Did a corporation make a taxable sale by paying one shareholder a cash dividend and another a stock dividend that greatly changed ownership percentages?

Plain-English summary

O--- D---, Inc. (ODI) had two corporate shareholders, F--- and G---, each holding 25,000 shares and 50 percent. ODI declared 32 additional common shares for each existing share—800,000 shares offered to each owner—with an option to take cash at $14.625 per share. F--- knew before declaration that G--- would choose cash. ODI obtained short- and long-term third-party loans, paid G--- cash, and distributed stock to F---, leaving 825,000 and 25,000 shares respectively and changing ultimate ownership by approximately 47 percent.

Senior Tax Counsel Warren Astleford concluded that the distributions were not taxable sales for two independent reasons. Stock certificates and cash were not tangible personal property for sales-and-use-tax purposes. The analysis also assumed neither shareholder provided consideration, promised ODI a new benefit, or assumed ODI debt; without consideration, there was no sale under section 6006(a).

The major percentage shift did not transfer the corporation's assets. Owning more corporate stock is different from owning the corporation's tangible property, which remained owned by the corporation.

The memorandum was expressly conditional. It assumed the distribution was not part of a step transaction designed to avoid or alter the parties' California sales-or-use-tax liabilities and that F--- would not next dissolve ODI to obtain assets through a nominally nontaxable liquidation. It provides no dividend resolutions, issued shares, cash amount, loans, articles, payment, later ownership or liquidation record, audit measure, assessment, or final outcome.

Auditor facts, two no-sale grounds, date conflict, and missing outcome

Astleford answered Out-of-State District employee Rusty Dane's September 9, 1997 memorandum, which is not included. The memorandum identifies ODI and its account only through redaction, quotes facts attributed to an auditor, and does not supply the audit report, workpapers, correspondence, questions, transactions, or proposed adjustment.

According to the auditor, ODI declared the dividend November 28, 1994. Each of the two 25,000-share owners was offered 32 shares per old share, or 800,000 new shares. The auditor said $14.625 per share was the company's actual value according to a Board of Directors memorandum, but that memorandum and its valuation support are absent. The source does not state the cash amount ODI actually paid.

F--- knew before declaration that G--- would take the cash option. ODI's board authorized ODI—not either shareholder—to assume additional short- and long-term debt to fund the dividend. The analysis says ODI borrowed from a third-party lender. No lender, note, principal, term, rate, security, proceeds, payment, board authority, ledger, or debt service is supplied.

The auditor also said ODI filed new articles of incorporation with the Oklahoma secretary of state just before paying the dividend. The source provides no articles, filing date, amendments, reason, legal effect, or relationship to California tax, and Astleford does not rely on that filing in the stated no-sale grounds.

The analysis says ODI distributed cash to G--- and stock to F---. It expressly assumes neither shareholder assumed any ODI debt and neither gave consideration, promised a benefit ODI lacked, or received tangible personal property. No dividend election, shareholder agreement, waiver, stock certificate, transfer ledger, cash record, canceled check, bank statement, loan-proceeds trace, debt assumption, or property schedule is included.

Section 6051 imposed sales tax on a retailer's California retail-sale gross receipts; sections 6201 and 6401 addressed use tax when sales tax did not apply. Regulation 1595(a)(6) and cited Annotation 395.1250 supported treating corporate stock as intangible even when federal income-tax treatment characterized a stock purchase as an asset acquisition. Cited Annotation 395.1992 supplied another stock-versus-assets example. The opinion reproduces none of those complete authorities.

Astleford's first ground was that neither cash nor a stock certificate was tangible personal property: the certificate indicated corporate ownership, while cash represented federally set value. His second ground was that neither shareholder provided consideration under section 6006(a). The source therefore found neither a sale nor a tangible-property transfer in the distributions.

A February 17, 1995 Deloitte & Touche letter reportedly said each shareholder owned 25,000 shares before ODI's November 28, 1995 declaration, then F--- and G--- held 825,000 and 25,000 shares. The source had already stated repeatedly that the declaration occurred November 28, 1994. The Deloitte letter is not included, and the record does not resolve whether 1995 is a typographical error, so the formal auditor account controls the page date while the conflict remains disclosed.

