1. SALT Aspects of Acquisitions— A Colorado Perspective
Presentation by Peter Rose to the
Tax Executives Institute
Denver Chapter
May 23, 2007

2. Colorado Taxes Income tax Sales and use tax Ad valorem (property) tax
State imposed
State collected
Home-rule imposed and collected
Ad valorem (property) tax
Other taxes
Severance tax
Gasoline and special fuel tax
Tobacco tax

3. Colorado Income Tax State-level only Flat tax of 4.63%
No general capital gains or dividend preference
Certain long-term Colorado-source capital gains may be non-taxable
Individual exclusion for interest, dividends, and capital gain is currently suspended
Not a detailed code but supplemented by regulations and FYIs

4. Statutory Structure C.R.S. § 39-22-101 et seq.
Part 1—General rules and individual tax
Part 2—Partners and partnerships
Part 3—Corporations (C and S)
Part 5—Special Rules (mainly credits)
Part 6—Procedure and Administration

5. Conformity “Moving conformity”
Taxable income generally computed from federal taxable income
Colorado income tax code is “synched” with federal tax code

6. Colorado Adjustments General conformity bows to Colorado adjustments
Individual adjustments—C.R.S. §
Corporate adjustments—C.R.S. §

7. Examples of Colorado Adjustments
Colorado NOL
Portion of federal NOL allocated to Colorado
Colorado corporate NOL cannot be carried back
Colorado-source Capital Gains Exclusion

8. Colorado Capital Gains Exclusion
Eligible Property
Real or tangible property located in Colorado at time of sale
Interests in Colorado entities
50% or more of property and payroll sourced to Colorado in every year of 5-year holding period
Does not apply to intangible personal property held outside of an entity

9. Colorado Capital Gains Exclusion
Holding Period
Acquired after May 9, 1994
Held for 5 years or more
Transfers in and out of FTEs may tack—see FYI Income 15 and DD-588
Expanded holding period rules apply only if Colorado has a qualified surplus

10. FTEs and Disregarded Entities
Colorado follows federal treatment
Flow-through entities (FTEs)
Any federal tax partnership including partnerships and LLCs
S corporations
Disregarded entities
Not a taxable entity in Colorado

11. Colorado Income Tax Planning
In general federal tax planning will have similar Colorado consequences because of conformity
But always check Colorado adjustments

12. Example—Making a § 338 Election
I.R.C. § 338 allows the purchaser of stock to treat the stock purchase as an asset purchase
OldCorp is deemed to have sold all its assets for fair market value
NewCorp is deemed to have purchased all of OldCorp’s assets for fair market value
OldCorp recognizes gain on sale and NewCorp has stepped-up basis
May be beneficial if OldCorp has historic NOLs or if target is an S corporation

13. Example—Making a § 338(g) Election
Colorado Treatment
§ 338 gain is included in federal taxable income and thus must be included in Colorado taxable income (DD-480)
Colorado NOL Trap
Colorado NOL might not be same as federal NOL

14. Related Transactions
Colorado has not directly adopted substance-over-form or step-transaction doctrines
Conformity effectively piggybacks Colorado onto federal tax law regarding related transactions

15. Multistate Aspects
Colorado taxable income is increased or decreased by:
Allocation of non-business income away from or to Colorado based on sourcing rules
Apportionment of business income away from or to Colorado based on multifactor tests

16. Business Income
Taxpayer position—gain on sale of out-of-state business is non-business income not taxable in Colorado
DOR position—“regular course” of business includes strategic acquisitions and divestment (DD-507)
Consider advantages of applying Colorado capital gains exception, if applicable

17. Colorado Income Tax Recap
Federal income tax planning generally has same effect at Colorado level
Be aware that Colorado adjustments may affect tax consequences
Colorado capital gains exclusion is a significant Colorado benefit
DOR’s broad definition of “business income” may create taxable gains in Colorado

18. Colorado Sales and Use Tax
State imposes and collects tax of 2.91%
State also collects on behalf of special districts
Statutory cities/towns/counties impose their own tax on the state tax base, but state collects their tax
Home rule cities impose and collect sales and use tax pursuant to their own ordinances
Use tax is a “soak-up” tax—imposing tax on purchases that escaped tax in the jurisdiction

19. Sources of Sales and Use Tax Law
C.R.S. § et seq.
State regulations and FYIs
Municipal ordinances
Municipal regulations and FYIs
Departmental decisions
Case law

20. Taxable Sale
Sale is an exchange of property or services for consideration
Taxable sales are
Retail sales of tangible personal property not otherwise exempted or excluded
Retail sales of specified services

21. Non-Taxable Sale Wholesale sale—sales for resale
Sale of intangible personal property

22. Sales of Stock
Stock sales are excluded from sales and use tax because stock is intangible personal property

23. Reorganizations
Reorganizations qualifying under I.R.C. § 368(a)(1) are generally excluded from definition of “sale”
Always check home rule ordinances
Denver does not exclude reorganizations per se
Other grounds for exclusion
B reorganizations should be excluded because transferred stock is intangible property
E and F reorganizations should be excluded because there is no exchange of tangible personal property

