July
11, 1991 Response from Tax
Commission
May
18, 1991 Letter from XXXXX of
XXXXX
XXXXX
Re:
Advisory Opinion - Sales and Leaseback
Dear
Mr. XXXXX:
This
letter is in response to your recent request for a Tax Commission ruling on
whether the sale of fixed assets which were taxed upon purchase and used by
your customer and later leased back to the same customer are subject to sales
tax on the lease payments. It is your opinion that a "financing"
lease is not a "true" lease, and therefore, not taxable.
The
Tax Commission policy is to refer such requests to the division most qualified
to analyze the request and make recommendations concerning it. As such, your
request was referred to the Tax Commission's Auditing Division for their
analysis and recommendation. The division's recommendations is as follows:
1.
The nature of the Utah sales and use tax law is to impose tax on the
transaction constituting a sale (or lease). Each transaction is a closed
transaction and stands on its own. The law then provides certain exemptions.
The sale by the customer of its used fixed assets is exempt because XXXXX is
entitled to the resale exemption. There is no exemption provided for the lease
of personal property to an, otherwise, taxable customer. Thus, your lease would
be considered a taxable lease.
2.
There is no distinction in the sales tax law or rule for a lease "intended
as security" from a regular lease. There is no definition or intention to
tax only "true leases." The FMA case cited is a civil case and has no
bearing on sales tax. The reference to "true" or
"financing" leases is irrelevant.
3.
In XXXXX's case, there is an actual change of legal ownership on the sale by
the customer to XXXXX. There will be another actual change of ownership when
the customer exercises the option to buy the assets at the end of the lease
term.
4.
XXXXX states as a reason that no tax should be due on lease payments, that they
don't take physical possession of the assets and that the customer will have
the benefits and burdens of ownership. In the case of a normal lease, lessors
often do not take possession of assets, and in the case of normal capital
leases, the lessee also has the benefits and burdens of ownership, but without
legal ownership or title.
5.
Sales Tax Rule R865-19-32S was recently amended to allow the lessee, at his
option, to treat conditional sales leases as a purchase. This only changes
which transaction is taxable, the sale or the subsequent lease payments.
6.
California has an option, like Utah now has, to treat financing leases as
purchases. That option also applies only to the original transaction. Although
other states, such as California, allow certain sale and leaseback agreements
to be treated as financing arrangements, no such provision exists in Utah.
In
summary, there is no provision in the Utah sales tax law or rule to allow an
exemption for lease payments in a sale and leaseback agreement.
Based
upon the facts presented in your letter, we are in agreement with the Auditing
Division's recommendation. Obviously, if there are deviations from these facts,
this opinion may be negated.
If
you do not agree with this determination, you may appeal to the Tax Commission
for a formal hearing. The results of that hearing would constitute a
declaratory judgment and be appealable to the Utah State Supreme Court. A
Notice of Appeal Rights is attached.
For
The Commission,
Joe
B. Pacheco
Mr.
XXXXX
Utah
State Tax Commission
160
East Third South
Salt
Lake City, Utah 84134
Dear
Mr. XXXXX:
XXXXX,
a Utah corporation, ("XXXXX") is contemplating a transaction (the
"Transaction") in the State of Utah on which it will need an advisory
opinion as to whether or not there is a taxable event for sales tax purposes. I
respectfully request that the Commission issue a written ruling in this matter.
XXXXX
has a Utah customer who wishes to sell to and leaseback from XXXXX
non-inventory items of equipment which customer currently owns and uses in its
business operations ("fixed assets"). The customer is a retailer of
tangible personal property which is different from the fixed assets it desires
to sell and lease back. The customer paid Utah sales tax on the fixed-assets at
the time of their original purchase. The customer now wishes to use those
assets as collateral to obtain additional operating capital, and there are
accounting reasons why a sale-leaseback would be more beneficial than a loan on
the assets.
The
Transaction is a sixty (60) month lease. Customer will be obligated to pay base
monthly lease payments in a fixed amount, which, later in the lease, will
increase in the monthly amount ("contingent rentals")if there occurs
any increase in the Consumer Price Index during an initial period of the lease.
At the end of the lease term, customer is required to make a final lump sum
payment to XXXXX (in an amount predetermined at the commencement of the lease)
at which time customer will be deemed the owner of the fixed assets. The
foregoing terms are fixed and irrevocable.
