Could a partnership use a new corporation, five statutory mergers, and a liquidation to acquire assets for cash or notes without sales or use tax?

Plain-English summary

A partnership proposed forming wholly owned Newco. Five unidentified corporations would merge into Newco under California Corporations Code sections 1100–1305. Their shareholders would receive cash or promissory notes for canceled shares. Newco then would dissolve into the partnership and distribute all assets in complete liquidation.

Tax Counsel Donald L. Fillman said no sales or use tax applied when each step was viewed separately. Although the requester stated other business purposes, Fillman said one could argue that the only real reason was letting the partnership buy the five corporations' tangible personal property for cash or notes without sales or use tax.

If that were determined to be the sole substantive motive, the intermediate steps would be disregarded and the partnership would be treated as paying cash or notes for tangible personal property. Tax would apply unless an independent exemption—Fillman's example was section 6006.5(a) occasional-sale treatment—covered the purchase. The opinion does not determine motive, identify the stated business purposes, establish an exemption, compute tax, or show any step occurred.

Proposed sequence, conditional substance test, authority defects, and missing outcome

The opinion answers D--- B. F---'s March 11, 1993 letter, which is not included. Fillman says the request did not meet section 6596 requirements and offers only an opinion based on the information provided. The source does not identify the client, partnership, Newco, five corporations, shareholders, businesses, assets, locations, tax accounts, permits, representatives, questions beyond the step transaction, or missing reliance elements.

The partnership would form and wholly own Newco. Five corporations would merge into it in statutory mergers under California Corporations Code sections 1100–1305. Each disappearing corporation's shareholders would receive cash or a promissory note for canceled shares. Newco then would dissolve into the partnership, which would receive all assets in a complete liquidating distribution.

No partnership agreement, Newco articles, merger agreement, plan, board or shareholder approval, appraisal, share count or class, cash amount, note principal or terms, canceled-share record, creditor treatment, asset schedule, liabilities, closing, statutory filing, liquidation plan, distribution, title, possession, accounting, or completed transaction is included.

Fillman says each formal step separately produced no sales or use tax. The source does not explain the separate statutory treatment, say which corporation paid shareholder cash or notes, distinguish tangible from real and intangible property, identify consideration at each step, or supply merger and liquidation requirements. The ultimate substance analysis focuses on the partnership's acquisition of tangible personal property.

The source states: Although other business purposes are stated, it could be argued that the only real reason was a tax-free partnership acquisition for cash or notes. It does not disclose those purposes, evaluate their evidence, state who would determine motive, or decide that avoidance was in fact sole. Its conclusion is expressly conditional: If it were determined that that was the sole substantive motive.

On that condition, Fillman would disregard intervening entities and transactions, treat the partnership as the cash-or-note purchaser, and apply sales or use tax absent another exemption. He identifies section 6006.5(a) occasional sale only as an example. No seller activity, permit requirement, sales series, property use, purchaser liability, exemption certificate, tax-paid status, gross receipts, sales price, allocation, rate, local component, or tax amount is supplied.

The source quotes Commission v. Court Holding Co. (1944) 324 U.S. 331, 334 for rejecting formalism existing solely to alter tax liabilities. The reporter resolves to Commissioner v. Court Holding Co., decided April 9, 1945—not Commission or 1944. The live annotation repeats the source's name and year. The quotation itself is preserved as printed, including formalism, which exist.

Fillman next says that In a California case where step entities wanted one-entity treatment, the California Supreme Court agreed, citing Mapo, Inc. v. State Board of Equalization (1975) 53 Cal.App.3d 245. That reporter resolves to the source-named case in the California Court of Appeal, not the California Supreme Court. The source supplies no Mapo facts, quotation, holding, later history, or explanation for the court-level error.

The Board's example was Business Taxes Law Guide Annotation 330.2800 dated August 14, 1969. The quoted annotation involved a related-party equipment sale at cost to a corporate sole owner, sales tax paid, and an ex-tax leaseback to the manufacturer, which then rented the equipment without collecting use tax. It contrasted a possible true separation of identities with non-arm's-length pricing below fair market value as evidence of evasion. The source prints identifies where context indicates identities and does not reproduce an underlying opinion or say the proposed five-merger transaction shared those facts.

The live annotation preserves the partnership, wholly owned Newco, five statutory mergers, cash or note cancellations, liquidation, all-assets distribution, separate-step result, substance recharacterization, Court Holding cite, and April 9, 1993 date. But it says it appears that the only reason was tax avoidance, strengthening the source's statement that other purposes existed and the tax-only motive could be argued. It retains If such is the case, but does not disclose that Fillman made no motive finding.

The live entry omits the March 11 request and section 6596 failure; California statutory-merger sections; unidentified other business purposes; section 6006.5(a) exemption alternative; conditional factual determination; Court Holding name and year errors; Mapo and its court-level error; Annotation 330.2800 and related-party example; missing records; and absent completed transaction, tax measure and outcome.

What this means for you

Partnerships acquiring corporate assets

Formal merger and liquidation steps may be disregarded when the proven sole substantive motive is a cash-or-note tangible-property acquisition without tax. Preserve independent commercial purposes, entity activity, approvals, economics and every closing step.

Accountants and tax professionals

Test each legal step and the collective substance. Document who paid cash or notes, what each shareholder surrendered, each asset and liability, merger and liquidation law, business-purpose evidence, alternatives, valuations, exemptions, reporting, and the final agency action.

Common questions

Q: Were the separate mergers and liquidation taxable by themselves?
A: The letter said no, when each formal step was viewed separately.