24. Sales of Partnership and LLC Interests
Transfers of partnership and LLC interests are excluded by state statute
Generally, home rule ordinances exclude transfers of partnership, but not LLC, interests
Are LLC interests excludible as intangible personal property?
Probably yes
Exclusions for partnerships are surplusage reflecting pre-RUPA view of partnership interests

25. Non-Corporate Mergers
Mergers involving partnerships and LLCs pursuant to state law should be excluded
Transfer is of entity interests, which should not be tangible personal property
Assets transfer by operation of law pursuant to state law merger or “junction box” statute

26. Asset Sale Colorado does not have a casual sale exemption
Asset sales are generally taxable to the extent that tangible personal property (not otherwise exempt or excluded) is transferred
In these respects, home rule jurisdictions generally are in accord with state treatment

27. Useful Exclusions or Exemptions from Sales and Use Tax
Real property
Inventory
Machinery and equipment

28. Real Property Exclusion
Real property is excluded because it is, by definition, not personal property
Personal property becomes real property when it is affixed to real property
Generally applicable to state and home rule jurisdictions

29. Inventory Exclusion
Applies only to property that is inventory in the hands of the seller and inventory in the hands of the buyer
Buyer should have a resale certificate to perfect exclusion
Generally applicable to state and home rule jurisdictions

30. Machinery and Equipment Exemption—C.R.S. § 39-26-709
Qualifying machinery
Used in Colorado
Directly and predominantly to manufacture tangible personal property for sale or profit
Cost more than $500
Capitalized
Qualify as creditable property under I.R.C. § 38
Tangible personal property with useful life of one year or more
$150,000 per year limit for used equipment

31. Machinery and Equipment Exemption—C.R.S. § 39-26-709
Scope of exemption is broadened in “Enterprise Zones”
Need not be capitalized
Construction or repair material is exempt
Mining equipment is eligible

32. Machinery and Equipment Exemption—Local Aspects
M&E exemption is an exception to the general rule that state tax base applies in statutory jurisdictions
Most statutory and home rule jurisdictions do not have an M&E exemption

33. Related Transactions
Colorado excludes certain transactions from the definition of a “sale”:
Certain corporate, partnership, and LLC formations
Certain corporate, partnership, and LLC liquidations
See C.R.S. § (10) (next slide)
These exclusions are not uniform across home rule jurisdictions

34. C.R.S. § (10) Exclusions
(a) A division of partnership or limited liability company assets among the partners or limited liability company members according to their interests in the partnership or limited liability company;
(b) The formation of a corporation by the owners of a business and the transfer of their business assets to the corporation in exchange for all the corporation's outstanding stock, except qualifying shares, in proportion to the assets contributed;
(c) The transfer of assets of shareholders in the formation or dissolution of professional corporations;
(d) The dissolution and the pro rata distribution of the corporation's assets to its stockholders;
(e) The transfer of assets from a parent corporation to a subsidiary corporation or corporations which are owned at least eighty percent by the parent corporation, which transfer is solely in exchange for stock or securities of the subsidiary corporation;
(f) The transfer of assets from a subsidiary corporation or corporations which are owned at least eighty percent by the parent corporation to a parent corporation or to another subsidiary which is owned at least eighty percent by the parent corporation, which transfer is solely in exchange for stock or securities of the parent corporation or the subsidiary which received the assets;

35. C.R.S. § 39-26-102(10) Exclusions (cont.)
(g) A transfer of a limited liability company or partnership interest;
(h) The transfer in a reorganization qualifying under section 368(a)(1) of the "Internal Revenue Code of 1986", as amended;
(i) The formation of a limited liability company or partnership by the transfer of assets to the limited liability company or partnership or transfers to a limited liability company or partnership in exchange for proportionate interests in the limited liability company or partnership;
(j) The repossession of personal property by a chattel mortgage holder or foreclosure by a lienholder;
(k) The transfer of assets between parent and closely held subsidiary corporations, or between subsidiary corporations closely held by the same parent corporation, or between corporations which are owned by the same shareholders in identical percentage of stock ownership amounts, computed on a share-by-share basis, when a tax imposed by this article was paid by the transferor corporation at the time it acquired such assets, except to the extent provided by subsection (12) of this section. For the purposes of this paragraph (k), a closely held subsidiary corporation is one in which the parent corporation owns stock possessing at least eighty percent of the total combined voting power of all classes of stock entitled to vote and owns at least eighty percent of the total number of shares of all other classes of stock.

36. D.R.M.C. § 53-24(19) Exclusions
A division of partnership assets among the partners according to their interests in the partnership;
The transfer of assets of shareholders in the formation or dissolution of professional corporations if no consideration including, but not limited to, the assumption of a liability is paid for the transfer of assets;
The pro rata distribution of a corporation's assets to its stockholders upon dissolution of the corporation if no consideration including, but not limited to, the assumption of a liability is paid for the transfer of assets;
A transfer of a partnership interest;
The transfer of assets to a commencing or existing partnership if no consideration including, but not limited to, the assumption of a liability is paid for the transfer of assets;
The repossession of personal property by a chattel mortgage holder or foreclosure by a lienholder.