The post-distribution share counts yield approximately 97.06 percent for F--- and 2.94 percent for G---, consistent with the auditor's approximately 47-percent shift from equal ownership. But the memorandum's legal distinction did not depend on treating shareholders as owners of ODI's underlying property. ODI continued to own its tangible assets; F--- acquired stock, not an interest in individual assets.

The source footnote adds two assumptions. First, the dividend was not part of a series among ODI, F---, and G--- undertaken to avoid or alter California sales-or-use-tax liabilities. It cites Annotations 395.1840, 570.0100, and 395.2000 for disregarding intervening steps in a step transaction. Second, F--- would not next dissolve ODI through a nominally nontaxable liquidating distribution when a direct ODI-to-F--- asset transfer would have been taxable. The current live entries confirm that 395.1840 concerned a business-purpose-supported sequence and 395.2000 viewed dependent steps as a whole; 570.0100 concerns an out-of-state delivery lacking a sufficient business purpose. Those distinct facts are not imported into ODI's transaction.

The source's only federal statement is a footnote saying ODI intended the transaction to qualify under Internal Revenue Code section 368(a)(1)(E). It supplies no federal analysis, filing, ruling, return, recapitalization record, or confirmation, and Astleford did not make federal treatment a California no-sale ground.

The live annotation preserves the two equal 25,000-share owners, 32-for-one declaration, cash option, no consideration, ownership change, stock-versus-asset distinction, no-sale result, and October 21, 1997 date. It omits the September 9 request; November 28, 1994 declaration date; 800,000-share offers; $14.625 price; F---'s prior knowledge; third-party borrowing; Oklahoma articles; post-distribution share counts; auditor attribution; 1994/1995 conflict; shareholder-debt and tangible-property assumptions; federal intent; step-transaction and liquidation assumptions; cited authorities; missing records; and absent tax outcome. It adds (M99–1), while the supporting PDF supplies no M99–1 text or amendment explanation.

What this means for you

Corporations and shareholders

A stock-ownership change does not itself transfer corporate assets. Preserve resolutions, elections, share records, payment and borrowing records, and proof that the entity—not a shareholder—retained ownership of each asset.

Reorganization teams

Trace all consideration, promises, debt assumptions, property transfers, and planned follow-on steps. The result can change if the dividend is one stage of a broader asset-transfer or liquidation plan.

Accountants and tax professionals

Federal recapitalization intent did not control the California characterization. Reconcile corporate records and dates, then separately analyze tangible property, consideration, debt, and the whole transaction series.

Common questions

Q: Why was the stock dividend not taxable?
A: A stock certificate represented corporate ownership rather than a transfer of ODI's tangible personal property, and the analysis assumed the recipient gave no consideration.

Q: Why was the cash dividend not taxable?
A: Cash was not treated as tangible personal property, and the shareholder gave no consideration for it.

Q: Did the 50%-to-97% ownership shift amount to an asset sale?
A: No. The corporation continued to own its own assets.

Q: What facts could change the result?
A: Shareholder consideration or assumed debt, distribution of tangible property, or a coordinated series designed to transfer assets or avoid tax.

Q: How many shares did each owner have after distribution?

A: The absent Deloitte letter reportedly showed F--- with 825,000 and G--- with 25,000, after both began with 25,000.

Q: How did ODI fund the cash election?

A: The source says ODI obtained short- and long-term third-party loans. It gives no amount, lender, terms, or payment record.

Q: Did the shareholders assume ODI debt?

A: Astleford expressly assumed they did not. The source supplies no debt-assumption documents.

Q: Why do 1994 and 1995 both appear?

A: The auditor account repeatedly says November 28, 1994; the discussion's description of an absent February 17, 1995 Deloitte letter says November 28, 1995. No supplied record resolves the conflict.

Q: Did Oklahoma's new articles decide the tax answer?

A: No stated analysis relies on them. The auditor merely reported they were filed shortly before payment, and the articles are absent.

