REQUEST LETTER
Response 1/27/03
02-036
NAME
ADDRESS
Re: Private Letter Ruling Request – Government Property Tax Exemption for COMPANY Rail Cars
Dear TP REP,
On behalf of ORGANIZATION, we hereby request a private letter ruling affirming our belief that rail cars to be acquired by ORGANIZATION from COMPANY will be exempt from Utah property tax.
COMPANY currently has possession of certain rail cars that will be transferred to ORGANIZATION and used as part of the ORGANIZATION light rail system in the early part of 2003. Under the terms of the acquisition agreement between ORGANIZATION and COMPANY, termed a "sublease agreement," ORGANIZATION will have possession, use and control of the rail cars, and will retain such under the terms of the agreement until 2017. In 2017, ORGANIZATION will take legal title to the rail cars through exercising a purchase option by paying an additional and nominal sum and, of course, continue to have full possession, use and control of the cars.
ORGANIZATION and COMPANY would prefer ORGANIZATION to take legal title to the rail cars now, but the rail cars are encumbered by the provisions of prior and still existing financing transactions wherein nominal legal title is in other entities until 2017. In 2017, when the terms of these prior transactions are complete, ORGANIZATION will exercise its nominal purchase option and obtain legal title to go along with all the other incidents of ownership its acquiring with the lump sum payment in 2003 as described below.
In exchange for possession, use and control of the rail cars between 2003 and 2017, ORGANIZATION will pay COMPANY a lump sum payment that is currently estimated to be $$$$$ million in 2003. ORGANIZATION will also pay for all maintenance, improvements and insurance while in possession of the rail cars. ORGANIZATION will also be required to pay any and all Utah state and local taxes imposed as a result of acquiring and using the cars in the Trax System. By January 1, 2004, ORGANIZATION has budgeted $$$$$ worth of capital improvements to the cars to be expended at its sole direction and expense. By DATE, ORGANIZATION has budgeted for a $$$$$ "half-life overhaul" of the rail cars, again to be expended at its sole direction and expense.
The multimillion payment ORGANIZATION will make for the right to possession, use and control of the rail cars is an obligation for the term of the agreement (until DATE) not subject to termination by ORGANIZATION. It is our belief that due to the rights and substantially all the incidents of ownership ORGANIZATION is acquiring, the cars are exempt from Utah property tax under Utah law, and we hereby request a private letter ruling from the Commission affirming our belief.
Because ORGANIZATION is a political subdivision of the state of Utah, the rail cars will be exempt from property tax in Utah if they are owned by ORGANIZATION for property tax purposes. See Utah Const. Art. XIII, § 3(1)(d) (effective January 1, 2003) and Utah Code §17A-2-1055.
Based on Utah law, we believe ORGANIZATION will own the rail cars for Utah property tax purposes, making the rail cars tax exempt, even though ORGANIZATION will not have formal legal title until 2017. In Salt Lake County v. First Security Leasing Co., 881 P.2d 1222 (Utah 1994) and Interwest Aviation v Salt Lake County Bd. Of Equalization, 734 P.2d 1222 (Utah 1987), the Utah Supreme court indicated that substantive Uniform Commercial Code ("UCC") and "incidents of ownership" tests, along with sound tax policy, dictate who owns property for property tax purposes, not formal, nominal legal title.
In Interwest, 734 P.2d at 1222, the Utah Supreme Court held that vendors at the Salt Lake airport had ownership of improvements at the facilities for property tax purposes because the vendors had more improvements at the facilities for property tax purposes because the vendors had more "significant incidents of ownership" than the airport authority. The Court stated that "the status of formal legal title, while relevant, is not controlling" in determining property tax ownership. Id at 1226 (emphasis added). The Court continued by stating "[t]he approach we adopt allows the taxation of property which is used exclusively by a private person even though legal title is clearly in a governmental agency, as long as the most significant incidents of ownership to the property are in the private user." Id. (emphasis added). The court also cited with approval a case where the Colorado Court of Appeals held this same principle to be true (a principle on all fours with the case at hand) where the roles of the parties were reversed. As stated by the Utah Supreme Court, the Colorado court ruled "in favor of tax exemption for property leased by a country from a private party because the county held the most significant incidents of ownership in the improvements." Id. (citing Gunnison County v. Board of Assessment Appeals, 693 P.2d 400, 404 (Colo. Ct. App. 1984)).
The Utah Supreme Court made similar statements in First Security, 881 P.2d at 877. In that case, the court held property tax ownership to be in lessees of First Security Leasing Company, even though First Security held formal legal title. The court stated property tax ownership should be determined by looking "to the essence of the transaction [under the UCC], irrespective of the legal form to which the parties to a transaction cast it." Id. At 879 (emphasis added).
