Does assuming a transferor's liabilities count as consideration that can make a business transferee a California successor?

Plain-English summary

A corporation that was already successor to an older business transferred its business assets to a new 50-50 partnership. The partnership assumed $1,242,435 of liabilities, and the transferor received a 50% partnership interest.

The hearing officer treated the assumption of liabilities as consideration, making the reorganization a sale. The transferor's retained 50% interest was below the 80% ownership level discussed for the occasional-sale rule, so the transaction did not qualify for that exemption.

Because the partnership bought the business, it became the next successor in line and was liable for the remaining tax, accruing interest, and penalty originating with the first business. The recommendation made no adjustment, while acknowledging that a pending appeal over whether the immediate transfer was a sale could affect the technical basis for the partnership's status.

What this means for you

Partnership organizers, restructuring advisers, and business transferees

Include assumed debt when testing whether a reorganization has purchase consideration. A noncash restructuring can create a sale and carry an existing successor liability into the next transferee.

Common questions

Q: Did assumed liabilities count as consideration?

A: Yes.

Q: Did the partnership become a successor?

A: Yes, under the recommendation.

Q: Was the transfer tax-free because the transferor retained half the partnership?

A: No. The decision said 50% was not the substantial continuity required for the occasional-sale rule it discussed.

Citations and references

• California Revenue and Taxation Code §§ 6006.5(b), 6367, 6811, and 6812
• Newco Leasing v. State Board of Equalization, 143 Cal. App. 3d 120 (1983)
• U.S. v. Hendler, 303 U.S. 657 (1937) (citation as printed in the source)

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 535.0004
• Original supporting opinion: 535.0004 PDF

Original ruling text

STATE OF CALIFORNIA

535.0004

BOARD OF EQUALIZATION

In the Matter of the Petition
for Reconsideration of
Successor Liability;
T--- CORPORATION, et.al.
dba M---/C--- M--Petitioner.

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DECISION AND RECOMMENDATION

No. SR --- XX XXXXXX-010

The above-entitled matter came on regularly for hearing on Thursday, December 22, 1983, in Covina, California before Robert H. Anderson. Appearing for Petitioners:

Mr. D--- E. S--Attorney at Law
---, ---, ---, --- & ---

Appearing for the Board:

Mr. Lee Smith
Auditor
Covina Branch Office

Protest
On August 9, 1982, petitioner was issued a notice of successor liability as a successor to C--- M--- Corporation. The assessment was for the following amounts: Tax

Interest

Penalty

Total

$15,884.88

$21, 322.94

$3,688.49

$40,896.31

*Interest calculated through 8-9-82 and is increasing at the rate of $7.83 for each day payment is made after August 9, 1982, to date of payment. Petitioner protests the assessment as successor. Contentions Petitioner is not a successor under authority of People v. Gabriel, (1943) 57 Cal.App.2d 788.

M---/C--- M---

-2-

March 6, 1984
535.0004

Petitioner’s predecessor, as a successor in line, obtained a sales tax clearance certificate from the Board for the transaction out of which petitioner is being held to be a successor. Summary This controversy arises as a result of a sale of a business to a commencing partnership. Petitioner is assessed tax as a successor to a corporation which is also a successor, and the assessment in this matter is what is left in an earlier assessment against the corporation’s predecessor. Background: In 1977 there was a Delaware corporation known as P & F I---. P & F I--- had offices in ---, New York and a division in California known as C--- M---, hereinafter Old C--M---. P & F I--- had qualified to do business in California and its division, Old C--- M---, held seller’s permit number SR -- XX XXXXXX. Old C--- M--- was audited for the period from 7-1-75 through 8-31-77, and a determination was issued for tax, interest and penalty on December 21, 1978. The assessment was for use tax on ex-tax assets purchased and on inventory withdrawn and consumed. Between February of 1979 and February of 1980 payments were made by or received from P & F I--- which were credited to the Old C--- M--- Account. P & F I--- sold the C--- M--- division (Old C--- M---) to R--- M--- who upon incorporating the business took the name C--- M--- Corporation, hereinafter New C--- M---. New C--- M--- was issued seller’s permit number SR --- XX XXXXXX. New C--- M--- is a successor to Old C--M---. In April of 1980 P & F I--- was suspended from trading stock on the American Stock Exchange and subsequently the corporation dissolved and filed a Chapter 7, no assets, bankruptcy. A successor billing was issued to New C--- M--- in April of 1979. In 1980 New C--- M--- sold its assets to a partnership entity known as M---, hereinafter M--Partnership. M--- Partnership holds a seller’s permit number SR --- XX XXXXXX and is the petitioner in this matter. The M--- Partnership is made up of C--- M--- Corporation (New C--- M---) which owns a 50 percent interest. The other partner is M--- Co. which owns a 50 percent interest. M--- Co. is a State of Washington partnership made up of two State of Washington corporations: (1) D--I---, and (2) R--- L---. The foregoing description of M--- Partnership is taken from the M--Partnership agreement dated February 1, 1980.

