Were three sales disposing of a taxpayer's United States renewable-energy businesses substantial and occasional, so the receipts were excluded from California's sales factor?

Plain-English summary

California Chief Counsel Ruling 2017-03 held that three sales disposing of nearly all of a taxpayer's United States renewable-energy businesses were substantial and occasional sales under title 18, regulation section 25137(c)(1)(A).

Each sale separately exceeded the regulation's 5% substantiality threshold.

The transactions were also outside the taxpayer's normal course of developing, owning, and operating energy facilities and occurred infrequently.

FTB therefore excluded the divestiture receipts from both the sales-factor numerator and denominator.

Business and divestiture facts

The global company developed, built, owned, and operated energy facilities and sold the resulting output in wholesale markets.

After the global financial crisis, it began strategically disposing of assets outside its core market to monetize value, reduce debt, and focus future investments.

The California water's-edge group operated its United States businesses through two brother-sister holding companies that filed on a combined basis.

During the ruling year, the group sold nearly all of its United States renewable-energy businesses in three transactions to three different purchasers. After the sales, the global company ceased operating in the United States and California.

California's special sales-factor rule

The ordinary California sales factor included gross receipts from transactions producing business income.

Regulation section 25137(c)(1)(A) excluded receipts from an occasional sale of fixed assets or other property used in the regular business when the receipts were substantial.

The two requirements were separate:

• substantial: excluding the sale reduced the taxpayer's or combined group's sales-factor denominator by at least 5%; and
• occasional: the transaction was outside the normal course of business and occurred infrequently.

Because each sale went to a different purchaser, FTB evaluated each transaction separately.

Why the sales were substantial

The ruling's dollar amounts and percentages were redacted.

But FTB stated that excluding each of the three sales reduced the combined group's denominator by more than the required 5%.

Each transaction therefore independently satisfied the substantiality test.

Why the sales were occasional

The taxpayer's ordinary business was developing, owning, and operating energy facilities and earning recurring revenue from their output—not regularly building projects for resale.

Selling the entire United States business was an extraordinary corporate event outside those normal operations.

The company's history also showed only a limited number of earlier divestitures over an eight-year period, with one prior divestiture by the United States taxpayer. FTB treated the ruling-year sales as infrequent.

Result for the sales factor

Because each divestiture was both substantial and occasional, its gross receipts were excluded from:

• the California sales-factor numerator; and
• the everywhere sales-factor denominator.

The holding was expressly based on the accuracy and completeness of the taxpayer's representations and remained subject to examination.

What this means for you

Businesses selling divisions or operating assets

A large disposition is not excluded merely because it is unusual. It must meet both the numerical substantiality threshold and the outside-normal-course/infrequency test.

Combined-reporting groups

Measure the 5% decrease against the denominator of the combined group as a whole. Separate purchasers can require separate transaction-by-transaction testing.

Corporate tax departments

Preserve denominator calculations with and without each sale, buyer identities, asset history, ordinary operating model, prior disposition frequency, board strategy materials, and evidence showing why the sale was extraordinary.

Common questions

Q: What made a sale substantial?

A: Excluding it reduced the combined group's sales-factor denominator by at least 5%.

Q: Did FTB aggregate all three divestitures?

A: No. Because they involved different purchasers, FTB evaluated them separately.

Q: Why were the sales outside the normal course?

A: The taxpayer normally developed, owned, and operated energy facilities rather than regularly selling them for profit.

Q: Did prior divestitures prevent occasional treatment?

A: No. FTB found the limited prior transactions over several years consistent with infrequent sales.

Q: Were excluded receipts removed from only the denominator?

A: No. They were excluded from both numerator and denominator.

