Was a partnership's transfer of mixed assets to its wholly owned subsidiary tax-free when the subsidiary assumed liabilities?

Plain-English summary

A California general partnership described a conveyance of tangible personal property and other assets to its wholly owned California corporate subsidiary. The Contribution Agreement called it a capital contribution, no stock was issued, and the subsidiary assumed liabilities.

Tax Counsel John S. Butterfield said assumed debt was consideration. The transaction therefore was a taxable sale rather than a pure capital contribution, regardless of whether income-tax law treated it as a capital contribution.

For tangible personal property plus other property, the taxable measure was determined by dividing tangible-property value by total transferred-asset value and applying that factor to total consideration. The final answer includes assumed liabilities and any other consideration. The parties could not allocate debt selectively to reduce tax—for example, by assigning a real-property mortgage only to the realty.

Request posture, assumed facts, allocation formula, and missing computation

The letter responds to a redacted May 31, 1996 request asking for a State Board of Equalization ruling on a described transaction. Butterfield states that only the Board, not the Legal Division, could issue a ruling; his letter would instead serve as a legal opinion. No Board consideration or later ruling appears.

The first page is addressed to Mr. M--- E. M--- at a redacted address; the second-page header instead names Mr. J--- S---, Controller. The record does not explain whether those are two representatives, a template/header difference or another relationship, so this page does not assign either a role beyond what is printed.

The request said N--- O--- R--- P---, identified as a California general partnership, conveyed tangible personal property to wholly owned California corporation S--- R--- P---. The Contribution Agreement called the transfer a contribution to capital, no stock was exchanged, and the subsidiary assumed unspecified liabilities. The requester asked for confirmation that liabilities would be allocated across all transferred assets and only the part allocable to tangible personal property would be taxed.

The opinion calls the conveyance completed in its facts but also calls it a proposed transaction in describing the requested opinion. No agreement, execution date, closing, title, possession, accounting entry, stock or ownership record resolves the timing.

Butterfield assumed solely for the analysis that the partnership held a seller's permit under Revenue and Taxation Code section 6066. The source supplies no permit, business activity, sales history, return or registration evidence. The assumption is not presented as a verified fact.

The letter says capital contributions generally are not taxable, citing Annotations 395.1520, 395.1960 and 495.0090. It then classifies a transfer subject to transferee-assumed debt as a taxable sale measured by the assumed liabilities, regardless of income-tax capital-contribution treatment. The prior annotations are cited but not reproduced or incorporated as facts.

The source says this transaction included tangible personal property and other property, offering stock and/or real property as examples. It does not say which other categories were actually conveyed. This page therefore does not convert those examples into an asset list.

The formula is: tangible-personal-property value divided by total value of all conveyed assets, multiplied by total consideration. The opinion parenthetically equates total consideration with total liabilities assumed, then its final sentence includes assumed liabilities plus any other consideration received. No property, fair-market value, liability, other consideration, factor, computation, measure, rate or tax amount is supplied.

The parties could not allocate liabilities selectively to reduce tax. Even if the only assumed liability were a mortgage against real property, the formula still allocated some consideration to the tangible-personal-property sale. That is a hypothetical example; the source does not say this partnership transferred real property subject to a mortgage.

Butterfield concludes that tax will be due measured by the allocable portion of assumed liabilities and other consideration, invites further questions, and supplies no return, audit, assessment, payment, claim, appeal or outcome.

The live 395.2544 annotation preserves the partnership, wholly owned subsidiary, capital-contribution label, no-stock fact, assumed liabilities, taxable-sale classification, relative-value formula and no-selective-allocation conclusion. It likewise gives stock or real property as examples of other property and the mortgage as a hypothetical, not as proven assets or debt in this transaction.

The official two-page PDF has a clean rendered text layer and only a small seal image. Two fresh downloads and extractions matched exactly, and the preserved source tail remains byte-identical after removal of only pdftotext's terminal newline and form feed. No case citation appears.

What this means for you

Parent entities and subsidiaries

Calling a transfer a capital contribution and issuing no stock did not control when the subsidiary assumed liabilities. Preserve the legal documents and accounting rather than relying on the label.

Accountants and tax professionals

Obtain supportable values for every transferred asset category, identify every liability and other item of consideration, and retain the formula and computation. Do not allocate a liability only to the asset securing it merely to reduce the tangible-property measure.

Common questions

Q: Are capital contributions generally taxable?
A: The letter says generally no, citing three prior annotations, but assumed liabilities changed this transfer into a sale.

Q: Did issuing no stock make the transaction tax-free?
A: No. The subsidiary's debt assumption was consideration.

Q: How was the tangible-property measure calculated?
A: Tangible-property value divided by total conveyed-asset value, multiplied by total consideration. The final answer includes assumed liabilities and any other consideration.

Q: Could a mortgage be allocated only to real property?
A: No. The opinion says the formula would allocate a portion to tangible personal property even if a real-property mortgage were the only liability assumed.

Q: Did this taxpayer actually transfer mortgaged real property?

A: The source does not say. It uses a real-property mortgage as a hypothetical allocation example.

Q: Did the Legal Division issue a binding Board ruling?