The Utah State Tax Commission has also applied the substantive UCC test for the past several years to determine who has property tax ownership. See First Security Leasing v. Salt Lake County, case no. 91-1255 (UT Tax Comm'n 1993); Tax Comm'n Appeal No. 92-1896 (1993); Tax Comm'm Private Letter Ruling 96-125 (1996). In 1990, the commission ruled that formal legal title controlled in determining property tax ownership. See ITT Commercial Financial Corp. v. Property Tax Division, case no. 88-1576 (UT Tax Comm'n 1990). In the 1993 First Security decision, however, the Commission specifically overruled the ITT decision and has applied a substance-based UCC test ever since in property tax cases.1
______________________________
1 There are cases where the Utah Supreme Court has appeared to look solely to bare legal title to determine who has ownership for property tax purposes. See University of Utah v Salt Lake County, 547 P.2d 207 (Utah 1976) (holding property taxable because it was owned by Picker X-ray, even though it was leased to and used by the University of Utah); Springville v Johnson, 37 P. 577 (Utah 1894) (holding property exempt because it was owned by Springville Cit, even though it was used by a private, taxable person for grazing of livestock). While these cases may appear to be in conflict with Interwest and First Security, the court resolved this apparent conflict in First Security by pointing out that the University/Picker X-ray transaction at issue in the University of Utah case did not satisfy the substantive UCC test. First Security, 881 P.2d at 879. In other words, the court, like the Tax Commission, feels a substantive test should be applied in every case to determine property tax ownership.
Based on Interwest, First Security, and this Tax Commission precedent, property tax ownership in the instant case is not controlled by the fact that another entity currently and temporarily has formal legal title to the rail cars. Rather, substantive tests dictate who has property tax ownership, and we believe under the many cases cited above that the essence of the ORGANIZATION/COMPANY transaction, as explained below, places property tax ownership in ORGANIZATION.
In First Security, the court declared that the substantive test for determining who has property tax ownership of personal property, such as the rail cars, is found in the UCC at Utah Code § 70A-1-201(37)9b). First Security, 881 p.2D AT 878-879. If a transaction constitutes a "security interest" under the UCC, then the relevant property has been "purchased" and the purchaser is the owner for property tax purposes. In the case at hand, the ORGANIZATION/COMPANY transaction indeed creates a security interest, meaning ORGANIZATION will have property tax ownership.
The UCC test provides as follows:
…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 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 an 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.
Utah Code § 70A-1-201(37)(b).
The ORGANIZATION/COMPANY transaction is a security interest under this test because a) the several million-dollar acquisition price ORGANIZATION is to pay COMPANY for the right to possession and use of the rail cars is an obligation for the term of the lease (through 2017) not subject to termination by ORGANIZATION, and b) ORGANIZATION will have the option to purchase the rail cars for nominal consideration in 2017 upon compliance with the terms of the lease agreement. Because the ORGANIZATION/COMPANY transaction creates a security interest, ORGANIZATION will be "purchasing" the rail cars rather than leasing them under the UCC analysis deemed to be the relevant analysis by the Utah Supreme Court and the Utah State Tax Commission. ORGANIZATION will thus be the owner of the rail cars, meaning the rail cars will be exempt from property tax.2
While the substantive UCC test indicates the rail cars will be tax exempt, so does sound tax policy. In First Security, the Utah Supreme Court said Interwest stands for the proposition that property tax ownership "should be decided on the purpose of the tax exemption, not on the meaning of the term "owner". . " Id. (emphasis added). This stands to reason because the Interwest Court stated "[f]or one unit of government. . to have levy a tax so that is can pay taxes to another overlapping unit . . .makes little economic sense and is bad tax policy." Id at 1225. In the case at hand, tax policy favors a property tax exemption for the rail cars. It makes little economic sense for ORGANIZATION to raise sales taxes a quarter cent to pay for property taxes to Salt Lake County. It is simply bad tax policy.3
_____________________________________
2 The Interwest case involved real property which is not subject to the UCC, so the court crafted an "incidents of ownership" test to determine who held property tax ownership. See Interwest, 734 P.2d at 1226, First Security, 881 P.2d at 879. This test analyzed who possessed, used, enjoyed, depreciated and profited from the property, who funded maintenance and improvements, and who paid taxes and insurance. Interwest, 734 P.2d at 1226-1227. While the rail cars are personal property and thus subject to the UCC, it is interesting to note that ORGANIZATION would likely own the rail cars under the "incidents of ownership" test as well.
COMPANY and ORGANIZATION will treat ORGANIZATIONas the property tax owner regardless of the Utah Tax Commission's determination by requiring ORGANIZATION to pay property taxes, if any are ever determined to be due.
In addition to the technical points of a substantive UCC analysis, the substance of the transaction from a practical perspective supports the conclusion of ORGANIZATION ownership of these rail cars. For all practical purposes, ORGANIZATION has all the rights and obligations of the owner of the cars. IT has the right to refurbish and overhaul the cars in any way it sees fit.4 In fact, the substantial overhaul contemplated in 2006 will cost more than the initial acquisition cost. It will also have the insurance and maintenance obligation associated with the possession and use of the cars.
