parent, A---, who will then contribute the shares of Newco to a newly-formed subsidiary, T--- Industries, Inc. ('Industries') in exchange for all of the issued and outstanding shares of Industries. As a result, Newco will become a wholly-owned subsidiary of Industries, which in turn will be a wholly-owned subsidiary of A---. A--- will then 'spin-off' and distribute the Class A common shares of Industries to its Class A shareholders (other than T---) on a one-share-for-one-share basis, and

Ms. R--- N. H---

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will distribute the Class B Common share of Industries to its Class B shareholders on a oneshare-for-one-share basis. As a result of the distribution of the Industries stock to the A--shareholders, Industries will become independent of A--- and at the date of the distribution will be owned by the shareholders of A--- in the same proportion that they own shares of A---. The principal asset of Industries will be all of the stock of Newco. The above transaction will qualify as a tax-free reorganization and a tax-free spin off under Sections 368(a)(1)(D) and 355, respectively, of the Internal Revenue Code; a ruling to this effect is presently pending with the Internal Revenue Service." With respect to these transactions you have asked the following questions: "1. Are we correct in our conclusion that the transfer of assets by T--to Newco qualifies as an exempt occasional sale pursuant to CRTC Sections 6006.5(b), 6367 and 6281?" Revenue and Taxation Code section 63671/ exempts from sales and use tax occasional sales of tangible personal property and the storage, use, or other consumption in this state of tangible personal property, the transfer of which to the purchaser is an occasional sale. The exemption does not apply to motor vehicles; however, section 6281 provides an exemption for sales and purchases of motor vehicles which is similar to the exemption which applies to occasional sales defined under section 6006.5(b). Section 6006.5(b) includes the following definition of an occasional sale: "(b) Any transfer of all or substantially all the property held or used by a person in the course of those activities when after the transfer the real or ultimate ownership of the property is substantially similar to that which existed before the transfer. For the purposes of this section, stockholders, bondholders, partners, or other persons holding an ownership 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." Regulation 1595(b)(2) provides that "substantially all of the property" means 80 percent or more of all the tangible personal property held or used in the course of activities, including tangible personal property located outside of this state. Real property and intangible property are not included in the test to determine if there was a transfer of substantially all of the property. See BTLG, Annotations 395.1260 and 395.1500.

1/

Unless otherwise noted, all further statutory references are to the Revenue and Taxation Code.

Ms. R--- N. H---

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Regulation 1595(b)(2) also provides that the real or ultimate ownership is "substantially similar" to that which existed before a transfer if 80 percent or more of that ownership of the tangible personal property is unchanged after the transfer. According to your letter, T--- will transfer all of its tangible personal property to Newco. The only property T--- will retain is intangible property. Therefore, the "all or substantially all of the property" requirement is met. It also appears that the real or ultimate ownership requirement is met. Immediately before and after the transfer, the ultimate owners of the property are the Class A and Class B common stock shareholders of A--- since Newco is a wholly-owned subsidiary of T---, which is a wholly-owned subsidiary of A--- - M---, which is a wholly-owned subsidiary of A---. The Board, however, will scrutinize a transaction where the shares of a subsidiary are sold or transferred to third parties immediately after the transfer of property to the subsidiary. If there is no business purpose other than the avoidance of sales or use tax for the transfer of assets to a subsidiary and thereafter a transfer of its stock to a third party, the Board will disregard the transaction and will regard the transaction as a sale of tangible personal property from the parent corporation to the third party. Where the stock of a parent corporation is publicly traded, the Board will not disregard a transaction as an occasional sale merely because the real or ultimate ownership changes because of routine public sales and purchases of publicly traded stock. From the facts you have given us, it appears that even after the several transfers of the stock of Newco, the real or ultimate ownership of the property transferred to Newco will be the Class A and Class B common stock shareholders of A--- and that such shareholders' ownership interests in Newco via Industries will be in the same proportion as their ownership interests in A---. We are assuming that the only changes in ownership interests in A--- immediately before distribution of the Industries stock to its shareholders will be due to routine public trading of its Class A shares. We are also assuming that immediately after the transfer of the Industries stock to the shareholders of A--- there will be no other unusual stock transactions. If these assumptions are correct, the exemptions under sections 6367 and 6281 apply to the transfer of the tangible personal property, including the motor vehicles, to Newco. "2. Are we correct in our conclusion that the assumption of liabilities by Newco is not taxable consideration provided the sale qualifies as a CRTC Section 6006.5(b) occasional sale?" Assumption of liabilities is consideration and is included in the gross receipts from the sale of tangible personal property. However, since the exemptions under sections 6367 and 6281 appear to apply to the sale of the tangible personal property to Newco, the gross receipts from this sale are exempt from tax.

Ms. R--- N. H---

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"3.
In the event the CRTC Section 6006.5(b) occasional sale test is not met, would the sale be otherwise exempt pursuant to Sales and Use Tax Regulation 1595(b)(4)?" No. T--- received consideration in the form of assumption of liabilities by Newco. Since T--- is engaged in the business of selling and leasing tangible personal property and holds a seller's permit, its sale of tangible personal property to Newco does not qualify as an occasional sale under section 6006.5(a). Tax would apply because Regulation 1595(b)(4) provides that tax applies if the transferor receives any consideration other than the first issue of stock, such as an assumption of indebtedness, and the transfer does not otherwise qualify for exemption. "4. If the answer to question 3 is yes except for the fact that liabilities are being transferred, what liabilities assumed by Newco are subject to tax (i.e., accounts payable, accrued employee benefits, etc.) in determining other consideration pursuant to Regulation 1595(b)(4)?" If the transfer to Newco is not an occasional sale under section 6006.5(b), the starting point for determining the measure of tax is the total amount of liabilities assumed by Newco, including accounts payable, accrued employee benefits, and indebtedness secured by real property. This amount is multiplied by the ratio of the total value of the tangible personal property located in California to the total value of all property transferred to Newco. For example, if the total amount of liabilities assumed is $5,000,000 (and no other consideration is given), the total value of the tangible personal property located in California is $2,000,000, and the total value of all property transferred is $10,000,000, the measure of tax is $1,000,000.
[$5,000,000 X ($2,000,000/$10,000,000)]
"5.
What procedures are necessary to obtain clearances for vehicles transferred pursuant to CRTC Section 6281?" Newco should call a local Board office and ask for the Compliance Supervisor or Tax Compliance Specialist who handles the BT-111 Forms. These forms are exemption certificates issued by the Board for presentation to the DMV when registering vehicles whose purchases are exempt under section 6281. The supervisor or specialist will be able to explain the procedure for obtaining the form and to list all of the documents which must be presented for each vehicle. Newco should also present a copy of this letter to the local office. "6. Will any of the transfers of stock among the various entities as part of the reorganization plan described above have any California sales or use tax consequences?" As discussed under question 1, if the transfers of the Newco stock among the various entities as part of the reorganization plan which you described have an independent business

Ms. R--- N. H---

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purpose and are not part of a plan whose sole purpose is to transfer tangible personal property free of tax, the transfer of Newco stock will not affect the sections 6006.5(b) and 6387 exemption or cause the transfer of property to Newco to be taxable. If you have further questions regarding Sales and Use Tax Law, please do not hesitate to write again. Sincerely,

Elizabeth Abreu
Tax Counsel
EA:cl