A: No. Butterfield expressly said only the Board could issue a ruling and characterized this response as a Legal Division opinion.

Q: Was the partnership's seller's permit verified?

A: No. The letter assumes one under section 6066 for purposes of the analysis.

Q: How much tax was due or paid?

A: No asset value, liability, allocation factor, measure, rate, tax amount, assessment or payment is supplied.

Citations and references

• California Revenue and Taxation Code § 6066
• Sales and Use Tax Annotations 395.1520 (January 11, 1955), 395.1960 (May 25, 1951), and 495.0090 (April 19, 1967) — cited for generally nontaxable capital contributions; not reproduced
• May 31, 1996 request and Contribution Agreement — referenced but not included
• Parties and representatives; seller's permit; ownership and stock records; assets and categories; liabilities and other consideration; transfer and accounting records; values and allocation; tax measure and rate; return; audit; assessment; payment; claim; appeal; and outcome — described, assumed or implicated but not included

Verbatim support

From the official August 1, 1996 Tax Counsel opinion:

Please note that the legal division may not issue a “ruling,” that is solely the province of the Board. We can, however, provide you with a legal opinion as to the application of the law to your proposed transaction. This letter shall serve as that opinion.

While capital contributions are not generally taxable (see BLTG Annots. 395.1520 (1/11/55), 395.1960 (5/25/51) and 495.0090 (4/19/67)), if the transfer is subject to a debt assumed by the transferee, we do not classify the transaction as a contribution to capital, rather there is a taxable sale measured by the assumed liabilities.

We first determine the value of the tangible personal property conveyed, and divide that amount by the total value of all assets conveyed. We then apply the resulting factor to the total consideration (i.e. total liabilities assumed) paid. The result is the taxable measure.

We do not permit the parties to allocate liabilities among the assets transferred to reduce the tax liability.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.2544
• Original supporting opinion: 395.2544 PDF

Original ruling text

395.2544

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

JOHAN KLEHS
First District, Hayward

LEGAL DIVISION (MIC:85)
450 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0085)
Telephone: (916) 324-2653
FAX: (916) 324-2618

DEAN ANDAL
Second District, Stockton
ERNEST J. DRONENBURG, JR.
Third District, San Diego
BRAD SHERMAN
Fourth District, Los Angeles
KATHLEEN CONNELL
Controller, Sacramento
────────

August 1, 1996

E. L. SORENSEN, JR.
Executive Director

Mr. M--- E. M--XXXXX --- Boulevard, --- Floor
--- ---, California XXXXX
Re:

N--- O--- R--- P---

Dear Mr. M---:
I have your letter of May 31, 1996 for response. In your letter you requested a “ruling” by the State Board of Equalization on the taxability for California Sales and Use tax purposes of a described transaction. Please note that the legal division may not issue a “ruling,” that is solely the province of the Board. We can, however, provide you with a legal opinion as to the application of the law to your proposed transaction. This letter shall serve as that opinion. In your letter you advised us that N--- O--- R--- P---, a California general partnership (“NORP”), conveyed certain tangible personal property to its wholly owned subsidiary S--- R--P--- Corporation, a California corporation (“SRPC”). The conveyance was described in the Contribution Agreement as a “contribution to capital.” The conveyance was not given in exchange for stock, and SRPC assumed certain liabilities as part of the transaction. You request that we “confirm that those liabilities will be allocated amongst all of the assets transferred and only that portion of the liabilities allocable to tangible personal property is subject to sales tax.”1 While capital contributions are not generally taxable (see BLTG Annots. 395.1520 (1/11/55), 395.1960 (5/25/51) and 495.0090 (4/19/67)), if the transfer is subject to a debt assumed by the transferee, we do not classify the transaction as a contribution to capital, rather there is a taxable sale measured by the assumed liabilities.2 Where the property transferred, as in 1

We assume, for purposes of this analysis, that NORP holds a seller’s permit under Revenue and Taxation Code section 6066. 2 This is true without regard to whether or not the transaction might be regarded as a contribution to capital for income tax purposes.

Mr. J--- S---, Controller

-2-

August 1, 1996
395.2544

this case, includes both tangible personal property as well as other property (intangible property such as stock, and/or real property) how do we determine what portion of the consideration is allocable to the taxable sale of tangible personal property? We first determine the value of the tangible personal property conveyed, and divide that amount by the total value of all assets conveyed. We then apply the resulting factor to the total consideration (i.e. total liabilities assumed) paid. The result is the taxable measure. We do not permit the parties to allocate liabilities among the assets transferred to reduce the tax liability. Hence, if the only liability assumed was a mortgage against real property, we would not consider that there was no taxable consideration paid for the tangible personal property component of the sale; rather we would apply the formula outlined above to allocate a portion of the assumed liabilities to the sale of the tangible personal property. Thus, tax will be due on the transaction in question measured by the portion of the liabilities assumed and any other consideration received which is allocable to the tangible personal property component of the property transferred in the transaction, as discussed above. I hope the foregoing response has been sufficient for your purposes. However, if you have further questions, please write again. Very truly yours,

John S. Butterfield
Tax Counsel
JSB/cmm