Citations and references

• Cal. Rev. & Tax. Code §§ 21012(a)(1), 25120(a), 25120(f), 25123-25127, and 25134
• Cal. Code Regs., tit. 18, §§ 25137(c)(1)(A) and 25137-1(f)(3)(A)
• Hoechst Celanese Corp. v. Franchise Tax Bd., 25 Cal. 4th 508 (2001)
• Appeal of New York Football Giants, Inc., 77-SBE-014 and 77-SBE-015
• Appeal of the Learner Company, et al., 80-SBE-103
• Appeal of Triangle Publications, Inc., 84-SBE-096

Source

• Landing page: California FTB Chief Counsel Rulings
• Official PDF: Chief Counsel Ruling 2017-03

Original ruling text

STATE OF CALIFORNIA
FRANCHISE TAX BOARD
chair Betty T. Yee| member Diane L. Harkey| member Michael Cohen

Legal Division MS A260
PO Box 1720
Rancho Cordova, CA 95741-1720
tel: 916.845.3190 fax: 916.845.0536
ftb.ca.gov

10.18.2017
Chief Counsel Ruling 2017 - 03

RE: Request for a Chief Counsel Ruling on Behalf of ** ** *****

Dear * ****,

In your letter dated *** you requested a Chief Counsel Ruling seeking guidance as to whether the Taxpayer's sale of its United States ("US") ** businesses through *** separate transactions (described below) are substantial and occasional within the meaning of title 18 of the California Code of Regulations ("CCR") section 25137(c)(1)(A), with the result that the proceeds from the sales should be excluded from the California sales factor for the tax year ended ("TYE") ***

The Taxpayer has reviewed the facts set forth below and represents that the facts are true and correct and that all material facts have been disclosed. The taxpayer represents that the issues in this ruling request are not the subject of an existing California audit, protest or litigation concerning the Taxpayer or a group member.

FACTS

Global Business

* * (“the Global Company”) is an *-based developer, owner and operator of *****. The Global Company develops, builds, owns and operates ** and directly manages the sale of * to a range of customers in the wholesale market. The *** is sold through ***

* *.

The Global Company was established in * and went public on the **
** . At the time it went public, the Company owned interests in **
** ** *** *. Its business strategy was to grow shareholder wealth through management of its existing * and the acquisition of additional . From *, it acquired additional ***
**, and, as of , owned interests in ** ***.

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Historically, the Global Company focused on **, but later expanded into
** to capitalize on * growing role as a * *. The Global Company viewed its expansion into ** as a natural extension of its **
* business because it took advantage of the Global Company’s skills in **

* ***. The Global Company’s business model for is no different than for *** – that is, to develop, build, own and operate *** *
***.

In *, responding to the global financial crisis, the Global Company announced its intent to begin strategically selling off ** **. The Global Company believed that through this process it could generate value by selling * for more than their implied value based on market capitalization. Also, this strategy would allow the Global Company to pay down debt and focus on the ** market. As a part of this strategy, the Global Company sold all of its ** in: * ** **

Following these divestitures and as of **, the Global Company operated solely in * and the United States.

US Business and Entity Structure

The Global Company began operating in the US in *, when it acquired a majority interest in **8*****. The Global Company continued to acquire and operate **** in the US over the next several years.

In *, the Global Company commenced a process to sell the entire US business as part of its previously announced plan to strategically sell off * outside of **, but, in **, pulled the US business off the market after it was unable to obtain a satisfactory price.

In * , after receiving an unsolicited but favorable offer, the Global Company sold *** of its *** * * * to for ***
****.

At the time of the * ** * described below, the Global Company operated in the US through *** holding companies: (1) * ** ** * *** (“Holdings I”), an elected corporation for federal and California income tax purposes which invested in
, and (2) * *** ** * (“Holdings II”), which invested in
**. Holdings I and Holdings II were brother-sister entities, wholly-owned indirectly by the Global Company. They do not have a common US parent corporation.

For the year ended * ** ***, Holdings I and Holdings II file on a combined basis for California franchise tax purposes because of unitary ties and common ownership through the Global Company. They file their California return on a water’s-edge basis. Together, Holdings I and Holdings II and their subsidiaries will be referred to as the “Taxpayer.”

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Taxpayer's Sale of their US Operations

During the TYE * ** , the Global Company re-engaged in its efforts to dispose of its US ** businesses in order to monetize their value, pay down debt and focus future investments in *, consistent with the strategic initiative that began in
*. They hired investment bankers and arranged a competitive bidding process. In
, the Taxpayer completed the sale of almost all of its
****** * business. The sale of the * business closed in ** . In ** , the Taxpayer sold its remaining * **.

