91-1582 - Sales

BEFORE THE UTAH STATE TAX COMMISSION

_____________________________

XXXXX )

: FINDINGS OF FACT,

Petitioner, : CONCLUSIONS OF LAW,

: AND FINAL DECISION

v. :

AUDITING DIVISION OF THE : Appeal No. 91-1582

UTAH STATE TAX COMMISSION, :

: Account No. XXXXX

Respondent. :

__________________________

STATEMENT OF CASE

This matter came before the Utah State Tax Commission for a formal hearing on XXXXX. Alan Hennebold, Presiding Officer, heard the matter for and on behalf of the Commission. Present and representing the Petitioner was XXXXX, of XXXXX. Present and representing the Respondent was XXXXX, Assistant Utah Attorney General.

Based upon the evidence and testimony presented at the hearing, the Tax Commission hereby makes its:

FINDINGS OF FACT

1. The tax in question is sales and use tax.

2. The period in question is XXXXX through XXXXX.

3. Respondent conducted a compliance audit of Petitioner's sales and use tax liability for the period in question. As a result of its audit, Respondent assessed additional tax in the amount of $$$$$, plus interest. Respondent did not assess penalty against Petitioner.

4. Respondent's audit covered five types of transactions, each set forth on a separate schedule.

Petitioner challenges the tax assessed on the second and fifth

schedules only. Schedule Two assesses tax on a "lease" transaction. Schedule Five assesses tax on "porting transactions".

5. With respect to the lease transaction, Petitioner had previously acquired and placed in service various items of business equipment. Utah sales tax had been paid on the equipment at the time of purchase. In order to obtain working capital, Petitioner transferred title of the equipment to XXXXX in return for a certain sum of money. Petitioner then "leased" the equipment back for a term of XXXXX, at specified monthly lease payments. At the end of the lease, Petitioner could purchase the equipment for its fair market value. XXXXX specifically retained all tax benefits arising from the equipment, such as depreciation. It provided no warranties with respect to the equipment. Petitioner was obligated to insure the equipment. XXXXX financing statement was filed showing Petitioner as the debtor and XXXXX as the secured party.

6. With respect to "XXXXX" transactions, the term refers to the practice of providing XXXXX to allow development of XXXXX. Such XXXXX arrangements benefit both the XXXXX by increasing potential market.

7. In this case, Petitioner followed the usual industry practice. It provided XXXXX to various XXXXX and paid XXXXX. Petitioner retained title to the XXXXX and received them back after XXXXX was complete. At that time, the XXXXX were usually XXXXX and their XXXXX. On rare occasions, returned XXXXX were sold intact as used XXXXX.

8. As the XXXXX were assembled, parts were transferred from Petitioner's inventory account to a depreciable assets account. When the XXXXX, the XXXXX were returned to inventory, with reversing entries made to the appropriate accounts.

CONCLUSIONS OF LAW

1. The Petitioner has the burden of proof to establish that its petition should be granted. (Utah Administrative CodeR861-1A-7(G).)

2. Sales or use tax is levied on the purchaser for the amount paid or charged for, among other things, leases and rentals of tangible personal property and tangible personal property stored, used, or consumed in Utah. (Utah Code Ann. §59-12-103(1)(k) and (1).)

3. The Tax Commission's Administrative RuleR865-19S-32(A) provides as follows:

The lessor shall compute sales or use tax on amounts received or charged pursuant to rental or lease agreements which are made in lieu of outright sales. In cases where an out-of-state lessor is not doing business in Utah and is not required to be licensed or registered with the Tax Commission, the tax must be paid directly to the Tax Commission by the lessee of the tangible personal property.

4. Utah Code Ann. 70A-1-201(37)(b) provides as follows:

Whether a transaction creates a lease or security interest is determined by the facts of each case; however, a transaction creates a security interest if the consideration the lessee is to pay the lessor for the right to possession and use of the goods is an obligation for the term of the lease and not subject to termination by the lessee, and:

(i) the original term of the lease is equal to or greater than the remaining economic life of the goods;

(ii) the lessee is bound to renew the lease for the remaining economic life of the goods or is bound to become the owner of the goods;

(iii) the lessee has the option to renew the lease for the remaining economic life of the goods for no additional consideration or nominal additional consideration upon compliance with the lease agreement; or

(iv) the lessee has an option to become the owner of the goods for no additional consideration or nominal additional consideration upon compliance with the lease agreement.