Q: Was federal recapitalization treatment confirmed?

A: No. A footnote states only that ODI intended to qualify under Internal Revenue Code section 368(a)(1)(E).

Q: Was there a final audit adjustment or assessment?

A: The memorandum supplies no amount, assessment, taxpayer response, claim, appeal, or later outcome.

Citations and references

• California Revenue and Taxation Code §§ 6006(a), 6051, 6201, and 6401
• California Sales and Use Tax Regulation 1595(a)(6)
• Sales and Use Tax Annotations 395.1250, 395.1992, 395.1840, 570.0100, and 395.2000
• Internal Revenue Code § 368(a)(1)(E) (the intended federal treatment noted in the source)
• September 9, 1997 district memorandum; auditor report and workpapers; November 28, 1994 board memorandum and declaration; February 17, 1995 Deloitte letter; Oklahoma articles; elections; shares; loans; payments; corporate-property records; federal treatment; returns; audit adjustment; assessment; claim; appeal; and outcome — described or implicated but not included
• (M99–1) — printed by the live annotation without supporting text or an amendment explanation in the PDF

Verbatim support

From the official October 21, 1997 Warren Astleford memorandum:

ODI’s distribution of stock and cash is not a taxable transfer for two reasons. First, stock certificates or cash are not regarded as tangible personal property for sales and use tax purposes.

Second, we understand that neither F--- nor G--- provided any consideration to ODI as part of the transfer of the stock or cash.

The key to what occurred, however, is the fact that the ownership of ODI’s tangible personal property did not change.

In reaching this conclusion, we further assume that the stock dividend is not part of a series of transactions undertaken between F---, G---, and/or ODI for the purpose of avoiding or altering the California sales or use tax liabilities between those parties.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.2177
• Original supporting opinion: 395.2177 PDF

Original ruling text

State of California

Board of Equalization
Legal Division-MIC: 82
Telephone: 324-2637

Memorandum
395.2177

To :

Mr. Rusty Dane
Out-of-State District Office

From :

Warren Astleford
Senior Tax Counsel

Subject:

O--- D---, Inc.
SS -- XX-XXXXXX

Date:

October 21, 1997

This is in response to your September 9, 1997 memorandum asking how tax applies to the transfer of stock and cash by O--- D---, Inc. (ODI) pursuant to a November 28, 1994 declaration of a stock dividend. The auditor provides the following facts: “[ODI] declared a dividend of 32 shares of common stock for each share of common stock held (prior to 11/28/94) on November 28, 1994, to each owner of stock (F--- E---, Inc. [(F---)] and G--- P---, Inc. [(G---)] each held a 50% ownership of the company, represented by common stock). The value of the stock dividend of 800,000 shares to be offered to each stockholder was equal to the actual value of the company (stated as $14.625 per share per Board of Directors memo). The dividend election to G--- and F--- . . . included an option to receive a cash dividend. “F--- . . . knew prior to the declaration of this dividend that G--- . . . was going to take the cash dividend option. In order to fund this dividend, additional short and long-term debt (liabilities) were assumed by . . . ODI under the authority of ODI’s Board of Directors. This distribution caused the ultimate ownership of ODI, that being the stockholders, to change substantially, by approximately 47%. “[ODI] filed new articles of incorporation with the Oklahoma secretary of state just before the payment of this dividend.” Discussion Sales tax is imposed on a retailer’s gross receipts from the retail sale of tangible personal property inside this state unless the sale is exempt from taxation by statute. (Rev. & Tax. Code § 6051.) When sales tax does not apply, use tax is imposed on the storage, use or other consumption of property purchased from a retailer for use inside this state. (Rev. & Tax. Code §§ 6201, 6401.) The sale of stock of a corporation is not a sale of tangible personal property and is not subject to tax. (Reg. 1595(a)(6); BTLG Annot. 395.1250 (5/8/87).) The

