Laws, Regulations & Annotations

Business Taxes Law Guide – Revision 2018

Sales and Use Tax Annotations

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Annotation 330.5023


330.5023 Closely Held Corporations. The stock of a winery is owned 99 percent by the father and 1 percent by his two daughters. In order to obtain financing to purchase a vineyard and increase the debt/equity ratio of the winery, the father formed another subchapter S corporation (which was 100 percent owned by the father) to purchase used wine barrels from the winery and lease them back to the winery.

The new corporation subsequently purchased additional barrels, and leased them back to the winery. The lease rate was high enough to allow the new leasing corporation to make the loan payments on the money borrowed to purchase the barrels and to make a slight profit. The leasing corporation's only activity consisted of buying these barrels from the winery and leasing them to the related entities. The leasing corporation had neither employees nor payroll. Its operations were run entirely by the winery employees. All books and records were also kept by winery employees. The only indicia of the leasing corporation's existence were (1) a bank account, (2) the books maintained by the winery, and (3) financial statements and other records required by the lender. Three years later when the winery's debt/equity ratio improved to a point that the leasing corporation was no longer needed, the corporation was dissolved through a merger into the winery.

Since both the winery and the leasing corporation were wholly owned S corporations, all of their taxable income was passed through each year to the father. The sale/leaseback arrangement forced the leasing corporation to report the full amount of lease proceeds received each year as income.

In this case, the leasing company (1) owned property and depreciated it, (2) had its own bank account, (3) assumed debts, (4) purchased property on its own, (5) bore the liability to the lender for the purchase price of the barrels, (6) received profits, (7) filed income tax returns, and (8) kept separate books. Therefore, the Mapo, Inc. v. State Board of Equalization court case is not controlling. In addition, the transaction was structured as if at arms length, i.e., the sales price to the lessor and the rentals payable were commercially reasonable as if between unrelated parties.

Accordingly, the transaction transferring the used barrels from the winery to the leasing corporation was a sale within the meaning of section 6006. Therefore, the transaction was subject to sales tax. However, since the property was immediately leased after purchase and the lessor did not pay tax on the purchase price, the applicable measure of tax is use tax measured by the rentals payable by the winery to the leasing corporation. 4/21/95.