How did California tax a single-film special-effects corporation's production charges, later stock sale, and liquidation into the studio?

Plain-English summary

Movie Special Effects, Inc. (MSE) was represented as formed solely to create effects for one studio's full-length theatrical picture. Through an experienced individual and payroll-service employees, it would develop and operate mechanical creature characters; provide creative, supervisory, management and consulting work; and perform preproduction, principal-photography and postproduction services. Its sole shareholder and the studio would concurrently sign an unconditional agreement requiring the studio to buy all MSE stock 30 days after production. The studio would then promptly liquidate MSE or cause it to cease business.

Tax Counsel Ronald L. Dick separated three transactions. First, the special-effects work qualified as motion-picture production services under section 6010.6. MSE's studio charges—including incorporated paintings, models, artwork, film, tape, and audiovisual embodiments—were not taxable. MSE instead consumed that property and was to pay sales-tax reimbursement or use tax on its purchases.

Second, the shareholder's stock sale to the studio was not a tangible-property sale under California law, even if Internal Revenue Code section 338 or another rule treated it as an asset sale for a different purpose. Third, a ratable in-kind asset distribution on liquidation generally was not a section 6006 sale. Even a pre-liquidation asset sale could be occasional under sections 6006.5(a) and 6367 unless MSE made three or more retail sales and became a retailer.

The answer depended on representations that MSE had never sold tangible property, would sell none except to the studio in the subject transactions, held only assets required for this one engagement, and would promptly liquidate or cease business after the stock closing. The source supplies no completed service, contract, charge, material purchase, stock sale, liquidation, asset disposition, reported tax, or outcome.

Labor structure, three transactions, source/live conflicts, and missing outcome

The opinion answers a redacted lawyer's August 4, 1989 letter. MSE was the only identified person, so Dick expressly limited section 6596 treatment to MSE's transactions. The shareholder, studio, Company, DISC payroll service, employees, picture and counterparties remain unidentified. The request, section 6596 facts, contracts, attachments and entity records are absent.

The studio wanted an experienced special-effects individual and several other people nominally employed by DISC for the benefit of the individual and a wholly owned Company. Labor and union reasons reportedly prevented direct studio employment, so the studio negotiated with the individual and Company on MSE's behalf. No union rule, collective-bargaining agreement, labor restriction, employment agreement, payroll contract, Company ownership, negotiation record, or payment arrangement is included.

The Production Services Contract would obligate MSE to create, develop and produce visual and photographic effects. Work included budgeting, scheduling, storyboarding, principal photography and postproduction; operation and photography of sophisticated mechanical creature characters; positioning cameras and performers; lighting consultation; and choreographing camera, performer and creature movement. No contract, script, budget, schedule, storyboard, character, set, footage, deliverable, intellectual-property term, charge, reimbursement, completion or acceptance record is supplied.

The request called the individual and employees DISC employees, but Dick observed that MSE contracted with the studio to provide them, appeared to subcontract for their services, and treated DISC as performing only a bookkeeping function. The source provides no employment or subcontract agreements, invoices, payroll, withholding, workers' compensation, supervision, control, union, agency, independent-contractor, or bookkeeping records to establish that characterization beyond the presented facts.

One quoted transaction paragraph says MSE was incorporated June 2, 1980. MSE's separate representation says June 2, 1989, and Dick's analysis relies on the 1989 date to assume every transaction followed section 6010.6's September 22, 1988 effective date. No articles, filing, tax return, business record, amendment or explanation resolves the nine-year conflict. The formal opinion does not change the quoted 1980 wording; this page uses 1989 only for the analysis Dick expressly made and discloses both.

The stock-purchase agreement would be signed concurrently with the production-services agreement. It unconditionally obligated the shareholder to sell and the studio to buy all MSE stock 30 days after picture production completed. No agreement, share count, class, price, valuation, payment, closing condition, completion date, title record, transfer ledger, section 338 election, or completed stock sale is included.

MSE represented it had never sold, transferred or disposed of tangible personal property for consideration; would make no such transfer during the contract except to the studio in the subject transactions; would acquire only performance assets; and would promptly liquidate or cease trade or business after the stock closing. No seller's permit, purchase or sales ledger, assets, inventory, fixed-property register, invoice, disposition, cessation, dissolution, return or audit record proves those statements.

For transaction one, section 6010.6 excluded qualified motion-picture production services from sale and purchase. Subdivision (b)(4) included fabrication in any capacity on film, tape or another audiovisual embodiment and listed photography, sound, music, special effects, animation, adaptation, technological modification, computer graphics, dubbing, mixing, editing and cutting. Dick treated the presented work as qualified.

