How could California collect after a tax debtor gifted business assets to his wife, who contributed them to a new corporation?

Plain-English summary

After California assessed an individual business owner, he purported to give the sole proprietorship's assets to his wife. She later contributed the assets to a newly formed corporation in exchange for all its stock, and the corporation continued the equipment business.

The attached hearing report treated the spouses as owners of the predecessor under then-applicable community-property law. It concluded the corporation purchased the business for stock and could be held as successor. It also concluded the gift could be disregarded or set aside as a fraudulent conveyance because the debtor transferred property without fair consideration and the corporation knew of the transfer.

The cover memorandum disagreed on the successor-statute route. It called the facts a classic fraudulent transfer, said it saw no basis under sections 6811 and 6812, and recommended either an Attorney General action to set aside the transfers or a levy on the transferred property. The published annotation follows that creditor-remedy recommendation.

What this means for you

Tax debtors, family transferees, corporations, and advisers

A gift label does not defeat creditor remedies when a debtor strips assets from the business. Analyze successor statutes, noncash stock consideration, community-property rules, and fraudulent-transfer law separately.

Common questions

Q: Did the attached hearing report find successor liability?

A: Yes.

Q: Did the cover memorandum agree with that statutory basis?

A: No. It preferred fraudulent-conveyance remedies.

Q: What remedies did the cover memorandum suggest?

A: Set aside the transfers through an Attorney General action or levy the transferred property.

Citations and references

• California Revenue and Taxation Code §§ 6811 and 6812
• Former California Civil Code §§ 3439.04, 3439.09, and 5116
• Knudsen Dairy Products Co. v. State Board of Equalization, 12 Cal. App. 3d 47 (1970)
• Widener v. Hartnett, 12 Cal. 2d 287 (1938)

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 535.0028
• Original supporting opinion: 535.0028 PDF

Original ruling text

State of California

Board of Equalization

Memorandum

535.0028

To:

Mr. Gary J. Jugum

From:

John H. Murray

Date:

April 23, 1985

Subject:

Attached is a photo copy of the hearing report submitted on the Petition for Reconsideration of Successor Liability filed on behalf of ______ and some related material from the petition file. I can see no basis for asserting successor liability under section 6811 and 6812. Indeed this is a classic case of a transfer in fraud of creditors. I think it should be treated as such. I would suggest that we should proceed in these cases in accordance with the provisions of the Civil Code relating to transfers in fraud of creditors. This could be done either by referring the case to the Attorney General with a request that he bring an action to set aside the transfers or that we levy from the transferred property. It appears to me that this is a good case for us to discuss at one of our Friday conferences.

535.0028

STATE OF CALIFORNIA
BOARD OF EQUALIZATION

In the Matter of the Petition
for Reconsideration of
Successor Liability for State
and Local Sales and Use Taxes

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DECISION AND RECOMMENDATION

The above-entitled matter came on regularly for hearing on January 9, 1985, in Oakland, California before John B. Adamo, Hearing Officer. Appearing for Petitioner: Appearing for the Board:

Protest
Petitioner protests the assertion of successor liability. The notice of successor liability was issued March 7, 1984 and reflected a total liability of tax, interest, and penalties of $111,861.52. Contention of Petitioner Petitioner contends that it was not the “purchaser” of the predecessor business. Summary Petitioner is a corporation engaged in the sale and leasing of construction equipment. An application for a seller's permit was submitted on behalf of petitioner on December 28, 1983 and was issued effective January 1, 1984. The immediate predecessor to the business operated by petitioner was __. Upon audit of the predecessor, the audit staff concluded that Mr. _ had a substantial unpaid tax liability; a notice of determination was issued on March 11, 1982. Mr. closed out his seller's permit effective December 31, 1983 and the business operation was succeeded, as noted above, by petitioner with an effective starting date of January 1, 1984. The subject notice of successor liability was issued on March 7, 1984. As further noted below, petitioner contends that it cannot be held liable for the tax liability of because there was no purchase price upon which to base successor's liability. Specifically, petitioner has noted that Mr. ___ executed a declaration of gift, dated February 22,