In summary, Taxpayer divested of its US renewable energy businesses during the TYE *
*** through three separate transactions as follows:

• In * , Holdings II sold most of its ** to ** *for $***.
• In **, a wholly owned subsidiary of Holdings I sold all of its *** * and the Taxpayer’s US project management business and headquarters to * * * for $****.
• In * , Holdings II sold its remaining to for $*.

These transactions, collectively referred to as the "* US divestments," generated almost all of the Taxpayer’s gross receipts for the TYE ** as follows:

Description
Contribution to Gross
Receipts
* Transaction
$ *
* Transaction $ *
** Transaction
$ **
* * Fees 1
$ *
** Sales
$ *

Total Gross Receipts
$ ****

Following these sales, the Global Company ceased to operate in the US and California and operated solely in *. As of *, the Global Company operated ** *
and a * *** in , and had a * *** to build additional *** and ** in **.

1This represents *** fees charged by the Taxpayer to its various flow-through

project entities that are not eliminated under CCR section 25137-1(f)(3)(A) due to less than 100% ownership of the * entities.

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ISSUE

Whether the gross receipts arising from the **** US divestments described above constitute substantial and occasional sales within the meaning of CCR section 25137(c)(1)(A) such that they should be excluded from the sales factor?

HOLDING

Based on the accuracy and completeness of the facts and representations provided by the Taxpayer, and subject to examination by the Internal Revenue Service and/or FTB of the facts, the **** US divestments are substantial and occasional under CCR section 25137(c)(1)(A).

DISCUSSION

For California apportionment purposes, the sales factor is a fraction, the numerator of which is the total sales of the taxpayer in this state during the taxable year, and the denominator of which is the total sales of the taxpayer everywhere during the taxable year. 2 For taxable years beginning on or after January 1, 2011, "sales" means all gross receipts of the taxpayer not allocated under CRTC sections 25123 to 25127. 3 Gross receipts means the gross amounts realized on the sale or exchange of property, the performance of services, or the use of property or capital in a transaction that produces business income. 4

However, CCR section 25137(c)(1)(A) provides a special rule excluding receipts from the sales factor when those receipts are substantial and arise from an occasional sale of assets used in the taxpayer's trade or business. CCR section 25137(c)(1)(A) states in pertinent part:

Where substantial amounts of gross receipts arise from an occasional sale of fixed assets or other property held or used in the regular course of the taxpayer’s trade or business, such gross receipts shall be excluded from the sales factor. For example, gross receipts from the sale of a factory, patent, or affiliate’s stock will be excluded if substantial. For purposes of this subsection, sales of assets to the same purchaser in a single year will be aggregated to determine if the combined gross receipts are substantial.

1. For purposes of this subsection, a sale is substantial if its exclusion results in a five percent or greater decrease in the sales factor denominator of the taxpayer or, if the taxpayer is part of a combined reporting group, a five percent or greater decrease in the sales factor denominator of the group as a whole.

2. For purposes of this subsection, a sale is occasional if the transaction is outside of the taxpayer’s normal course of business and occurs infrequently.

2 California Revenue and Taxation Code ("RTC") section 25134. 3 RTC section 25120(f)(1). 4 RTC section 25120(f)(2).

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This regulation requires that two elements be met before the gross receipt exclusion applies: the sale must be (1) “substantial” and (2) “occasional.” In situations where both of these elements are met, the gross receipts from the transaction will be excluded from both the sales factor numerator and denominator. These elements must be evaluated separately for each of the Taxpayer's * US divestments during **, as each sale was made to a different purchaser.

1. The * US Divestments are Substantial

A sale is substantial if its exclusion results in a five percent or greater decrease in the sales factor denominator of the taxpayer’s combined reporting group. 5 As outlined below, excluding the gross receipts from each of the * US divestments (evaluated separately) reduced Taxpayer's sales factor denominator by , ***, and *** percent, respectively:

Sales Factor Sales Factor
Denominator Denominator Percentage
Including the Excluding the
Decrease in
Sale Sale Difference Denominator

Sale of ** $ ** $ * $ ** ***%

Sale of ** $ * $ * $ * **%

Sale of ** $ ** $ * $ ** ***%

As each of the above percentage decreases are greater than the five percent threshold set forth in the regulation, the **** US divestments are substantial.