The
Transaction will be structured as a non-tax lease in that customer will remain
the owner for federal income tax purposes and the transaction will not
constitute a sale as defined in the Internal Revenue Code. The assets will
remain on the customer's "tax" books and will continue to be
depreciated by the customer for federal and Utah income tax purposes in
accordance with its previously established methods. The fixed assets will
remain in customer's possession at their current Utah location and will
continue to be used by customer in the same manner after the lease is in
place. XXXXX will never take possession
of the fixed assets. The customer will retain all of the burdens and benefits
of ownership of the fixed assets, including the obligation to pay property
taxes, insurance, and maintenance. As mentioned in the preceding paragraph, at
the end of the lease, customer shall be deemed the owner of the fixed assets
for no additional consideration beyond payment of the minimum lease payments
called for in the contract. Because the parties deem the transaction to be a
non-tax lease, XXXXX will not claim depreciation or other income tax benefits
with respect to its purchase of the fixed assets.
Based
upon the following analysis, it is XXXXX’s conclusion that neither its purchase
nor lease of the fixed assets as set forth above is subject to imposition of
the Utah sales or use tax:
I.
Under Utah case law. the Transaction is a "lease intended as
security" and not a "true lease", and customer will remain the
legal and beneficial owner of the fixed assets.
Notwithstanding
attempts to characterize a transaction as a lease of personal property, the
Utah Supreme Court has continually held such transactions to be "leases
intended as security", "conditional sales" or "financing
arrangements" and not "true leases" where lessee has received or
retained substantially all of the burdens and benefits of ownership of the
personal property. FMA Financial Corporation v. Pro-Printers, 590 P2d. 803
(1979); Arnold Machinery Company v. David M. Balls et al., 624 P2d. 678 (1981);
Colonial Leasing Company v. Larsen Brothers Construction, 731 P2d. 483 (1986);
First Security Financial v. Oakland Ltd. Inc., 750 P2d. 195 (1988). Such cases also hold the lessee/user to be
the legal and beneficial owner of the property subject to the transaction.
The
Utah Supreme Court's analysis of the "true lease" versus "lease
intended as security" issue has arisen principally in the context of
determining whether the "security interest" provisions of Article 9
of the Utah Uniform Commercial Code ("UCC") apply to a transaction
denoted as a "lessee": If the
transaction is a "true lease", then the user has no ownership
interest in the personal property and Article 9 does not apply; if, however,
the transaction is not a "true lease", but is a "lease intended
as security" or "conditional sale", then the user is deemed to
be the owner of the personal property rather than the lessor, and lessor is
deemed to have a security interest in the equipment by virtue of Article 9.
The
Utah Supreme Court first addressed this issue in FMA Financial Corporation v.
Pro-Printers (supra). In that case, the Court focused upon Section
70A-1-201(37) of the UCC which provided in part,
"Whether
a lease is intended as security is to be determined by the facts of each case;
however, (a) the inclusion of an option to purchase does not of itself make the
lease one intended for security, and (b) an agreement that upon compliance with
the terms of the lease the lessee shall become the owner of the property for no
additional consideration or for a nominal consideration does make the lease one
intended for security."
The
Court then focused upon the question of what constitutes "nominal
consideration" and concluded to apply a three-pronged test used by other
courts:
"(1)
Compare the option price with the original list price or cost of the property;
(2) Compare the option price with 'sensible alternatives'; and (3) Compare the
option price to the fair market value of the property at the time the option is
to be exercised."
With
respect to the above tests, the Court then stated:
"We
believe it unwise to restrict our analysis of the problem to one specific test,
in view of the fact that all three tests are somewhat related, and each can
offer insight into the nature of the transaction which is being examined."
The
Court then proceeded to apply the three-pronged test to the facts of the case,
which were as follows:
As
in the instant Transaction, the case involved a sale-leaseback arrangement
wherein XXXXX ("XXXXX") purchased printing equipment from XXXXX and
leased the equipment back to him for 60 fixed monthly lease payments. At the
time of lease, XXXXX orally promised XXXXX he could buy the equipment at the
end of the lease for a "minimal fee" determined by the Court in this
case to be 10% of the original equipment cost to XXXXX. With the permission of
XXXXX, XXXXX then assigned the lease to XXXXX ("XXXXX"). Thereafter,
XXXXX failed to make certain lease payments and XXXXX repossessed and sold the
equipment. By legal action, XXXXX endeavored to enforce collection of a
deficiency against XXXXX, and the lawsuit ensued.