37. The Drop-Kick Transaction
The dropkick combines two excluded transactions:
Seller transfers assets to a newly formed partnership or LLC, an excluded transfer under C.R.S. § (10)(i).
Seller transfers the partnership or LLC interest to Buyer, an excluded transfer under C.R.S. § (10)(g).
Does this work?

38. International Paper v. Cohen 126 P.3d 222 (Colo. App. 2006)
Seller and Buyer agreed to an asset purchase of Denver box plant
Seller transferred the box plant to an LLC in exchange for LLC interests
Seller sold the LLC interest to Buyer
Denver audited Seller and assessed sales tax on the transfer of the box plant’s tangible personal property to the LLC

39. International Paper v. Cohen
Denver Sales Tax Code does not exclude transfers to an LLC
Seller argued that transfer to the LLC was not for consideration and thus not a sale

40. International Paper v. Cohen
Court of Appeals upheld Denver Assessment
Seller received consideration in the form of a membership interest for transferring the box plant to the LLC
The membership interest was valuable consideration since the Buyer immediately paid $16.5 million for the membership interest
The transfer to the LLC was thus an exchange for consideration and therefore a sale

41. International Paper v. Cohen
Key holding of International Paper is that third-party consideration can support a taxable sale
The Court did not explicitly invoke substance-over-form or step-transaction doctrines

42. Third-Party Consideration
Colorado’s partnership contribution exclusion
The formation of a limited liability company or partnership by the transfer of assets to the limited liability company or partnership or transfers to a limited liability company or partnership in exchange for proportionate interests in the limited liability company or partnership….(C.R.S. § (10)(i))
Denver’s partnership contribution exclusion
The transfer of assets to a commencing or existing partnership if no consideration including, but not limited to, the assumption of a liability is paid for the transfer of assets…. (D.R.M.C. § 53-24(19)(e))

43. Third-Party Consideration
Denver may assert that a dropkick involving a partnership is a transfer for consideration based on International Paper’s third-party consideration holding
Outcome of a challenge is unpredictable
International Paper did not involve an explicit statutory exclusion
International Paper facts were favorable to Denver—will other fact patterns favor taxpayers?
State law does not qualify its exclusion with regard to consideration—third-party or otherwise—so International Paper is not directly pertinent to state sales tax

44. Step-Transaction Doctrine
Primarily an income tax concept
Sometimes applied to ad valorem taxes, for example, in California
Rarely applied in sales and use tax cases
Compare Hutton v. Johnson (Tenn. App. Ct. 1996) (applying step-transaction doctrine) with TJX Companies (N.Y. Div. Tax App. 1995) (refusing to apply step-transaction doctrine)
International Paper was not decided on step-transaction grounds
Denver and other jurisdictions will continue to press the issue in audits, hearings, and appeals

45. Sales Tax Liability—Entity Sale
Historic sales and use tax liability remains an entity liability
In general, no transactional sales tax liability should be incurred
Conventional for sales agreement to include
Covenants that sales and use taxes are paid and/or properly accrued
Indemnification extending past statute of limitations on assessment of sales tax for unpaid or unaccrued sales and use tax
Seller rights in an audit, hearing, or appeal

46. Sales Tax Liability—Asset Sale
Historic and transactional sales tax liability attaches to assets transferred unless buyer complies with the procedure of C.R.S. § (d) and (e):
Buyer must withhold sufficient funds to cover sales tax liability of seller
Seller’s final return is due within 10 days
Buyer cannot release withheld funds without a clearance certificate from DOR
Home rule jurisdictions have similar provisions that must also be complied with

47. Sales Tax Liability—Asset Sale
Clearance certificate procedure is rarely used by buyers and sellers. Instead, parties provide in agreement for:
Allocation of transactional sales taxes by contract—all to seller, all to buyer, or shared
Indemnification for historic tax liability of business

48. Sales Tax Liability—Asset Sale
Allocations in sales agreement are not binding on DOR
Seller is liable if withholding/clearance certificate procedure is followed
Seller and buyer are liable if withholding/clearance certificate procedure is not followed
Buyer is potentially liable for use tax

49. Ad Valorem Tax Basics
Property is assessed on January 1 of the taxable year
Inchoate lien is created on the assessment date
Mill levy and thus actual tax is determined during the taxable year
Tax becomes due and payable on the subsequent January 1
Tax is delinquent on June 16

50. Liability for Ad Valorem Tax
Default rule—C.R.S. §
Seller pays if conveyance is after June 30
Buyer pays if conveyance is before July 1
No allocation—default rule is all or nothing

51. Contractual Allocation of Ad Valorem Tax
Default rule only applies if “instrument of conveyance” does not contain express agreement otherwise
To avoid all or nothing default allocation, allocate ad valorem tax in the sales contract based on date of conveyance
Include method to true-up based on actual levy