535.0028
1983, to his spouse of the assets of the sole proprietorship. Thereafter, Mr. __ continued to operate the business until December 31, 1983. At the preliminary hearing, petitioner's attorney stated that Mrs. _ was completely uninvolved with the business conducted by her husband. Petitioner was incorporated in November 1983 and Mrs. contributed the assets gifted to her to petitioner in exchange for stock. Petitioner then commenced operation on January 1, 1984 with Mrs. as the sole shareholder and officer. At the preliminary hearing, petitioner's attorney stated that Mrs. is solely responsible for business operations and that Mr. works only as a commissioned salesman. Petitioner claims that some of the items that Mrs. acquired by gift in February 1983 were disposed of prior to January 1, 1984; the balance of the items were contributed to petitioner. Petitioner further contends that it did not acquire any of the liabilities of Mr. and has made no payments on any of the sold proprietorship's outstanding obligations. Moreover, petitioner asserts that the business it conducts is different from that of Mr. in that all, or virtually all, of its equipment sales are on a consignment basis. Mr. leased the property where he conducted his business from . This lease required that Mr. obtain the prior written consent of
to any sublease of the property. Petitioner has submitted a copy of a sublease agreement, effective January 1, 1984, entered into by and between petitioner and Mr. for the sublease of the business property. was not notified of this sublease. Petitioner contends that it cannot be held liable for Mr. tax liability because under Revenue and Taxation Code Section 6812 there must be a purchase of a business or stock of goods by the successor before the latter can become liable for the predecessor's liability. In this case, petitioner argues, it purchased nothing from Mr. rather, Mrs. was gifted certain items by her spouse and subsequently contributed them to petitioner. The Board's staff has concluded that the sequence of events outlined above is insufficient to relieve petitioner's liability and has reported that Mr. ___ stated to certain of his customers that the actions described above constituted a device designed "to beat those tax people." Analysis and Conclusions Section 6811 of the Revenue and Taxation Code provides that if any person liable for any amount under the Sales and Use Tax Law sells out his business or stock of goods or quits the business, his successors or assigns shall withhold sufficient of the purchase price to cover such amount until the former owner produces a certificate from the Board stating that no amount is due. Section 6812 provides that if a purchaser of a business or stock of goods fails to withhold purchase price as required, the purchaser becomes personally liable for the amount required to be withheld by him to the extent of the purchase price. Civil Code Section 5116, operative January 1, 1975, provides that the property of the marital community is liable for the contracts of either spouse which are made after marriage and prior to or after January 1, 1975. While Section 5116 refers to "contracts," it is well settled that the same rule of community liability extends to tax debts. (See Kingsbury v. United States, 563 F.2d 1019 (1977) wherein the court, applying California law, held that the wife's interest in community property is subject to the tax debts of her husband; see also Weinberg v. Weinberg, 67 Cal.2d 557 (1967); In re Marriage of Smaltz, 82 Cal.App.3d 570 (1978).)

535.0028
The liability of Mr. __ was established prior to the purported "gift" to his spouse. Consequently, she too is liable for that debt. In light of California community property law Mr. and Mrs. _ owned the predecessor business as a husband and wife partnership notwithstanding that Mr. obtained a seller's permit as a sole proprietor. Consequently, in that the continued to operate the business as partners both before and after the supposed "gift," petitioner can properly be held liable as their successor even if only Mrs. received petitioner's stock in exchange for the contribution of assets. We believe that the record of this petition clearly supports the audit staff's determination that petitioner did purchase the predecessor business and stock of goods. In consideration for that business and its assets, petitioner issued all of its outstanding stock to Mrs. . The purchase price is represented by petitioner's issuance of those shares. It is difficult to envision a more complete takeover of a going business than that which occurred here. There is no authority to support the proposition that the transfer of assets by a partnership in exchange for stock issued by newly-formed successor corporation wholly-owned by a former partner does not constitute a purchase of the predecessor business by the corporation. Indeed, the relevant case law is in contradiction to that position. (See Knudsen Dairy Products Co. v. State Board of Equalization, 12 Cal.App.3d 47 (1970).) In that case, a creamery corporation, which held the outstanding stock of a food market corporation, directed the latter to transfer all of its operating assets to a subsidiary of the creamery. The subsidiary in turn issued to the creamery a promissory note equivalent to the value of the assets received. The creamery then credited the food market corporation, in reduction of its pre-existing indebtedness to the creamery, in the amount of the value of the assets transferred. A closeout audit of the food market corporation by the Board disclosed additional taxes due on certain sales. Under these circumstances, the court held that the subsidiary was a "purchaser" of the food market corporation and that it was liable for the taxes under the provisions of Section 6811 and 6812. We see no reason to reach a contrary result here. Finally, petitioner's argument that there were no funds from which a withholding could have been made is also misplaced. Section 6812 specifically refers to "purchase price valued in money" (emphasis added); there is no requirement that the purchase price must take the form of cash. (Knudsen Dairy Products Co. v. State Board of Equalization, supra.) It would have been a relatively simple matter for petitioner, at the time it acquired the predecessor business and assets, to provide that a portion of the issued shares be set aside for the payment of the tax liability. In addition to the above, there is another basis upon which to conclude that petitioner is liable for the tax liability of Mr. ___. Civil Code Section 3439.04 provides that every conveyance made by a person who is or will be thereby rendered insolvent is fraudulent as to creditors without regard to his actual intent if the conveyance is made without a fair consideration. Section 3439.09 of the Civil Code sets forth the remedies available where a conveyance is fraudulent as to a creditor. Such a creditor, when his claim has matured, may, as against any person except a purchaser for fair consideration without knowledge of the fraud at the time of purchase: (i) have the conveyance set aside to the extent necessary to satisfy his claim; or (ii) disregard the conveyance and attach or levy execution upon the property conveyed. There is specific case authority holding, in circumstances indistinguishable from those presented here, that where, in consideration of love and affection, a debtor husband conveyed all of his property to his wife and

535.0028
rendered himself insolvent, the conveyance could be set aside by the husband's creditors. (Widener v. Hartnett, 12 Ca1.2d287 (1938)).) Petitioner was aware of the fraudulent conveyance from Mr. __ to his spouse. Thus, notwithstanding the consideration paid by petitioner for the assets contributed to it, the Board's compliance staff may make use of the remedies set forth in Civil Code Section 3439.09 to satisfy the subject liability. Finally, in that the conveyance from Mr. _ to his spouse may be disregarded for sales and use tax purposes, petitioner can also be considered as the direct successor to the ___, i.e., the community property owners of the predecessor. Recommendation We recommend that the petition for reconsideration of successorship liability be denied.

John B. Adamo, Hearing Officer

Date

REVIEWED FOR AUDIT:

Principal Tax Auditor

Date