Occasional Sale Exemption (Sales of Entire Operating Assets) – Tax Rule 3.316 (d)

Imagine that you purchased all the heavy equipment assets of a Texas contractor for $2 million dollars. Then a year later the Texas Comptroller’s Office randomly selects your business for audit.

Next, imagine that the Sales Tax Auditor decided to tax the entire $2 million dollar purchase because he/she believed the entire operating assets were not purchased in a single transaction as required by Tax Rule 3.316 (d) resulting in a Texas Sales & Use Tax bill for almost $200,000 (tax, penalty, interest).

Dino Marcaccio, President Former Texas Comptroller State Tax Auditor, 16 Years

Dino Marcaccio, President
Former Texas Comptroller State Tax Auditor, 16 Years

In the scenario described above, it could be that all the operating assets were indeed transferred, but the Comptroller’s auditor decided to tax the transaction based on insufficient supporting evidence (i.e., purchase contract, etc.). How can this happen?

To begin with, asset purchases involving tangible personal property (TPP) are generally presumed to be subject to sales tax in Texas unless specifically exempted.  In the case of a purchase of assets of a sales tax permitted business all operating assets must be purchased in order to be exempted from sales tax.  Note, other possible sales tax exemptions may apply if the seller is not permitted or is not required to be permitted for sales tax by Texas or any other state.

Tax Rule 3.316 (d) states in part: ‘The sale of the entire operating assets of a business or of a separate division, branch or identifiable segment of a business is an occasional sale.’

What is an operating asset and how is it determined if all of these assets were included in the transaction?  These are two good, but somewhat vague questions.

The entire operating asset sales tax exemption is a sometimes complicated area of Texas sales tax law with almost 800 published Texas Comptroller letter rulings and administrative hearings on the subject.

As far as (1) what constitutes all the operating assets and (2) whether they were all sold depends many times on the opinion of the Comptroller Tax Auditor, Hearings Attorney or possibly the Administrative Hearings Judge. And to top it off, the business owner bears the burden of proof to show that an exemption applies in these transactions because they involve tangible personal property (TPP).

It is entirely possible that an asset purchase transaction qualifying for this exemption is denied due to the auditor’s erroneous claim of insufficient documentation. At that time it then becomes an uphill battle through the Administrative Hearings process to prove the entire operating assets were sold.

Administrative Hearing No. 26,453 (shown further below) is a classic example of a business not being able to prove to the judge that all operating assets were sold. In this case, the judge did not say the exemption didn’t apply. He simply said the Petitioner lacked evidence to support the exemption argument. It is often an unfair burden because the auditor may not have to prove anything except a suspicion that not all operating assets were transferred.

One other obvious way to lose the exemption would be if the purchase contract language specifically excluded any operating assets.  For instance, it could be that the contract itself contained ‘excluded asset’ language. Also keep in mind that any contract language that states that the buyer assumes no responsibility for any existing or future sales tax liabilities is simply ignored by the Texas Comptroller’s Office. Any of these sales tax issues between the seller and buyer would then become a civil matter.

In another scenario the auditor could demand to see the booked assets of the seller and compare it to the purchaser’s assets. But what if the seller was not in business or did not want to cooperate. In any event, the auditor can assess tax on the entire asset purchase and then shift the burden of proof to the client to prove the exemption applies.

I have included a one administrative hearing and one letter ruling decision below so that the reader can understand how dangerous and ‘subject to interpretation’ this exemption area can be.

 

Texas Comptroller Administrative Hearing Number 26,452

A company is audited and the auditor taxed the sale (liquidation) of a division because he/she believed that the entire ‘operating assets’ were not sold. The judge ruled in favor of the auditor and stated:

‘No evidence was submitted to show that the assets not sold to Company XXX were used for any purpose other than the operation of the liquidated division.’

This comment by the judge could easily have been restated as follows:

‘The sale of the division may very well have qualified for the ‘operating asset’ exemption per Tax Rule 3.316(d) but due to the lack of documentation I must disallow the exemption.’

 

Texas Comptroller Taxability Response Number Number 1186

This is a letter ruling from 1990 technically called a Taxability Response. The Comptroller replies to the following two questions posed by a business owner regarding the ‘operating assets’ sales tax exemption. Q1. What if the sale excluded certain assets with no book value? Q2. What if the purchaser had the option to pick and choose which assets would be purchased. As expected the response to each question was negative and is restated below:

…to qualify as an occasional sale, the entire operating assets (excluding intangibles and real property) of a business or of an identifiable segment of a business must be sold in a single transaction to a single purchaser. “Operating assets” means those assets used exclusively by the enterprise in providing the product or service, but does not mean assets maintained and used for general business purposes in addition to use by the specific enterprise. 

In the situation presented, the “entire operating assets” of the business are not sold when some of the operating assets are removed; therefore, the occasional sale exemption is lost.

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