5. Utah Code Ann.59-12-102(14) defines "use" as:

(a) . . . the exercise of any right or power over tangible personal property under SubSection 59-12-103(1), incident to the ownership or the leasing of that property, item, or service.

(b) Use does not include the sale, display, demonstration, or trial of that property in the regular course of business and held for resale.

DECISION AND ORDER

Whether or not Petitioner's lease transaction and its XXXXX transactions are subject to sales or use tax are distinct issues and will be discussed separately.

The facts of Petitioner's leasing transaction are not in dispute. Petitioner transferred already-owned and XXXXX to XXXXX in return for cash, then leased the equipment back at a fixed rate. At the end of the lease, Petitioner could purchase the equipment at fair market value.

Lease payments are subject to sales tax under Utah's Sales and Use Tax Act. Transfers of tangible personal property as security for loans or other obligations are not taxable. Petitioner argues that the transaction in this case, although termed a "lease", was in fact a secured loan. Respondent argues the transaction was a true lease, and therefore taxable.

Utah's version of the Uniform Commercial Code contains standards for determining whether a transaction is a lease or a secured loan:

(i) the original term of the lease is equal to or greater than the remaining economic life of the goods;

(ii) the lessee is bound to renew the lease for the remaining economic life of the goods or is bound to become the owner of the goods;

(iv) the lessee has an option to become the owner of the goods for no additional consideration or nominal additional consideration upon compliance with the lease agreement. (Utah Code Ann. 70A-1-201(37)(b).)

The foregoing statute recognizes that a transaction's status as "lease" or "secured transaction" depends upon the facts of each case. However, the statute also sets forth four specific tests by which a transaction may qualify as a secured loan. Petitioner has failed to prove the existence of any of those four factors. As to the general rule that each transaction must be judged on its facts, the Commission concludes that the transaction in this case is, in fact, a lease. The Commission reaches its conclusion based on the facts that the parties designated the transaction as a lease, depreciation benefits flow to XXXXX, and Petitioner must pay full fair market value to purchase the equipment at the end of the lease. As a lease of tangible personal property, the lease payments in question are subject to sales tax.

The second area under appeal is the assessment of use tax on XXXXX. Petitioner argues that its use of such XXXXX is not taxable because it falls within a statutory exception to the definition of "use", as follows:

Use does not include the sale, display, demonstration, or trial of that property in the regular course of business and held for resale. (Utah Code Ann.59-12-102(14)(b).)

The facts with respect to the XXXXX are not in dispute. Petitioner provides XXXXX to other companies for development of XXXXX. After XXXXX development is completed, the XXXXX are returned to Petitioner. The XXXXX are then sold as used XXXXX or, more commonly, XXXXX and returned to inventory. Petitioner retains title to the XXXXX throughout the process.

Petitioner argues that the foregoing porting transactions are exempt from tax as the "sale, display, demonstration, or trial of property in the regular course of business and held for resale" within the meaning of Utah Code Ann.59-12-102(14)(b). However, Petitioner's XXXXX are not for "sale, display, demonstration or trial and held for resale". They are instead used by Petitioner in the course of product development. The XXXXX have been removed from Petitioner's inventory account and classified as depreciable capital assets.

Based on the foregoing, the Commission concludes that Petitioner itself is the ultimate consumer of its XXXXX, and that a taxable transaction occurs when it removes XXXXX from inventory to XXXXX such XXXXX.

Petitioner's final argument is that even if the XXXXX are otherwise subject to tax, they are exempt because Utah Code Ann. §59-12-103(1)(a) and (1) impose sales and use tax only on sales or uses of tangible personal property within Utah. However, the taxable transaction in this case occurs when the XXXXX are assembled from inventory. (See Tummurru Trades, Inc., v. Utah State Tax Commission, 802 P.2d 715 (Utah 1990).) The fact that Petitioner later sends the XXXXX outside Utah is of no significance.

In summary, the Commission finds that Respondent's assessment of sales and use tax with respect to Petitioner's lease and XXXXX transactions is correct. The Commission therefore affirms Respondent's audit. It is so ordered.

DATED this 1st day of September, 1992.

BY ORDER OF THE UTAH STATE TAX COMMISSION.

R. H. Hansen Roger O. Tew

Chairman Commissioner

Joe B. Pacheco S. Blaine Willes

Commissioner Commissioner