Is sales tax due on assets transferred into a new corporation or partnership as part of a statutory merger or a tax-free IRC 351 reorganization?

Subject

Contribution To Capital — Transfer Of Assets To A New Entity For Initial Capitalization Or Set — Up — Guidelines

Plain-English summary

This letter answers a taxpayer's question about whether Texas sales tax applies to assets moved into a new entity during a corporate restructuring -- specifically a statutory merger qualifying under IRC 368(a) and a tax-free reorganization under IRC 351.

The Comptroller's answer: assets transferred as the result of a statutory merger of two or more companies are not subject to sales tax. Likewise, assets transferred to a newly formed ("commencing") corporation or partnership are not taxable if either:

• the transfer covers 100% of the operating assets, or
• the transfer is made without a change in ownership, as provided in subsection (e) of Rule 3.316 (the occasional-sale and tax-free-sale rule).

To qualify under the no-change-in-ownership route, three conditions from Rule 3.316(e) must be met:

1. What counts as a "transfer." A transfer of all or substantially all the property held or used in the course of an activity qualifies as an occasional sale if, after the transfer, the real or ultimate ownership of the property is substantially similar to what existed before. A lease or rental does not count as a "transfer" because ownership must actually change hands.
2. Who counts as an "owner," and what "substantially similar" means. Stockholders, bondholders, partners, or others holding an interest in a corporation or entity are treated as having the "real or ultimate ownership" of that entity's property. Ownership is "substantially similar" if the person transferring the property owns 80% or more of the stock in the corporation receiving the transfer, or if 80% or more of the stock in the transferring corporation is owned by the entity receiving the transfer.
3. What "all or substantially all" means. Property is treated as "all or substantially all" transferred if 80% or more of it is transferred.

The letter closes with the Comptroller's standard caveat that the opinion is based on the facts presented and that other, similar-looking facts could produce a different result.

What this means for you

Businesses undergoing a merger or reorganization

If your company is merging with another under IRC 368(a), or restructuring through a tax-free IRC 351 transfer to a new corporation or partnership, the assets you move over are not automatically hit with Texas sales tax. What matters is whether the transfer is a true statutory merger, or whether it covers 100% of the operating assets, or whether ownership stays substantially the same (80% or more) before and after the transfer.

Business owners forming a new entity to hold existing assets

If you're capitalizing a brand-new corporation or partnership with assets from an existing business, check the 80% ownership overlap test in Rule 3.316(e) before assuming the transfer is tax-free. A transfer where ownership genuinely changes hands (below the 80% threshold) would not qualify for this treatment, since it would no longer be "substantially similar" ownership.

Accountants and tax professionals

The ruling walks through the mechanics of Rule 3.316(e)'s occasional-sale exemption as applied to entity-formation and merger transactions: the definition of "transfer" (ownership must change; leases/rentals don't count), the 80% ownership-overlap test for "substantially similar" ownership, and the 80% threshold for "all or substantially all" property. All three prongs need to be satisfied together for the no-change-in-ownership path; alternatively, transferring 100% of the operating assets works on its own.

Common questions

Q: Is sales tax due on assets transferred in a statutory merger?
A: No. The letter states that assets transferred as the result of a statutory merger of two or more companies are not subject to sales tax.

Q: What if assets are being contributed to a brand-new corporation or partnership instead of a merger?
A: Those transfers are not taxable either, as long as the transfer is 100% of the operating assets, or it qualifies as an occasional sale under Rule 3.316(e) because ownership doesn't substantially change.

Q: What does "substantially similar" ownership mean?
A: Ownership is "substantially similar" if the person transferring the property owns 80% or more of the stock in the corporation receiving the transfer, or if 80% or more of the stock in the transferring corporation is owned by the transferee.

Q: Does leasing or renting property to a new entity qualify as a "transfer" under this rule?
A: No. The letter is explicit that since ownership must be transferred, "transfer" does not include the lease or rental of property.

Q: Could this answer change under different facts?
A: Yes. The letter states the opinion is based on the facts presented, and other facts, though similar, may produce a different result.

Citations and references

Statutes and rules:

• 34 Tex. Admin. Code Rule 3.316(e) (occasional sales and other tax-free sales)
• IRC 368(a) (statutory merger reorganization)
• IRC 351 (tax-free reorganization / transfer to a controlled corporation)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9608L1432G10

Original ruling text

August 20, 1996

Dear ***:

This is in response to your request for a ruling on the
taxability of assets transferred as the result of a statutory merger qualifying
under IRC 368(a) and a tax-free reorganization under IRC 351.

Assets transferred as the result of the statutory
merger of two or more companies are not subject to sales tax. Assets
transferred to a commencing corporation or partnership would not be taxable if
the transfer is 100% of the operating assets or is made without change in
ownership as provided in subsection (e) of Rule 3.316, concerning occasional
sales and other tax-free sales. In order to qualify, the following conditions
must be met:

(1) Any transfer of all or substantially all the
property held or used by a person in the course of an activity, when after such
transfer the real or ultimate ownership of such property is substantially
similar to that which existed before such transfer, is an occasional sale.
Since ownership must be transferred, "transfer" does not include the lease or
rental of property.

(2) For the purposes of this section, stockholders,
bondholders, partners, or other persons holding an interest in a corporation or
other entity are regarded as having the "real or ultimate ownership" of the
property of such corporation or other entity. Ownership is "substantially
similar" if the person transferring the property owns 80% or more of the stock
in the corporation to which the transfer is being made. Ownership is
"substantially similar" if 80% or more of the stock in the corporation making
the transfer is owned by the transferee.

(3) "All or substantially all" of the property will be considered to have been
transferred if 80% or more is transferred.

This opinion is based on the facts presented. Other
facts though similar may provide a different result. You may call me
toll-free at 1-800-531-5441, extension 3-4502. The direct line is
512/463-4502. You may also write to Tax Policy Division, Comptroller of Public
Accounts. My Internet address is: [email protected].

Sincerely,

Gilbert Zamora
Tax Policy Division

NOTE: Previous Accession Number 9608596L