M---/C--- M---

-3-

March 6, 1984
535.0004

In a petition for reconsideration of successor liability dated September 23, 1982, Mr. D--E. S---, counsel for petitioner, stated that he represented T--- Corporation, a partner in M---, a general partnership doing business as C--- M---. However, that is not apparent in any of the records made available to the hearing officer except that the Notice of Successor Liability was issued to T--- Corporation, et al., doing business as M---/C--- M---. Be that as it may, the transfer of assets giving rise to the successor-to-successor liability (M--- Partnership successor) under consideration in this petition triggered a sales tax assessment against New C--- M--- for tax on the sale of the business to the commencing M--- Partnership. The M--- Partnership successor liability amount in question in this petition does not include the tax on the sale of the business assets to the M--- Partnership. The amount in question is what is left of the tax plus accruing interest on it that was originally set up against the original or Old C--- M--- (the California division of P & F I---) and which the first successor (New C--- M---) has not paid. In respect to the tax on the sale of the assets to the M--- Partnership, it was paid by New C--M--- who is presently suing the Board for a refund in the Los Angeles Superior Court (C--- M--Corporation v. State Board of Equalization, No. -XXXXXX) claiming that the transfer of assets to M--- Partnership was not a sale because (1) it was to a commencing partnership; (2) there was no consideration; and (3) if it was a sale only 50 percent of the measure of tax should be taxed since the plaintiff-transferor owned 50 percent of the transferee M--- Partnership entity. The “no consideration” argument was rejected by the Board because the M--- Partnership assumed the liabilities on the assets transferred. New C--- M--- is suing for a refund of $73,000; the case is being handled by Deputy Attorney General Patti Kitching who, in the latter part of February, prevailed on a motion for summary judgment against New C--- M---, the plaintiff. It is understood that New C--- M--- Corporation-plaintiff will appeal the summary judgment. The foregoing is important to the successor issue in this petition because if New C--- M--Corporation-plaintiff prevails there would be no sale of assets to M--- Partnership and therefore no M--- Partnership successor. The successor issue is further complicated by the fact that a [Mr.] M--- is the sole surviving shareholder of C--- M--- Corporation (New C--- M--- successor to Old C--- M---) and there is reportedly an indemnification agreement from Mr. M--- to cover the M--- Partnership successor liability, if any. Note also, that the New C--- M--- successor liability is still substantial and is in excess of $40,000 counting interest. The tax is almost $16,000. Mr. M--- offered the Board
$15,000 as a compromise settlement to release the New C--- M--- successor liability and a full release of all claims against future successor entities which would be the M--- Partnership and any successors to the M--- Partnership that would inherit the original or Old C--- M--- liabilities.

