When a leasing subsidiary liquidates and distributes its leased equipment to its two corporate-partner owners, is that a taxable sale, and does it matter whether the subsidiary's debt gets paid off first?

Plain-English summary

A corporate parent ("Company P") had a leasing subsidiary ("Lease Co.," a Delaware LLC owned 99% by "Company A" and 1% by "Company B," both Company P subsidiaries). Lease Co. bought equipment tax-free using a resale certificate, then leased it to Company A under a master lease agreement, funding its purchases through a line of credit from Company A. Lease Co. decided to liquidate and distribute its leased equipment to Company A and B, its two partners -- and planned to pay off its line of credit with a capital contribution from Company A first, wiping out all debt on the equipment before distributing it.

The taxpayer asked five related questions, and the Comptroller's answers turn entirely on one concept: whether there's consideration.

1. Is the distribution a taxable sale? A transaction isn't a sale without consideration, and consideration can be the assumption of debt. Because the taxpayer's own facts stated Company A would contribute funds specifically to pay off Lease Co.'s debt before the equipment was distributed, the Comptroller found that funding was consideration -- meaning a taxable sale occurred.
2. Does the "occasional sale" exemption (§ 151.304(b)(3)) apply? No. If there's no consideration, there's simply no sale to begin with (so the exemption is irrelevant). If there is consideration, the charge is really a lease termination or a sale of resale inventory -- neither of which is an "occasional sale" in the first place.
3. Would Company A or B owe tax on equipment received? Only if there's no consideration and the equipment is a pure contribution -- but per the answer to Question 1, on these facts there does appear to be consideration.
4. Would Lease Co. owe tax on its own equipment purchase cost before distributing? If Lease Co. simply gives the equipment to the related companies for no consideration, that's a taxable "divergent use" of items it bought tax-free for resale under § 151.154.
5. If tax applies, on what amount? Tax on a no-consideration divergent-use scenario would be based on the equipment's original purchase cost.

What this means for you

Corporate groups liquidating leasing or holding subsidiaries

Don't assume an intercompany asset distribution during a liquidation is automatically tax-free just because it's "internal." If any related entity is required to pay off the liquidating entity's debt (or otherwise provide value) as part of the transaction, that can constitute taxable consideration -- making the distribution a taxable sale rather than a tax-free contribution.

Accountants structuring intercompany liquidations

The title of this ruling is itself a useful caution: debt assumption is consideration when it's actually required as part of the deal, but the Comptroller cautions that outstanding debt should not be automatically presumed to be "assumed debt" in every liquidation -- the facts of who is obligated to satisfy the debt, and why, control the analysis.

Entities that bought equipment tax-free for resale

If you distribute or transfer resale-exempt equipment to a related party with no consideration, watch for potential "divergent use" tax exposure under § 151.154, measured by the equipment's original cost -- a tax on the entity making the transfer, not the recipient.

Common questions

Q: Is an intercompany liquidating distribution of equipment automatically tax-free?
A: Not automatically. It's tax-free only if there's truly no consideration. If a related party is required to fund paying off the transferring entity's debt as part of the plan, that funding is consideration, and the distribution becomes a taxable sale.

Q: Would this qualify for the "occasional sale" exemption instead?
A: No -- the Comptroller found that if consideration exists, the transaction is really a lease termination or sale of resale inventory, neither of which fits the occasional-sale exemption in § 151.304(b)(3).

Q: If there's no consideration, is everyone in the clear?
A: Not necessarily -- the entity that originally bought the equipment tax-free for resale can still owe its own tax for "divergent use" under § 151.154, based on the equipment's original cost, even when the recipients owe nothing.

Q: Does this letter bind the Comptroller for my company's transaction?
A: No -- this is an informal 2001 letter addressing one taxpayer's specific facts, not a modern Private Letter Ruling or General Information Letter, and it cannot be relied on by anyone else.

Citations and references

Statutes:

• Tex. Tax Code § 151.304(b)(3) (occasional sale exemption)
• Tex. Tax Code § 151.154 (divergent use of items purchased tax-free for resale)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/200110530L

Original ruling text

October 2, 2001

Dear **:

Thank you for your letter concerning the taxability of the distribution of
leased assets to related entities.