In
applying the first two test of the three-pronged test to the facts, the Court
concluded the transaction to be a "lease intended as security"
because the Court considered the 10% purchase option to be "nominal"
within the Utah UCC definition and concluded that when the purchase option
amount was compared to and found to be only 6% of the total lease payments,
"the lessee in this case [was left with] no sensible alternative but to
purchase the equipment." Inasmuch as no testimony was provided at trial as
to the equipment's fair market value at the time the option to purchase was to
be exercised, the Court did not apply the third test.
Later
Utah cases (cited above) have confirmed the holding of the Court in the XXXXX
case regarding the test to determine "true lease" or "lease
intended as security" status.
Section
70A-1-201(37) of the UCC was subsequently amended and now provides as follows:
"(b)
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 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;
(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.
(c)
A transaction does not create a security interest merely because it provides
that:
(i)
the present value of the consideration the lessee is obligated to pay the
lessor for the right to possession and use of the goods is substantially equal
to or is greater than the fair market value of the goods at the time the lease
is entered into;
(ii)
the lessee assumes risk of loss of the goods, or agrees to pay taxes,
insurance, filing, recording, or registration fees, or service or maintenance
costs with respect to the goods;
(iii)
the lessee has an option to renew the lease or to become the owner of the
goods;
(iv)
the lessee has an option to renew the lease for a fixed rent that is equal to
or greater than the reasonably predictable fair market rent for the use of the
goods for the term of the renewal at the time the option is to be performed; or
(v)
the lessee has an option to become the owner of the goods for a fixed price
that is equal to or greater than the reasonably predictable fair market value
of the goods at the time the option is to be performed.
(d)
For purposes of this subsection:
(i)
Additional consideration is not nominal if, when the option to renew the lease
is granted to the lessee, the rent is stated to be the fair market rent for the
use of the goods for the term of the renewal determined at the time the option
is to be performed, or when the option to become the owner of the goods is
granted to the lessee the price is stated to be the fair market value of the
goods determined at the time the option is to be performed.
(ii)
Additional consideration is nominal if it is less than the lessee's reasonably
predictable cost of performing under the lease agreement if the option is not
exercised.
(iii)
'Reasonably predictable' and 'remaining economic life of the goods' are to be
determined with reference to the facts and circumstances at the time the
transaction is entered into.
(iv)
'Present value' means the amount as of a date certain of one or more sums
payable in the future, discounted to the date certain. The discount is
determined by the interest rate specified by the parties if the rate is not
manifestly unreasonable at the time the transaction is entered into; otherwise,
the discount is determined by a commercially reasonable rate that takes into
account the facts and circumstances of each case at the time the transaction
was entered into."
In
addition to the foregoing definition/tests, Utah Sales Tax Rule R865-19-32S,
defines a "conditional sale lease" as a transaction in which:
"
1. the consideration the lessee is to pay the lessor for the right to
possession and use of the property is an obligation for the term of the lease
not subject to termination by the lessee, and
2.
the total consideration to be paid by the lessee is fixed at the time the lease
is executed and cannot be modified by use, condition, or market value, and either:
a.
the lessee is bound to become the owner of the property; or
b.
the lessee has an option to become the owner of the property for no additional
consideration or nominal additional consideration upon compliance with the
lease agreement. Nominal consideration in this sense means ten percent or less
of the original lease amount."
The
Rule was promulgated to give the possessor/user of equipment the option of
treating the transaction either as a "sale" or "lease" for
sales tax purposes; that is, the possessor/user has the option to pay sales tax
up front on the calculated sales price, or it may pay sales tax on each lease
payment as made. The Rule recognizes the true intent of the parties concerning
a transaction falling within the Rule's definition; that it is essentially a
"sale" or "financing arrangement" and not a "true
lease". The Rule no doubt was promulgated to comprehend the typical
"conditional sale lease" transaction, which is where a seller
(lessor), at the request of a purchaser (lessee), acquires property from a
third party vendor specifically to sell (lease) to the purchaser (lessee). For
accounting or other reasons, the parties label the transaction as a
"lease", but they really intend a "sale".