M---/C--- M---

-4-

March 6, 1984
535.0004

The $15,000 settlement offer was turned down in light of the lawsuit by C--- M--- Corporation (New C--- M---) that is seeking a refund of $73,000 from the Board. However, headquarters suggested to the --- district that Mr. M--- be counter offered a settlement proposal in the amount of $25,000. Apparently this counter proposal was made to Mr. M--- because his attorney, who incidentally is not Mr. S---, wrote on July 20, 1983 to the --- district and stated that his client was making the $25,000 settlement offer conditioned upon full releases of all parties including M--- Partnership (referred to as T---) interest. A copy of the letter is in the petition file; the original is in the master file. The position already taken by the Board is that M--- Partnership purchased the business assets from New C--- M---, and as noted, the Board has assessed sales tax on the sale. This would automatically make M--- Partnership a successor. However, the issue of whether M--- Partnership is a successor appears to technically hang on the outcome of C--- M--Corporation’s (New C--- M---) suit for refund on the tax paid on the sale of its business to the M--- Partnership. And, as noted, if C--- M--- Corporation prevails there would be not sale and without a sale there would be no successor as far as the M--- Partnership is concerned. On the other hand, if the Board prevails, as it has so far by reason of the summary judgment against C--M--- Corporation, we still have the M--- Partnership successor that is being assessed what is left of the original liability assessed against Old C--- M--- (SR -- XX XXXXXX) and which New C--- M--- (through its shareholder [Mr.] M---) has offered a $25,000 compromise settlement to release all claims against New C--- M--- as well as the M--- Partnership successor liability. Conclusions M--- Partnership (petitioner herein) is a successor to New C--- M--- that is a successor to Old C--- M--- and is liable for what is left of the tax, interest which is still accruing, and penalty on the original liability assessed against Old C--- M---. We make no conclusion or recommendation on the compromise settlement offer. However, we do note that if there is no M--- Partnership successor as a result of the appeal on the summary judgment by C--- M--- Corporation (New C--- M---) there is still a successor liability outstanding against New C--- M---. The case of People v. Gabriel, (1943) 57 Cal.App.2d 788, cited by counsel, holds that a purchaser of fixtures and equipment is not liable for sales tax due from the seller, on account of failing to withhold sufficient of the purchase price to cover such liability when the evidence showed that the purchaser did not purchase the business of the former owner (of the fixtures and equipment) or become his successor to the business.

M---/C--- M---

-5-

March 6, 1984
535.0004

People v. Gabriel is not authority for petitioner’s release from the successor’s liability. The partnership entity purchased New C--- M---’s business. The agreed upon fair market value of New C--- M---’s interest in the business was $2,800,000. M--- Partnership, the purchaser, assumed New C--- M---’s liabilities in the amount of $1,242,435 and for this New C--- M--received a 50% interest in the M--- Partnership. Sales tax measured by $1.1 million was assessed on the sale of the fixtures and equipment. The reorganization into the 50-50 partnership entity was one that resulted in a sale by reason of the assumption of the liabilities which is consideration (see U.S. v. Hendler, (1937) 303 U.S. 657; Newco Leasing v. State Board of Equalization, (1983) 143 Cal.App.3d 120). The sale does not qualify for the occasional sale exemption under section 6367 of the Sales and Use Tax Law because it was not an occasional sale as defined under section 6006.5(b) in that after the transfer the real and ultimate ownership held by New C--- M--- was not substantial which requires retaining at lease 80 percent; New C--- M--- only retained a 50 percent interest. Finally, New C--- M--- is properly being held liable for the tax owed by Old C--- M--- as a successor. There was no sales tax clearance obtained from the Board on the purchase of the Old C--- M--- business. Thus, the remaining New C--- M--- successor liability carries over to the next-in-line successor which is M---/C--- M---, petitioner herein. According to the audit staff, petitioner sometimes transferred sketches and patterns to customers who had elected not to purchase costumes from petitioner. Unless otherwise exempt, tax would apply to these transactions measured by the portion of the design fees allocable to the sketches and patterns transferred. The tax applies not because the design is part of the sale of costumes, but because the transfer of sketches and patterns is itself a sale of tangible personal property. Recommendation No adjustment to the successor liability assessment.

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Robert H. Anderson, Hearing Officer

3/6/84
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Date