Q: Why could tax still apply?
A: California could ignore steps existing solely to alter tax liability and view the partnership as buying the assets for cash or notes.

Q: Did the letter find that tax avoidance was the actual sole motive?
A: No. It says other purposes were stated and that a tax-only motive could be argued; recharacterization followed only if sole substantive motive were determined.

Q: Could another exemption still apply after collapsing the steps?
A: Yes. The letter gave a qualifying occasional sale as an example.

Q: What other business purposes were stated?

A: The source says they existed but does not identify or evaluate them, and the request is absent.

Q: Did the source correctly identify Court Holding?

A: No. It prints Commission and 1944; 324 U.S. 331 resolves to Commissioner v. Court Holding Co., decided in 1945.

Q: Was Mapo a California Supreme Court case?

A: No. The source says so, but 53 Cal.App.3d 245 resolves to the California Court of Appeal.

Q: Why did the sale-and-leaseback example matter?

A: It illustrated disregarding a related-party form where below-market pricing and the parties' lack of true separation indicated use-tax evasion. The opinion does not say those same facts existed here.

Q: Did any merger, payment or liquidation occur?

A: The source supplies no agreement, approval, closing, asset transfer, tax return, audit, assessment, payment, claim, appeal, or outcome.

Citations and references

• California Corporations Code §§ 1100–1305
• California Revenue and Taxation Code §§ 6006.5(a) and 6596
• Commission v. Court Holding Co. (1944) 324 U.S. 331, 334 — source form; reporter resolves to Commissioner v. Court Holding Co., decided 1945
• Mapo, Inc. v. State Board of Equalization (1975) 53 Cal.App.3d 245 — reporter resolves to the Court of Appeal, not the California Supreme Court stated by the source
• Business Taxes Law Guide Annotation 330.2800 (August 14, 1969) — quoted related-party sale-and-leaseback example; underlying opinion not included
• March 11, 1993 request; client, partnership and corporation records; business-purpose evidence; mergers; cash and notes; shares; assets and liabilities; liquidation; exemption support; values; tax measure and rate; return; audit; assessment; payment; claim; appeal; and outcome — described or implicated but not included

Verbatim support

From the official April 9, 1993 Donald L. Fillman opinion:

Your request does not meet those requirements, but we are pleased to give you our opinion based on the information provided.

Although other business purposes are stated, it could be argued that the only real reason for this step transaction is for the partnership to acquire for cash and/or promissory notes, the tangible personal property of the five corporations without incurring a sales or use tax.

If it were determined that that was the sole substantive motive, the intervening steps would be ignored and the only relevant factors would be that cash or promissory notes were paid by the partnership for the acquisition of the tangible personal property.

To permit the true nature of the transaction to be disguised by mere formalism, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies....

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.2473
• Original supporting opinion: 395.2473 PDF

Original ruling text

395.2473

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

MEMBER
First District

450 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) (916) 445-2641

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

April 9, 1993

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

Mr. D--- B. F----- & --XXX --- -----, CA XXXXX
Dear Mr. F---:
This is in response to your letter of March 11, 1993. You requested our opinion regarding the application of sales or use taxes to a "step transaction". Please be advised that before you may rely upon our written opinion your request must meet the requirements of Rev. & Tax. Code § 6596. Your request does not meet those requirements, but we are pleased to give you our opinion based on the information provided. You provided the followings facts. A partnership forms a wholly owned corporation (Newco). Five other corporations are merged into Newco in a statutory merger in accordance with California Corp. Code §§ 1100-1305. The shareholders of the five other corporations receive cash or a promissory note in cancellation of their shares. Newco is then dissolved into the partnership, with the partnership receiving all the assets in a complete liquidating distribution. If we look at each step separately, no sales or use taxes are applicable to any of the separate steps in the transaction. Although other business purposes are stated, it could be argued that the only real reason for this step transaction is for the partnership to acquire for cash and/or promissory notes, the tangible personal property of the five corporations without incurring a sales or use tax. If it were determined that that was the sole substantive motive, the intervening steps would be ignored and the only relevant factors would be that cash or promissory notes were paid by the partnership for the acquisition of the tangible personal property. Unless such a purchase were otherwise exempt, e.g. - an occasional sale under Rev. & Tax. Code § 6006.5(a), a sales or use tax would apply.

Mr. D--- B. F---

-2-

April 9, 1993
395.2473

The U.S. Supreme Court stated: "To permit the true nature of the transaction to be disguised by mere formalism, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies...." Commission v. Court Holding Co. (1944) 324 U.S. 331, 334. In a California case in which the "step" entities wanted to be treated as one entity, the California Supreme Court agreed. Mapo, Inc. v. State Board of Equalization (1975) 53 Cal.App.3d 245. The Board has previously considered a sales tax avoidance scheme between related parties, for example: Sale and Leaseback, Arms Length Transactions. Tax evasion occurs when taxpayer, a corporation and the manufacturer of mechanical equipment, sells the equipment at cost to the sole owner of the corporation who pays sales tax on the equipment and leases it back to the corporation ex-tax. The corporation then rents the equipment without collecting a use tax. Although such a transaction might be proper if there was true separation of the identifies of the parties, the sale and leaseback transaction is not at arms length and the sale at cost, rather than at fair market value, indicates an attempt to evade the use tax the manufacturer would be required to collect if he rented the equipment himself. (Business Taxes Law Guide Annotation 330.2800 (8/14/69). If you have further questions, please contact me. Sincerely,

Donald L. Fillman
Tax Counsel

DLF:es