2. The * US Divestments are Occasional In considering whether a transaction occurred outside the taxpayer's normal course of business, the Court's analysis in Hoechst Celanese Corp. v. Franchise Tax Bd.6 ("Hoechst Celanese") may be helpful. In considering whether certain receipts constituted business income under the transaction test – a test which requires an analysis similar to that required by the regulation – the Court in Hoechst Celanese held that the "controlling factor" for determining whether a transaction occurred outside the regular course of a taxpayer's business activity is the "nature of the particular transaction" generating the income. 7 Here, the disposition of its entire US * businesses is an extraordinary corporate occurrence. The Taxpayer's normal course of business was to develop and operate (not sell) **** ** and sell the resulting **. Almost all of Taxpayer's recurring revenues come from such sales of **. While Taxpayer had a plan in place to strategically sell off * outside of *, Taxpayer's ongoing and normal business model did not contemplate regular, reoccurring, and ongoing divestitures of its *****. The Global Company

5 CCR section 25137(c)(1)(A)1.
6Hoechst Celanese Corp. v. Franchise Tax Bd., (2001) 25 Cal 4th 508, 526. 7 Ibid.

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continues to own and operate ****** in
* ** *** with aim of operating these facilities in the future. Stated another way, the Taxpayer's day-to-day business did not involve building and developing ** * for sale at a profit, and Taxpayer did not normally or regularly sell * . Rather, as previously stated, Taxpayer's normal course of business involved the development, owning and operating of **
* * with its regular and recurring revenues coming from the sale of
* *** *. Thus, the US divestments during TYE
**** are outside of the normal course of Taxpayer's business.

In addition, in order for a transaction to be occasional within the meaning of CCR section 25137(c)(1)(A) it must also be infrequent. Here, case law considering whether income is "business income" under the transactional test (codified in RTC section 25120(a)) can be useful, although it does not control whether a sale is occasional under CCR section 25137(c)(1)(A)). In Appeal of New York Football Giants, Inc.,8 the State Board of Equalization (the "Board") held that a professional sports team playing one game in California in a taxable year was occasional. Also, in Appeal of Learner Company, 9 the Board held that trips made by the taxpayer's officers once or twice a year were infrequent and occasional. The Board also provided context to the meaning of "occasional" under CCR section 25137(c)(1)(A) in Appeal of Triangle Publications, Inc.10 There the Board recognized that the sale of two corporate divisions and a building during a four-year period were "occasional" under CCR section 25137(c)(1)(A). Here, the Global Company has made four prior divestitures over an eight year period, and the Taxpayer had a single prior divestiture in a prior year. 11 Thus, the * US divestments during the TYE *** are also infrequent.

HOLDING

Based on the accuracy and completeness of the facts and representations provided by the Taxpayer, the * US divestments are both substantial and occasional under CCR section 25137(c)(1)(A) and the gross receipts from these divestments should be excluded from the Taxpayer's sales factor for the TYE ***.

Please be advised that the tax consequences expressed in this Chief Counsel Ruling are applicable only to the named taxpayer and are based upon and limited to the facts you have submitted. In the event of a change in relevant legislation, or judicial or administrative case law, a change in federal interpretation of federal law in cases where our opinion is based upon such an interpretation, or a change in the material facts or circumstances relating to your request upon which this opinion is based, this opinion may no longer be applicable. It is your responsibility to be aware of these changes, should they occur.

This letter is a legal ruling by the Franchise Tax Board's Chief Counsel within the meaning of paragraph (1) of subdivision (a) of section 21012 of the CRTC. Please attach a copy of this

8 Appeal of New York Football Giants, Inc., 77-SBE-014, February 3, 1979 and 77-SBE-015,

June 28, 1979.
9 Appeal of the Learner Company, et. al., 80 SBE-103, September 30, 1980. 10 Appeal of Triangle Publications, Inc., 84-SBE-096, June 27, 1984. 11 The * sale of the two * to * for $***.

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letter and your request to the appropriate return(s) (if any) when filed or in response to any notices or inquiries which might be issued.

Very Truly Yours,

Cheryl L. Akin
Tax Counsel