When a business reorganizes — transferring assets to a new subsidiary, contributing assets between related corporations, or trading stock between commonly-owned subsidiaries — which of those transfers are subject to Texas sales tax, and how are stock-sale receipts allocated for franchise tax?
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Plain-English summary
The Texas Comptroller's Tax Policy Division answered a series of questions from a taxpayer planning a corporate reorganization involving both sales tax and franchise tax. The letter works through several distinct scenarios:
Occasional sale exemption and shared-use assets. If a transfer of business assets otherwise qualifies as an exempt "occasional sale" under Tex. Tax Code § 151.304, leaving out an asset used by more than one segment of the business (the letter's example is a computer) does not destroy the exemption for the rest of the transfer — though that leftover shared-use asset itself may be taxed if it's later sold off as part of an identifiable segment.
"Substantially all the property" test. Real property and intangibles (contracts, accounts receivable, trademarks) are not counted when determining whether "substantially all the property" of a business has been transferred for occasional-sale purposes — the exemption has been read to apply even when those items stay behind.
Initial capitalization of a new subsidiary. When Sub 1 transfers assets to a newly incorporated Sub 2 in exchange for 100% of Sub 2's stock, that transfer is nontaxable because the stock has no value yet at the moment of exchange. Additional asset transfers from Sub 1 to Sub 2 afterward remain nontaxable contributions (not sales) as long as no additional stock or other consideration is given in return.
Later transfers for additional stock are taxable. If Sub 1 later transfers more assets to Sub 2 in exchange for additional stock — even though Sub 1 still owns 100% of Sub 2 before and after — that transfer is taxable, because Sub 2's stock now has value and functions as consideration. The one exception: if the assets transferred represent all the assets used by Sub 1 in an activity. The letter also flags that the related-corporation sales rule (34 Tex. Admin. Code Rule 3.331) excludes the joint-ownership transfer exemption under § 151.306 where the only "joint ownership" is common stock ownership.
Chains of contributions. If Sub 1 contributes assets to Sub 2, which immediately contributes some or all of those assets on to Sub 3, each transfer is evaluated independently and is not treated differently just because it's one link in a longer chain — both can be nontaxable contributions.
Franchise tax apportionment of a stock sale. If Sub 1 sells its Sub 2 stock to commonly-owned Sub 3 (incorporated in a different state, e.g., Delaware) as part of the reorganization, and the income from the sale is unitary, the receipts are apportioned based on the location of the payor — meaning Sub 3's state of incorporation, not Sub 1's Texas domicile.
General reorganization mergers. The Comptroller agreed with the taxpayer's general premise that related mergers occurring alongside these transfers won't, by themselves, turn an otherwise-exempt occasional sale or capital contribution into a taxable event — but cautioned that each transaction still needs to be examined on its own facts.
What this means for you
Businesses restructuring into subsidiaries
If you're forming a new subsidiary and funding it with assets in exchange for its initial stock issuance, that initial transfer and follow-on asset contributions (with no additional stock given) should be treated as nontaxable capital contributions, not sales. But once you start exchanging assets for new stock issuances after the subsidiary is already capitalized, expect that later transfer to be taxable — the new stock has value and counts as payment.
Businesses selling off a division or segment (occasional sale exemption)
You don't have to sweep in every shared-use asset (like a computer used company-wide) to preserve the occasional sale exemption on the rest of the sale, and you don't need to include real property or intangibles to meet the "substantially all the property" threshold. But watch out: an asset left out of the sale because it's shared across segments can itself become taxable if it's later transferred as part of a sale of an identifiable segment.
Groups selling subsidiary stock between related entities
If commonly-owned subsidiaries buy and sell each other's stock as part of a reorganization, remember that for franchise tax apportionment purposes the receipts follow the buyer's (payor's) state of incorporation — not the selling entity's Texas domicile. That can shift income out of the Texas apportionment factor.
Accountants and tax professionals structuring multi-step reorganizations
Each step in a chain of transfers or contributions is analyzed independently on its own facts; a nontaxable capital contribution doesn't lose that treatment just because it's followed immediately by another contribution down the chain. Also keep the related-corporation carve-out in Rule 3.331 in mind — the joint-ownership transfer exemption under § 151.306 won't apply merely because related corporations share common stock ownership.
Common questions
Q: Does leaving a shared-use asset like a computer out of an asset sale destroy the occasional sale exemption?
A: No. According to this letter, if the computer is used for general business purposes across the company, excluding it from the sale of an identifiable segment does not cause a loss of the occasional sale exemption for the rest of the transaction — though the computer itself could be taxable if later sold with that segment.
Q: Do real property and intangibles count toward the "substantially all the property" requirement for the occasional sale exemption?
A: No. The letter states the exemption has been construed as applying even when real property and intangibles (contracts, accounts receivable, trademarks) are not transferred.
Q: Is transferring assets to a brand-new subsidiary in exchange for all of its stock taxable?
A: No. The letter says this is nontaxable because there is no value to the stock exchanged for the transferred assets at that point.
Q: What about a later transfer of more assets to that same subsidiary for additional stock?
A: That is taxable, per the letter, because by then the subsidiary's stock has value and serves as consideration for the transferred assets — unless the assets transferred represent all the assets used in an activity.
