Today I want to talk about the state franchise or income tax cost of selling a business. Let’s say that you are the CFO of a Virginia based company operating globally. You earn about 30% of your operating income from your California subsidiary.
You receive what looks like a great offer to buy the California subsidiary for $50,000,000, all cash. It is a big deal to your company: global revenue that year (excluding this deal) was $100,000,000. It is the first transaction your company has ever contemplated.
So, in evaluating the deal you need to determine the net after tax sales proceeds. In calculating your California franchise tax, do you exclude the $50,000,000 sales proceeds from the company’s California sales factor (meaning, exclusion both from the numerator and denominator of the sales factor)?
Why does it matter? Because inclusion of the deal proceeds in the California sales factor would significantly decrease the net after tax proceeds from the sale of the California subsidiary, because more of the company’s net income would be apportioned to and taxed at California’s higher tax rates.
The answer is no. You can exclude the deal sales proceeds from the California sales factor under these facts. A recent California ruling tells us why. There, a global company in a similar situation, asked California that question. The California Franchise Tax Board Chief Counsel’s Office said that the sales proceeds for the sale by the global company of its U.S. operations, in three asset sales, were excluded from the California sales factor because the sales were substantial and occasional.
The sale was substantial because the sales proceeds were at least the required 5% of the company revenues for the year (which included the asset sales revenue). The sale was occasional because the three asset sales were outside the normal course of the global company’s business and business sales were infrequent for this global company.
The California ruling is Chief Counsel Ruling 2017-03, California Franchise Tax Board, October 18, 2017, and can be found at: https://www.ftb.ca.gov/law/ccr/2017/03.pdf
Comment. California law in this area is substantially based upon the model regulation adopted by the Multistate Tax Commission. You may see this rule applied by other states.
By John McCauley: I help people buy and sell businesses.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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