The service charges and charges for incorporated paintings, models, artwork, film, tape and other sound, image or computer-graphics embodiments were not taxable to the studio. MSE was the consumer and owed sales-tax reimbursement or use tax on those material purchases. The source gives no material, vendor, purchase price, tax-paid invoice, out-of-state purchase, use, incorporation, charge allocation, exemption certificate, tax amount or payment.

Dick warned that three or more MSE retail sales of other tangible property in any twelve-month period made MSE a retailer for those sales, even if every buyer was the studio. The source prints regardless that hose sales are only only to the Studio; the missing t and repeated only are preserved. No other property, sale count, twelve-month window, buyer, gross receipts or retailer filing is supplied.

For transaction two, stock was intangible for California sales-and-use-tax purposes under cited Annotation 395.1250. Dick said another regime—using Internal Revenue Code section 338 as an example—could treat stock as corporate property without changing California's characterization. He did not decide federal treatment and supplies no federal election, filing, ruling or outcome.

For transaction three, the source sentence says the studio would promptly liquidate MSE or cause MSE to cease depends upon the facts of transaction, an incomplete printed construction. Dick then states the general rule that a ratable in-kind corporate asset distribution on liquidation is not a section 6006 sale, citing source-printed BTLG Annots. 395,2280, 395.2240. The first comma appears in place of a decimal; neither supporting opinion is reproduced, and 395.2240's distinct profit-distribution facts are not imported here.

If MSE instead sold assets to the studio before or in lieu of liquidation, Dick said the sale would be occasional under section 6006.5(a) and exempt under section 6367 unless MSE made three or more retail sales to qualify as a retailer. No assets, liabilities, consideration, assumption, distribution ratio, stock ownership after acquisition, sale agreement, liquidation plan, asset sale, tax measure, or exemption analysis is supplied.

The live annotation preserves June 1989 formation, one-picture purpose, studio contract, concurrent stock agreement, later liquidation or cessation, qualified services, intangible stock, liquidation and occasional-sale conclusions, and October 6, 1989 date. But it says the individual sold stock to the corporation; the source unambiguously says the studio was the buyer. It also says two or more sales in a twelve-month period could make MSE a retailer, while the supporting PDF twice says three or more retail sales. No supplied record resolves the threshold difference.

The live entry adds that a ratable in-kind liquidation requires no shareholder consideration such as assumed liabilities. That condition is consistent with its summary but not expressly stated in this PDF's liquidation paragraph. The live page omits the August 4 request; section 6596 identity limit; labor and DISC structure; detailed effects work; unconditional 30-day agreement; 1980/1989 conflict; MSE representations; section 6010.6 effective-date reasoning and service list; consumer material taxes; section 338 and BTLG references; source defects; missing records; and absent outcomes.

What this means for you

Motion-picture special-effects providers

Historical qualified-production-service treatment made the provider the consumer of incorporated production materials rather than a retailer charging the studio. Separate services, materials and other tangible-property sales, and document tax paid to vendors or use tax reported.

Accountants and tax professionals

Separate service charges, material purchases, other property sales, stock transfer, liquidation and any asset sale. Reconcile entity identities, contracts, closing order, sales count, ownership, liabilities and consideration. Section 6596 treatment was limited to identified MSE transactions.

Common questions

Q: Were the studio's special-effects service charges taxable?
A: No. The opinion treated the work as qualified motion-picture production services.

Q: Who owed tax on models, artwork, film, and similar materials?
A: The special-effects corporation, as consumer, on its purchases of those materials.

Q: Was the shareholder's sale of all corporate stock taxable?
A: No under California sales-and-use-tax law. The source says the buyer was the studio, not the corporation as the live annotation states.

Q: Was the later liquidation taxable?
A: A ratable in-kind distribution generally was not a sale; a separate pre-liquidation asset sale could be occasional if the company stayed below the stated retail-sales threshold.

Q: Was MSE incorporated in 1980 or 1989?

A: The quoted transaction says June 2, 1980; MSE's representation and Dick's operative analysis say June 2, 1989. No supplied record resolves the conflict.

Q: How did DISC fit into the work?

A: The request called the individual and employees DISC employees, but Dick treated MSE as obtaining their services by subcontract and DISC as performing only bookkeeping. No labor or payroll contracts are included.

Q: What material taxes did MSE owe?

A: It was to pay sales-tax reimbursement or use tax on paintings, models, artwork, film, tape and other embodiments consumed in qualified services. No purchase or tax amount is supplied.

Q: Was the retailer threshold two or three sales?

A: The PDF says three or more retail sales in twelve months. The live annotation says two or more. No supplied source resolves that wording difference.

Q: Could the individual and studio claim section 6596 protection?

A: The opinion says only MSE was identified and limits section 6596 application to MSE's transactions.

Q: Did the production, stock sale or liquidation occur?