The cars will be painted and outfitted and for all practical purposes will look like the other cars in use in the Trax system that are owned by ORGANIZATION and are exempt fro property tax.
The cars are under the total control of ORGANIZATION to be deployed in the Trax system as they see fit.5 The cars will be controlled, possessed and used before and after legal title is obtained in 2017 in an indistinguishable manner.
Based on the foregoing analysis, we believe property tax ownership will lie with ORGANIZATION. Substantively and practically, the rail cars are owned by ORGANIZATION for property tax purposes and therefore the cars should be exempt from property tax in Utah.
We know of the Commission's busy schedule, made even more so with the legislature in session in mid-January, but inasmuch as the answer to this questions affects the budget of ORGANIZATION and the economics of this potential acquisition. UTA would appreciate a private letter ruling as soon as possible. A reply by February 1, 2003 would allow ORGANIZATION to more appropriately structure the deal terms as it attempts to acquire these needed cars. If you need more information, please contact me. Thank you for responding to our request.
________________
4 The only restriction ORGANIZATION has with respect to the cars is that they must be used with ORGANIZATION Trax System and cannot be taken out of service and put into private, non-governmental use.
Sincerely,
NAME
Cc: NAME
NAME
NAME
NAME
RESPONSE LETTER
January 24, 2003
NAME
ADDRESS
RE: Private Letter Ruling Request – Government Property Tax Exemption for Leased Property
Dear NAME,
We have received your request for a private letter ruling concerning the “sublease agreement” for rail cars between the ORGANIZATION and the COMPANY Transportation. You have asked the Commission to confirm your belief that ORGANIZATION would be considered the owner of these rail cars for property tax purposes and, because of ORGANIZATION'S exempt status, that the rail cars would not be subject to Utah property taxes.
Before addressing your specific question, we need to clarify an underlying issue. The Tax Commission is responsible to assess “railroads” and “rail car companies.” Utah Code Ann. §59-2-203(1). However, these terms are not defined in Title 59 of the Utah Code and there is no authority presented to suggest that a governmental entity (ORGANIZATION) should be considered a “railroad” or “rail car company” for assessment purposes. For these reasons, we assume that the county assessor, not the Tax Commission, would assess any rail cars brought into Utah by ORGANIZATION; i.e., the county assessor would initially determine if the rail cars were exempt from taxation.
As a result, any guidance the Tax Commission might offer you in a private letter ruling would not be binding on a county assessor or board of equalization in their determination of whether locally assessed property is exempt from taxation. In addition, a party subject to local assessment has the right to appeal a county decision to the Tax Commission under Utah Code Ann. §59-2-1102. Should either of the parties you describe appeal a county assessment, we would address their specific circumstances through that process.
Furthermore, we note that we have not seen an actual lease or any of its specific items. Accordingly, we offer a general response to your request, so that this letter should not be considered an answer to the specific circumstances of the entities you describe.
The issue we address here, then, is whether personal property leased by a Utah government entity is exempt from taxation when: 1) the lessor retains legal title to the property; 2) the consideration paid by the lessee for the right to possession and use of the leased property is an obligation for the term of the lease not subject to termination by the lessee; and 3) the lessee has an option to become the owner of the leased property for no additional consideration or nominal additional consideration upon compliance of the lease agreement.
Ordinarily, the property tax on personal property is assessed to and responsibility of that property’s owner of title, even when that property is leased to another entity. Under certain circumstances, however, the Utah Supreme Court has held that a lessee is considered the owner of leased personal property for property tax purposes. See Salt Lake County v. First Security Leasing Co., 881 P.2d 877 (Utah 1994). These criteria are specified in the Uniform Commercial Code (“UCC”), as codified in Section §70A-1-201(37)(b) of the Utah Code. Such a distinction is critical when the lessee is a tax-exempt government entity and the lessor is an entity subject to taxation. In such circumstances, the property is exempt from taxation if the tax-exempt lessee, not the owner of title, is considered the owner of the leased property for property tax purposes.
In accordance with First Security, the Tax Commission considers a lessee to be the owner of personal property for property tax purposes to the extent that the terms of the lease meet the Section 70A-1-201(37)(b) UCC guidelines. With such a lease in place, the leased property would be exempt from taxation if the lessee were a Utah governmental entity.
While the terms of the lease that you describe appear to comply with the criteria listed above, we reiterate that, without analyzing the actual lease, and more importantly, because of the county’s apparent right to assess the rail cars, this letter is not a binding ruling that addresses the specific parties and circumstances set forth in your request. Please contact us if you have any other questions.
For the Commission,
Marc B. Johnson
Commissioner
Cc: NAME
NAME
02-036