Mr. Rusty Dane

-2-

October 21, 1997
395.2177

purchase of stock is also not a purchase of tangible personal property even where the stock purchase is treated as an asset acquisition for federal income tax purposes. (Id.) ODI’s transaction involves both the transfer of stock and cash to its shareholders as well as a percentage change of ownership in ODI. For purposes of clarity, we have separately addressed how tax applies each portion of this transaction. Stock/Cash Distribution ODI declared a stock dividend to its two shareholders, F--- and G---, on November 28, 1994. Each shareholder had the option to receive cash in lieu of the stock at a set price of
$14.625 per share.1 G--- opted to take the cash which in turn required ODI to raise cash in order to satisfy its dividend obligation to G---. We understand that ODI raised this money by obtaining both long and short term loans from a third party lender. ODI then distributed a cash dividend to G--- and a stock dividend to F---. We assume that neither G--- nor F--- assumed any debts or obligations of ODI as part of ODI’s respective dividend distributions. ODI’s distribution of stock and cash is not a taxable transfer for two reasons. First, stock certificates or cash are not regarded as tangible personal property for sales and use tax purposes. (See, generally, BTLG Annots. 395.1250 (5/8/87), 395.1992 (3/29/68).) The stock certificate is indicia of ownership in a corporation and the cash is a representation of a value set by the federal government. This means that ODI did not transfer any tangible personal property to F--- or G--by virtue of the stock and cash distribution. Second, we understand that neither F--- nor G--provided any consideration to ODI as part of the transfer of the stock or cash. That is, we assume that F--- or G--- did not promise to provide a benefit to ODI that it was not otherwise entitled to as an inducement for the stock/cash transfer. Without consideration, there can be no sale. (See Rev. & Tax. Code § 6006(a).) Thus, under these facts, ODI did not make a sale, nor transfer tangible personal property as part of its cash and stock dividend distribution. Tax does not apply to this portion of the transaction. Percentage Change In Ownership Deloitte & Touche’s February 17, 1995 letter to F--- and G--- provides that each owned 25,000 shares of ODI prior to ODI’s November 28, 1995 declaration of a stock dividend. Upon ODI’s distribution, F--- and G--- owned 825,000 and 25,000 shares of ODI, respectfully. We again note that ODI alone obtained the loans necessary to fund its payment in lieu of stock to G-- and, we assume, received no consideration whatsoever from G--- or F--- for the stock/cash distribution. We further assume that ODI’s distribution consisted entirely of stock or cash and that no tangible personal property was transferred by ODI to F--- or G---. The distributions to F--- and G--- resulted in a change in the amount of stock owned by each party. The key to what occurred, however, is the fact that the ownership of ODI’s tangible 1

We understand that ODI intended this transaction to qualify as a federal income tax exempt reorganization pursuant to Internal Revenue Code section 368(a)(1)(E).

Mr. Rusty Dane

-3-

October 21, 1997
395.2177

personal property did not change. F--- increased its percentage ownership of the stock of ODI, but did not ever obtain any ownership interest in the assets owned by ODI. The ownership of stock is very different than the ownership of tangible personal property and the ownership of one does not equate to ownership of the other. This means that F---’s increased ownership of ODI stock did not result in ODI selling any of its tangible personal property to F---.2 Thus, we do not regard the percentage change in stock ownership by the parties as subject to tax. Our opinion above is based on the facts, representations, and understandings as set forth above. If any of these facts, representations, or understandings are incorrect, our opinion might be different. If you have any further questions or believe we have misstated or omitted any relevant facts, please write again.

WLA:cl
cc:

2

Out-of-State District Administrator (OH)

In reaching this conclusion, we further assume that the stock dividend is not part of a series of transactions undertaken between F---, G---, and/or ODI for the purpose of avoiding or altering the California sales or use tax liabilities between those parties. (See, e.g., BTLG Annot. 395.1840 (3/1/66; 7/28/86); 570.0100 (1/24/58); 395.2000 (11/19/74) (the intervening steps of a step transaction will be disregarded).) For example, we assume that F--- will not then dissolve ODI pursuant to a non-taxable liquidating distribution which would have been a taxable transaction had ODI transferred it assets directly to Franklin from the outset.