A: The source supplies no completion, charges, purchases, closing, stock transfer, liquidation, asset sale, return, audit, assessment, payment, claim, appeal, or outcome.

Citations and references

• California Revenue and Taxation Code §§ 6006, 6006.5(a), 6010.6, 6010.6(b)(4), 6367, and 6596
• Internal Revenue Code § 338 — example of different stock-sale treatment; no federal opinion given
• Business Taxes Law Guide Annotations 395.1250, 395.2240, and 395.2280 — cited; complete supporting materials not reproduced
• August 4, 1989 request; entities; labor, payroll and union records; production and stock-purchase agreements; picture and effects; assets and materials; purchases and charges; sales history; stock and sale; liquidation or cessation; asset disposition; returns; tax; audit; assessment; payment; claim; appeal; and outcome — described or implicated but not included

Verbatim support

From the official October 6, 1989 Ronald L. Dick opinion:

Since MSE is the only person you identified in your correspondence, our opinion will apply only to transactions by MSE, for purposes of section 6596.

We believe that the work performed by the Individual and the Employees is qualified production services.

MSE should pay sales tax reimbursement or use tax on its purchase of such property to consume in performing the qualified production services.

The sale of shares of stock in a corporation is not considered to be a sale or purchase of tangible personal property for purposes of the Sales and Use Tax Law notwithstanding that for income tax purposes (e.g., Int. Rev. Code § 338), or other purposes, the sale of shares of stock may be treated as a sale of the tangible personal property of the corporation.

Further, unless MSE makes three or more retail sales to qualify as a retailer, a sale of the corporate assets to the studio in lieu of, or prior to, a liquidation would be an occasional sale under Revenue and Taxation Code section 6006.5, subdivision (a), and exempt from tax under section 6367.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.2470
• Original supporting opinion: 395.2470 PDF

Original ruling text

395.2470

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION
1020 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) 445-6450

October 6, 1989

Ms. S--- W--- N--H--- W--- T--- & M--- Lawyers
XXXXX --- Blvd.
--- ---, CA XXXXX-XXXX
Re:

Movie Special Effects, Inc.

Dear Ms. N---:

This is in reply to your August 4, 1989 letter regarding the application of sales tax to certain transactions by M--- S--- E---, Inc. (MSE). You note that you wish our opinion to be subject to Revenue and Taxation Code section 6596. Since MSE is the only person you identified in your correspondence, our opinion will apply only to transactions by MSE, for purposes of section 6596. Your letter provides the following factual background and transactions. “I.

Factual Background.

A motion picture studio (‘Studio’) intends to produce a full-length theatrical motion picture (the ‘Picture’). In order to produce certain special effects necessary for the Picture, Studio desired to obtain the services of an individual (‘Individual’) who has considerable experience in the field of special effects. Studio also desired to obtain the services of several other individuals (the ‘Employees’) who were employed by DISC, a payroll service, for the benefit of Individual and wholly-owned corporation (‘Company’). For labor and union related reasons, Studio could not employ Individual and the Employees directly. Thus, Studio on behalf of MSE, entered into negotiations with Individual and Company. “II.

Subject Transactions.

MSE was incorporated June 2, 1980 by Individual for the sole purpose of providing special effects services to Studio in connection with the production of the Picture. MSE will enter into a contract (the ‘Production Services Contract’) with Studio pursuant to which MSE will create, develop and produce the special effects necessary for the Picture. Individual and the Employees will be employed by DISC payroll service for the benefit of MSE.

Ms. S--- W--- N---

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Pursuant to the Production Services Contract, Individual and the Employees will originate, create, develop, construct, operate and otherwise produce certain special visual and photographic effects (the ‘Subject Effects’) for the picture. The Subject Effects will include the operation and photographing of several sophisticated, mechanical ‘creature characters’. Individual and certain of the Employees will engage in supervisory, management, consulting, advisory and related creative and business services from the inception of development of the special visual and photographic effects to the completion of production and integration of the special visual and photographic effects into the Picture through the pre-production (including budgeting, scheduling and story-boarding), principal photography post-production phases of the production of the Picture. MSE will agree to furnish the services of Individual on the set during principal photography to participate actively with the director and cinematographer of the Picture in photographing scenes involving the Subject Effects contemplated to be integrated into the Picture, including positioning of cameras, live performers and the creature characters, consulting concerning the lighting of sets in which the creature characters will appear, and choreographing movements of cameras, live performers and the creature characters. Concurrently with the execution of the Production Services Contract, Individual and Studio will enter into a binding stock purchase agreement (the ‘Stock Purchase Agreement’) pursuant to which Individual will be unconditionally obligated to sell all of the MSE stock to Studio and Studio will be unconditionally obligated to purchase all of the MSE stock thirty days after the production of the Picture has been completed. After studio acquires the stock of MSE, Studio will promptly liquidate MSE or cause MSE to cease to do business.” You noted that MSE makes the following representations: “A. MSE was incorporated on June 2, 1989 for the sole purpose of creating, developing and producing the special effects for the Picture. “B. MSE has not, at any time prior to the subject Transactions, sold, transferred or otherwise disposed of any tangible personal property for any consideration whatsoever. During the term of the Production Services Agreement, MSE will not sell, transfer or otherwise dispose of any tangible personal property to any individual or entity other than to Studio pursuant to the Subject Transactions. “C. MSE does not own, and will not acquire, any assets other than those required in order for MSE to perform its obligations pursuant to the Production Services Agreement.