Your client, Company P, owns several subsidiaries. This ruling request involves
three of the entities: Company A, Company B, and Lease Co. Both Company A and B
are domestic operating companies incorporated in the state of Delaware. Lease
Co. is a Delaware Limited Liability Corporation (LLC) taxed as a partnership
for federal income tax purposes. Lease Co. is owned 99% by Company A and 1% by
Company B and Company A and B are members of the consolidated group of Company
P.

Lease Co. is engaged in two primary activities: procurement and leasing. Lease
Co. purchases assets primarily for use by Company A. Typically, the longer
lived assets are sold while the shorter lived assets are leased. Lease Co.
issues a resale exemption certificate for all its purchases and, therefore,
pays no sales tax at the time of purchase.

Lease Co. has a line of credit with Company A which it utilizes in making its
purchases. This line of credit has a current interest rate of 9% per annum.

Lease Co. has a master lease agreement with Company A to acquire and lease
assets as requested by Company A. Currently, the lease terms are for 5 years
with residual values for the equipment of 52% and 58%, depending upon the
equipment type. The implicit interest rate utilized in the lease is currently
7.25% per annum. At the end of the 5 year term Company A has the ability to
purchase the asset at its fair market value.

To illustrate, equipment with a purchase price of $100,000, a residual value of
58%, and an implicit interest rate of 7.25% would have a monthly lease payment
of $1,260. Sales tax is collected and remitted, when appropriate, on a monthly
or quarterly basis in the state the equipment is utilized.

Lease Co. has decided to liquidate its operations and transfer the assets to
its partners, Company A and B. This decision is based upon Lease Co.'s
inability to effectively manage and coordinate its procurement and leasing
functions. Currently, Lease Co. has leases with remaining terms ranging from 2
to 5 years. As a result of this liquidation the leases will terminate and no
further payments will be made. Prior to the proposed liquidation, Lease Co.
intends to pay off the line of credit through a capital contribution from
Company A, thus eliminating all debt on the leased assets.

You asked the following questions:

1. Will the distribution of Lease Co.'s leased assets to its partners be
   considered a sale, subject to Texas sales and use tax purposes?

Response. You are correct in stating that a transaction is not a sale unless
there is consideration present. Consideration can be the assumption of debt.
If Company A was required to contribute the funds to pay off the Leasing Co.'s
indebtedness, a taxable sale occurred. You stated "(p)rior to the proposed
liquidation, Lease Co. intends to pay off the line of credit through a capital
contribution from Company A, thus eliminating all debt on the leased assets."

2. Is the distribution of Lease Co.'s leased assets in a liquidating
   distribution considered an occasional sale as defined by Section 151
   .304(b)(3)?

Response. No. If there is no consideration, there is no sale. If there is
consideration, the charge is for lease termination or the sale of inventory
purchased for resale. These are not occasional sales.

3. As a result of the distribution, will Company A or B be subject to sales/use
   tax on the assets received from Lease Co.?

Response. If there is no consideration given and the items are simply
contributed to Company A or B, Company A or B will not be liable for any tax.
However, see Response 1. It appears that there may be consideration.

4. Prior to the distribution, will Lease Co. be subject to sales/use tax on any
   portion of its equipment purchase cost?

Response. If Lease Co. gives the equipment to the related entities for no
consideration, they have made a taxable divergent use of the items purchased
tax free for resale. See Texas Tax Code 151.154.

5. If the distribution is subject to tax, on what amount would the tax be
   assessed?

Response. If the Leasing Co. gives the equipment to the related entities, tax
would be due on the original cost of the equipment.

This opinion is based on the facts presented. If there are additional or
different facts, the opinion may change. You may call me toll free at
1-800-531-5441, ext. 5-0613. The direct line is 512/475-0613. You may also
write to Tax Policy Division, Comptroller of Public Accounts.

Sincerely,

Kevin Koller
Tax Policy Division