Authored by: Bruce H. Davis, Donald R. Bast, Tracey G. Sellers
Businesses undergoing reorganizations—e.g., mergers, consolidations, acquisitions, dispositions, liquidations, bulk sales of assets—usually focus on the federal tax implications of the transactions. However, by disregarding state sales-tax implications of reorganizations, businesses often miss opportunities to diminish tax risk and/or experience tax savings. Using illustrations drawn from four states’ sales tax laws or regulations—California, Illinois, New York, and Texas—this article addresses some of the sales tax implications inherent in business reorganizations and considers how advance tax planning might mitigate resulting tax risk and/or enhance tax savings.
Sources of Authority
The first issue to consider herein is identifying the primary source of authority controlling a state’s treatment of business reorganizations. The source is not, as it is commonly thought, the Internal Revenue Code (“the IRC”). Rather, state sales tax statutes in this respect stand effectively on their own. The first principle within the state sales-tax law is the imposition statute. It generally reads that a transaction, involving an exchange of tangible personal property and executed within the taxing jurisdiction, is subject to sales tax only if it involves the exchange of title or interest (or, in some states possession) of tangible personal property in return for a consideration—broadly construed as not just money but anything of measurable value.1 Thus, if any transaction does not meet the requirements of the imposition statute, it falls outside of the scope of the sales tax.
Stock sales are not subject to sales tax because stock is an intangible asset and not tangible personal property. For example, if a corporation considers the sales tax treatment of an IRC §338(h)(10) election, it might find that the transaction is treated for sales-tax purposes as an exempt stock sale, pursuant to Generally Accepted Accounting Principles, and not as a sale of assets as it is treated under the IRC.2
Section 351 Drop-Down of Assets
Suppose that Corp. I, an Illinois widget manufacturer, wants to establish a subsidiary to hold one of its business divisions. It subsequently contributes to an existing subsidiary finished-goods inventory, manufacturing machinery and equipment, a fleet of trucks for shipping finished goods, office furniture, and an airplane. The drop-down of the assets may be sales-tax exempt for several reasons. First, if the assets were contributed to the subsidiary in exchange for no stock, the transaction would qualify as an IRC §351 deemed exchange but would not technically be a sale because no consideration was tendered in return for the assets. Second, if stock were received by Corp. I in exchange for its contribution of assets, the exchange may still be exempt under one of the exceptions to the general imposition statute such as a so-called “occasional” sale.3 In Illinois, occasional sales are made by persons who neither hold themselves out as, nor habitually engage in, making sales of the types of property being transferred. For example, Corp. I habitually sells widgets, not widget-making machinery or office furniture. Thus, these contributions are considered tax-exempt occasional sales.4 Nonetheless, there is a “trap” lurking here. The airplane transfer, while admittedly an occasional sale, is subject to tax under the Illinois Aircraft Use Tax Act which taxes transfers of planes.5 Still, it may be possible to avoid this tax by contributing the plane to a legally separate and distinct transportation subsidiary to carry out its intended function ferrying for hire in interstate commerce personnel of Corp. I and its affiliates. The airplane used in this way is sales-tax exempt.
In addition to the occasional-sale exception, other states may exempt an exchange of stock for assets under other exceptions. For example, assume that California Corporation C (“Corp. C”) contributes operating assets to a newly incorporated subsidiary. The transaction would not be taxable because it was made in exchange for first-issue stock of the subsidiary. In this case, the stock is not deemed consideration for the assets because the stock, having never been traded before on a securities exchange, is not yet thought of as having measurable value. Of course, this would not be the case if the assets were traded for previously-issued stock (say, in a pre-existing affiliate) or even a liability such as an assumption by the subsidiary of Corp. C’s indebtedness.6 Then the transaction would involve consideration and be subject to sales tax.
Sale of a Business and a Business Liquidation
If Texas Corporation T sells at least 80 percent of its assets (e.g., the sale of a branch, division, or an identifiable business segment) to another buyer, the transaction would be ostensibly sales-tax exempt as a Texas occasional sale. However, this would not be the case should the overall transaction involve sales of stock to more than one buyer, none of whom purchases at least 80 percent of the assets. In this case the sale would be deemed to consist of more than one transaction, each of which would fail the 80 percent requirement. Similarly, the sale would fail the Texas occasional-sale exception if the figure of 80 percent of the assets transferred could not be substantiated by the seller’s books and records.7
Should a New York limited liability company liquidate its assets and return them to its members, the transaction would be considered a tax-exempt liquidating dividend. It is deemed tax-exempt because the assets are not being transferred for consideration to a separate entity, but rather are being returned back to their current owners. Thus, no sale occurs.8 This is also the case with consolidations that do not involve any exchange of stock. There is deemed to be no sale if there is no exchange of old ownership for new—no change in the continuity of ownership.9
Perhaps the greatest risk involving sales tax liability within the context of a reorganization occurs as a result of a “bulk sale” of assets. Most states’ bulk-sale regulations read essentially the same as they do in the Illinois sales tax regulations. “A bulk sale occurs when any taxpayer, outside the usual course of their business, sells or transfers the major part of any one or more of: the stock of goods which they are engaged in the business of selling; or the furniture or fixtures; or the machinery and equipment; or the real property of any business that is subject to the provisions of the Retailers’ Occupation Tax Act [commonly known as the sales tax in Illinois]. The purchaser or transferee of such assets must, no later than 10 business days after the sale or transfer, file a notice of sale or transfer of business assets with the Department of Revenue. If the purchaser or transferee fails to file the notice of sale with the Department, they will be personally liable for the amount owed by the seller or transferor.” 10
The risk here does not involve the taxability of the bulk sale assets but rather the failure of the purchaser of the assets to notify the taxing authority of the transaction. As a result, the purchaser might find itself liable for past- due sales tax deficiencies of the seller because of the purchaser’s failure to notify the state of the transaction. Thus, if the taxing authority is unable to collect any past tax due from the seller, the purchaser may become liable for the tax. If the seller has outstanding tax liabilities, there will also be a reduction to the seller of the monies that it would receive pursuant to the bulk sales transaction to the extent of the monies held by the purchaser in an escrow account for the seller. These escrowed funds could be used by the purchaser to cover the seller’s outstanding tax liabilities and for which the purchaser would otherwise be held liable. Thus, failure to comply with bulk sales regulations poses a risk to both the buyer and the seller.
As it has been briefly demonstrated, corporate reorganizations have implications for assessment of state sales taxes. Thus, to control the adverse effects therefrom and to seize opportunities to experience tax savings, multistate corporate due diligence in this area is required when undertaking reorganizations. The sales tax professionals at True Partners Consulting have vast experience in assisting companies to navigate the often confusing array of state sales tax statutes to ensure a tax-efficient result to both buyer and seller. Learn more by contacting a member of our Sales Tax Team.
1 86 Ill. Admin. Code 130.101. NY Tax Law 1105
2 Cal. Reg. 1595(a)(b). Texas Tax Code 151.010
386 Ill. Admin. Code 130.110(a), (b), and 130.120(f)
4Some of the contributed assets may fall under other statutory sales-tax exemptions, such as the Illinois Manufacturing Machinery and Equipment Exemption. 86 Ill. Admin. Code 130.330
535 ILCS 157/10
6Cal. Reg. 1595(b)(4)
7Texas Tax Code 151.304(b), (c), and Reg. 3.316(d)
8NY Tax Law 1101(b)(4) and NYCRR 526.6(d)(1)
1086 Ill. Admin. Code 130.1701
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