Ms. S--- W--- N---

3

October 6, 1989
395.2470

“D.
Promptly after the closing of the Stock Purchase Agreement, Studio will either liquidate MSE or will cause MSE to cease to engage in any trade or business.” Given this information, you requested that we provide an opinion that the transactions are exempt from California sales and use tax. In both your factual background and explanation of the transactions, you note that the individual and Employees will be “employed” by DISC. On the other hand, under the facts you presented, it is MSE which contracts with the Studio to provide the Individual and Employees to develop and produce the special effects. It then appears that MSE will be subcontracting to obtain the services of the Individual and Employees, and DISC is performing only a bookkeeping function. Opinion We have identified three relevant transactions: 1) MSE’s providing special effects to the Studio; 2) Individual’s sale of MSE’s corporate stock to the Studio; and 3) MSE’s transfer of assets to the studio pursuant to the liquidation of MSE. MSE’S Providing Special Effects to the Studio Since MSE was incorporated on June 2, 1989, we assume that all of the transactions will occur after September 22, 1988. On that date, section 6010.6 was added to the Revenue and Taxation Code to exclude from the definition of “sale” and “purchase” the performance of qualified production services in connection with the production of all or any part of any qualified motion picture. Persons performing those qualified production services are consumers of paintings, models and artwork used by those filming special effects, titles, or credits, and of film, tape, or other embodiment upon which sound, visual images or computer-generated graphics are created or recorded, notwithstanding that title to the property may be transferred pursuant to the qualified production services contract. Subdivision (b)(4) of section 6010.6 defines “qualified production services” to include any fabrication performed by any person in any capacity (whether as an employee, agent, independent contractor, or otherwise) on film, tape, or other audiovisual embodiment in connection with the production of all or any part of any qualified motion picture. The term includes, but not limited to, photography, sound, music, special effects, animation, adaptation (language, media, electronic, or otherwise), technological modifications, computer graphics, dubbing, mixing, editing or cutting services. We believe that the work performed by the Individual and the Employees is qualified production services. Tax does not apply to MSE’s charge to the studio for performing the qualified production services. Also, tax would not apply to MSE’s charge to the studio for

Ms. S--- W--- N---

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October 6, 1989
395.2470

paintings, models, and artwork used by those filming the special effects, nor for film, tape or other embodiment upon which the sound, visual images, or computer-generated graphics are created or recorded. MSE should pay sales tax reimbursement or use tax on its purchase of such property to consume in performing the qualified production services. On the other hand, if MSE makes three or more retail sales of other tangible personal property during any 12-month period, MSE will be a retailer for purpose of those sales regardless that hose sales are only only to the Studio and no other persons. Individual’s Sale of Stock to the Studio California sales tax is imposed on retailers for the privilege of selling tangible personal property at retail. The sale of shares of stock in a corporation is not considered to be a sale or purchase of tangible personal property for purposes of the Sales and Use Tax Law notwithstanding that for income tax purposes (e.g., Int. Rev. Code § 338), or other purposes, the sale of shares of stock may be treated as a sale of the tangible personal property of the corporation. See Business Taxes Law Guide Annotation 395.1250. MSE’s Transfer of Assets to the Studio Pursuant to the Liquidation of MSE You note that, after the Studio acquires the stock of MSE, the Studio will promptly liquidate MSE or cause MSE to cease depends upon the facts of transaction. Generally, the ratable distribution in kind of corporate assets to shareholders upon liquidation and dissolution of the corporation is not regarded as a sale under Revenue and Taxation Code section 6006. (See BTLG Annots. 395,2280, 395.2240.) Further, unless MSE makes three or more retail sales to qualify as a retailer, a sale of the corporate assets to the studio in lieu of, or prior to, a liquidation would be an occasional sale under Revenue and Taxation Code section 6006.5, subdivision (a), and exempt from tax under section 6367. (See BTLG Annot. 395.2280.) We hope this answers your questions; however, if you need further information, feel free to write again. Very truly yours,

Ronald L. Dick
Tax Counsel

RLD:sr