The
above Transaction, is different from a typical "conditional sale
lease" in that the lessor (XXXXX) is acquiring the fixed assets not from a
third party vendor, but from the lessee (customer), with the intent of allowing
the lessee (customer) the continued possession and use of those assets. In this
sense, the Transaction should not be viewed as two consecutive
"sales" of assets (i.e.. from customer to XXXXX and from XXXXX back
to customer), but rather as a "financing arrangement" where XXXXX is
providing financing and is using the fixed assets as collateral. Essentially,
from start to finish, customer is the legal and beneficial owner of the
equipment. While the parties use "lease language" to satisfy
accounting or other purposes, the Transaction is nothing more than a financing.
That
no "sale" will be deemed to occur under the Transaction is further
supported by the analysis that under the XXXXX case, the Court determined that,
notwithstanding the parties' labeling of the transaction as a lease, XXXXX
merely had a security interest in the property. By legal definition, a party is
not deemed to create or possess a security interest in property which it
already owns. That is not the intent of Article 9 which governs security
interests.
While
there is considerable overlap between the definition and tests for determining
a "true lease" and a "lease intended as security" under
Utah case law, the UCC and the Sale Tax Rule, there is no contradiction between
these definitions and tests.
The
Transaction falls within the above definition of a "lease intended as
security" under the revised UCC, and the "conditional sale
lease" under the Sales Tax Rule in that under the Transaction, upon
payment by customer of the scheduled lease payments (including the final lump
sum payment), customer will be deemed the owner of the fixed assets at
termination of the lease for no additional consideration.
Furthermore,
the Transaction meets the three-pronged test set forth in the XXXXX case in
that at the end of the lease, the customer will become the owner of the equipment
for no additional consideration.
Section
59-12-103(1) of the Utah Code Annotated, as amended, provides for the
imposition of sales tax [at subpart (a)] on the "retail sales of tangible
personal property made within the state" and [at subpart (k)] on "leases
and rentals of tangible personal property if the property situs is in this
state. . ."
In
accordance with the foregoing analysis, inasmuch as customer (and not XXXXX)
will be deemed to be the owner of the fixed assets throughout the Transaction
and notwithstanding the Transaction, no "sale" or "lease"
should be deemed to have occurred which would give rise to the incidence of
sales tax. Accordingly, neither XXXXX's "purchase" of the fixed
assets from customer nor its "lease" of such fixed assets back to
customer should create a taxable event for purposes of the Utah Sales Tax.
II.
For sales tax purposes. other states have exempted similar transactions from
sales and use tax where the transaction is more a "conditional sale"
or "lease intended as security" than a "true lease":
California:
California Sales and Use Tax Regulation 1660 at (a) provides in part:
"Where
a contract designated as a lease binds the 'lessee' for a fixed term and the
'lessee' is to obtain title at the end of the term upon completion of the
required payments or has the option to purchase the property for a nominal
amount, the contract will be regarded as a sale under a security agreement from
its inception and not as a lease."
Further,
Pamphlet No. 46 entitled, "Tax Tips for Leasing of Tangible Personal Property in
California" contains the following instruction:
SALE
AND LEASEBACK TRANSACTIONS
In
general, transactions structured as sales and leasebacks will be treated as
financing transactions if:
(1)
the "lease" transaction would be regarded as a sale under the
security agreement from its inception under the above guidelines (Regulation
1660)
(2)
the purchaser-lessor does not claim any deduction, credit or exemption with
respect to the property for federal or state income tax purposes, and
(3)
the amount which would be attributable to interest, had the transaction been
structured originally as a financing agreement, is not usurious under
California law.
South
Carolina: In a private letter ruling (#90-13, 10-3-90), the South Carolina Tax
Commissioner's office decided that a sale-leaseback transaction was a financing
arrangement rather than an actual sale and lease and, therefore, was not
subject to South Carolina sales and use tax. The transferor purchased equipment
from several vendors and subsequently "sold" the property to the
transferee, who then leased it back to the transferor. However, the transferor
retained legal title to the property as well as the benefits and burdens of ownership.
Additionally, the equipment was never physically conveyed to the transferee.
Since it was the intention of the parties to create a financing agreement and
not a transfer of tangible personal property, no sales or use tax was due on
the transaction.
XXXXX
would appreciate your earliest response to its request for a ruling as
mentioned in the first paragraph.
Very
truly yours,
XXXXX
General
Counsel