Did a senior security interest and absence of cash protect an inventory buyer from the seller's unpaid sales tax?

Plain-English summary

A company bought another company's inventory without arranging payment of the seller's outstanding sales tax. It argued that a senior secured creditor had rights to the inventory or proceeds and that there was no cash available to withhold.

California said those facts did not eliminate successor liability. Before buying, the purchaser could request a tax clearance certificate, require the seller to pay the tax as a closing condition, renegotiate the economics, or refuse the transaction.

The Board was not asserting a superior lien against the inventory. It imposed a personal liability on the purchaser under section 6811 for buying the inventory without providing for the seller's tax. Like other tax debts, that liability could be paid from any assets the purchaser possessed. Knudsen foreclosed the argument that lack of cash made withholding impossible.

What this means for you

Inventory buyers, secured lenders, distressed sellers, and tax advisers

Price the seller's tax exposure into the transaction and obtain clearance before closing. A senior lien or noncash structure does not automatically protect the purchaser.

Common questions

Q: Did the senior security interest control?

A: No.

Q: Was the Board claiming a superior lien on the inventory?

A: No. It imposed personal successor liability on the buyer.

Q: Did absence of cash eliminate withholding?

A: No.

Citations and references

• California Revenue and Taxation Code § 6811
• Knudsen Dairy Products Co. v. State Board of Equalization, 12 Cal. App. 3d 47 (1970)

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 535.0060.325
• Original supporting opinion: 535.0060.325 PDF

Original ruling text

535.0060.325

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

LEGAL DIVISION (MIC:82)
450 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0082)
Telephone: (916) 445-6496
FAX: (916) 323-3387

April 22, 1996

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

REDACTED TEXT
Re:

E. L. Sorensen, Jr.
Executive Director

REDACTED TEXT

Dear REDACTED TEXT:
This office has received your letter dated April 16, 1993, in which you acknowledge receipt of our letter to you dated March 11, 1996. In your letter you state that you “[r]espectfully challenge [the Board] to describe a method of making payment to the State Board which would not have violated REDACTED TEXT’s superior right to cash (even though there wasn’t any) and which would not have resulted in REDACTED TEXT agreeing to pay more for the goods than they were worth, i.e. more than the parties bargained for.” In any prospective purchase and sale of inventory from one company to another, the potential purchaser must determine if the price of the inventory is reasonable in consideration of all of the factors involved. One of those factors is the possibility that the potential purchaser will become liable for the seller’s sales tax liability pursuant to Revenue and Taxation Code section 6811. A potential purchaser may request a tax clearance certificate from the Board disclosing the seller’s sales tax liability. The potential purchaser can then require that the seller pay its tax liability to the Board as a condition of the purchase of the inventory. If the seller does not agree to this condition, the potential purchaser can refuse to purchase the inventory finding that the “price” to be paid for the inventory is too high. The Board has imposed liability on REDACTED TEXT because it purchased the inventory of REDACTED TEXT without providing for the payment of the outstanding sales tax liability. The fact that the inventory may have been subject to a senior security interest is irrelevant. The Board is not imposing a superior lien on the inventory sold requiring REDACTED TEXT to pay the Board, rather than REDACTED TEXT, when inventory is sold. Liability is imposed on REDACTED TEXT for the taxes due by REDACTED TEXT pursuant to Revenue and Taxation

REDACTED TEXT

-2-

April 22, 1996
535.0060.325

Code section 6811. As with any tax liability, REDACTED TEXT may pay this liability from any assets that it possesses. We cannot accept your contention that since there was no cash for REDACTED TEXT to withhold, REDACTED TEXT can escape liability under Revenue and Taxation Code section 6811. As we indicated in our letter to you dated March 11, 1996, the Knudsen case holds otherwise. Very truly yours, Thomas J. Cooke Staff Counsel TJC/cmm bc:

Ms. Charlotte Paliani (w/incoming letter - MIC:70)
Culver City District Administrator (w/incoming letter - AS)