Q: Does a chain of contributions (Sub 1 to Sub 2 to Sub 3) get treated as one combined transaction?
A: No. The letter states each transfer stands on its own and isn't treated differently just because it's one of a series of transfers.
Q: How are receipts from a sale of subsidiary stock between related companies apportioned for franchise tax?
A: Based on the location of the payor (buyer). In the letter's example, because the buying subsidiary was incorporated in Delaware, the selling company had non-Texas receipts from that stock sale.
Q: Can another taxpayer rely on this letter for their own reorganization?
A: No. The letter says its answers are based on the facts presented and that other facts could change the answers; STAR letters generally can be relied on only by the taxpayer to whom they were issued.
Citations and references
Statutes and rules:
- Tex. Tax Code § 151.304 (Occasional Sale exemption)
- Tex. Tax Code § 151.306 (Transfers of Common Interest in Property)
- 34 Tex. Admin. Code Rule 3.331 (sales between related corporations)
Source
- STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
- Opinion: https://star.comptroller.texas.gov/view/9511224L
Original ruling text
November 27, 1995
Dear **:
In regard to your letter of November 6, 1995, you asked several questions
involving both the sales and franchise taxes in regard to corporate
reorganizations. The answers to your questions are based on the information
presented in your letter. Other facts could change the answers. While I will
not restate the facts in the letter, they are the basis for the answers to the
following questions:
- Is it correct that a transfer of assets that otherwise qualifies as an
occasional sale under Sec. 151.304 is an exempt transaction if an asset (e.g.,
a computer) that is used by more than one segment or division is not included
in the transfer?
Answer. Yes. The computer at issue is used for the general business purposes of
the overall business, and the failure to include it in the sale will not result
in a loss of the occasional sale exemption provided the transaction would
otherwise qualify as an occasional sale. As just stated, the computer is used
for general business purposes of the overall business; therefore, if it is
transferred as part of an occasional sale of a identifiable segment of the
business, it may be subject to sales tax.
- For the purposes of this exemption, is it correct that the following are not
included in determining whether "substantially all the property" has been
transferred: real property and intangibles (including contracts, accounts
receivable and trademarks)?
Answer Yes. The occasional sale exemption has been construed as applying even
though real property and intangibles are not transferred.
- If Sub 1 transfer assets to Sub 2 (a newly incorporated corporation) in
exchange for 100% of Sub 2 stock, is it correct that:
(a) This transfer is nontaxable?
Answer: Yes. We have considered this a nontaxable transfer because there is no
value to the stock exchanged for transferred assets.
(b) Subsequent asset transfer by Sub 1 to Sub 2 will be nontaxable transactions
so long as no additional stock (or other consideration) is given to Sub 1 for
the asset?
Answer: Yes. It is considered a contribution rather than a sale.
(c) Subsequent asset transfers by Sub 1 to Sub 2 in exchange for additional
stock are nontaxable if Sub 1 owns 100% of Sub 2's stock both before and after
the transfers?
Answer: No. Subsequent transfer of assets from Sub 1 to Sub 2 will be taxable
as the stock of Sub 2 would have value at the time of the transfer and would
constitute consideration for the transfer of the asset. The only exception to
this would be if the asset transfers represented all of the assets used by Sub
1 in the course of an activity. If you are referring to the joint ownership
transfer exemption (Section 151.306, Transfers of Common Interest in Property)
in this question, please note that Rule 3.331 excludes from that exemption
sales between related corporations where the only joint ownership is the
ultimate ownership of the corporation stock.
(d) A transfer that otherwise qualifies as a nontaxable capital contribution is
a nontaxable transfer without regard for the fact that it is one of a series of
capital contributions (e.g., if Sub 1 contributes assets to Sub 2 which
immediately contributes some or all of the assets to Sub 3, both Sub l's and
Sub 2's transfer are nontaxable contributions?
Answer: Yes. Each transfer stands on its own and is not treated differently
because it is one of a number of vertical transactions.
- Sub 1 owns 100% of newly incorporated Sub 2 and Sub 3. For purposes of this
section, if Sub 1 sells its Sub 2 stock to Sub 3 as part of a general corporate
reorganization, are we correct that Sub l's receipts from this sale will be
allocated to Sub 3's state of incorporation (e.g., Delaware) rather than to Sub
l's domicile (Tex).
Answer. My response is based on the presumption that the income from the sale
of the stock is unitary. Yes, the receipts from the sale of the stock are
apportioned on the basis of the location of the payor. In this case, Sub 3
purchases the stock from Sub 1. Because Sub 3 is a payor which was incorporated
in Delaware, Sub 1 will have non-Texas receipts regarding the transaction.
- In your final substantive paragraph, you note that the planned
reorganization may take a number of forms involving transfers of assets and
mergers. Your understanding is that these related mergers will not cause a
transfer that otherwise qualifies as an exempt occasional sale (or as a
nontaxable capital contribution) to be taxable.
Answer: I agree with this general premise. But, each transaction must be
examined carefully to be sure it does qualify.
I hope this satisfactorily answers your questions.
Sincerely,
Wade Anderson
Director, Tax Policy
cc: Karey Barton, Manager, Tax Policy
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