97-026
Response
May 8, 1997
REQUEST
LETTER
RE: Request for Determination
To
Whom It May Concern::
Pursuant
to a recent telephone conversation, request is hereby made for a written
opinion of the Tax Commissioner.
FACTS
Party
#1 [the lessee], is leasing various communications and computer equipment
located in your state from Party #2 [the lessor]. The true lease transaction stipulates
that title remains in the name of the lessor and, as signed, does not provide
an option for an early buyout.
The
lessee no longer has a use for the equipment under lease. However, under the
terms of the lease contract, the lessee cannot return or purchase the equipment
prior to fulfillment of the full lease term. Therefore, we have identified
three possible scenarios whereby this situation would be resolved.
Scenario
#1
As stipulated in a separate
Termination of Service" agreement, the lessee would purchase the equipment
from the lessor at fair market value.
Under the agreement, a lump-sum fee*
would be paid by the lessee to the lessor for the express purpose of ending the
initial contract relationship.
Physical possession of the equipment
would continue to be retained by the lessee/purchaser.
Title of the equipment would pass to the
lessee/purchaser.
Scenario
#2
As stipulated in a separate
Termination of Service" agreement, the lessee would purchase the equipment
from the lessor at fair market value.
Under the agreement, a lump-sum fee*
would be paid by the lessee to the lessor for the express purpose of ending the
initial contract relationship.
The equipment would be resold by the purchaser to a third
party.
Physical possession of and title to the equipment would
be transferred to the third party.
Scenario
#3
The lessee would return the equipment to the lessor.
As stipulated in a separate
“Termination of Service" agreement, the lessor would agree to terminate said
lease contract in exchange for a lump-sum fee* to be paid by the lessee to the
lessor for the express purpose of ending the initial contract relationship.
*
This fee would not be related to the use or retention of the equipment.
REQUESTED
OPINION
We
request the following opinions:
Scenario
#1
The fair market value buyout amount
would be taxable.
The lump-sum payment associated with
the separate.
Termination of Service" contract
would be a nontaxable fee. since the fee itself does not represent a payment
for use or purchase of the tangible leased equipment.
Scenario
#2
The fair market value buyout amount would be a nontaxable
sale for resale.
The lump-sum payment associated with
the separate “Termination of Service" contract would be a nontaxable fee,
since the fee itself does not represent a payment for use or purchase of the
tangible leased equipment.
The subsequent resale of the equipment
at fair market value would be taxable unless a valid Utah exemption certificate
was supplied by the third party.
Note: In the event that you deem the lump-sum fee
in Scenario #2 to be related to the equipment acquisition, then we would
request the opinion that the fee is a part of the nontaxable sale for resale of
the equipment. It would then follow that the fair market value resale would be
the taxable amount in this transaction unless otherwise exempted.
Scenario
#3
The lump-sum payment associated with
the separate "Termination of Service" contract would be a nontaxable
fee, since the fee does not represent a payment for use or purchase of the
tangible leased equipment.
Please
contact me if you should have any questions. I look forward to a favorable
response at your earliest convenience.
Sincerely,
NAME
RESPONSE LETTER
NAME
ADDRESS
CITY
STATE ZIP
Advisory
Opinion - Application of sales tax to purchase of leased equipment.
Dear
NAME,
We have received your request for
sales tax guidance pertaining to the buyout of an equipment lease. We offer the following:
1. Lease v. Secured Transaction. The lines between equipment leases and
financing arrangements are often blurred.
Therefore, we turn to the Utah Uniform Commercial Code to distinguish
one from the other.
A lease is a transfer of the right
to possession or use of goods for the term of the agreement in exchange for
consideration. A lease is a transfer of the right to possession and use of the
goods for a term in return for consideration.
Utah Code Ann. §70A-2a-103 (1)
(j). A secured transaction is
distinguished from a lease in the Utah Uniform Commercial Code, which states in
part:
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; 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 Ann. §70A-1-201 (37) (b). (The
full text of this statute is enclosed for your information.)
You indicate that the lessee is
obligated for the term of the lease. If
the lease also meets the conditions set out in subsections (i), (ii), (iii) or
(iv) of the statute cited above, the transaction will likely constitute a sale
rather than a lease. We cannot
determine from the facts presented in your letter whether your transactions are
true leases or financing agreements that use lease terminology. However, you represent the transactions as
true leases, so we base our comments on
that assumption.
2. Tax implications of scenarios
presented.
a. Scenario
#1:: Under the facts presented in
scenario #1, the purchase of the equipment would be a separate transaction than
the rental of the equipment. The lessor
should have been collecting and remitting sales tax on each rental
payment. The lessor is also obligated
to collect sales tax on the total sales price at the time of the sale. (Note that the lessor has nexus with Utah
for tax purposes because lessor owns property located in Utah.)
Had the original contract included
an independent penalty provision for early termination of the contract, we may
be inclined to agree that the termination fee is nontaxable. However, in this scenario, the lessee is
negotiating a purchase price for the equipment. The purchase price is the total amount for which the lessor is
willing to sell the equipment. We view
the “fee” as part of the purchase price, so it is taxable.
b. Scenario
#2: Under the facts presented in
scenario #2, the “fee” would be taxable as part of the sale for the reasons
described above. If lessee purchased
the items for resale in the regular course of business, lessee could
purchase the items tax free. To do so,
lessee would have to be in the business of selling that type of equipment and
apply for a Utah sales tax license.
That sales tax license number would be included on the Utah exemption
certificate that lessee presents to lessor.
Lessee would then collect and remit the tax on its subsequent sale of
the items to the final consumer.
As an alternative, the lessor could
collect and remit the sales tax on the sale to lessee. Lessee, in turn, could sell the items to a
third party tax free as an isolated sale of its business equipment. Under section 59-12-104 (14) of the Utah
Code and Utah Administrative Rule R865-19S-38, a sale is exempt as an isolated
sale when it is made by a person who is not pursuing his regular course of
business of selling tangible personal property. The sale by a business of its used fixtures, machinery, and
equipment is considered an isolated or occasional sale unless the sale is one
of a series of sales sufficient in number to indicate the seller deals in the
sale of such items. Utah Admin. R.
R865-19S-39 (E).
c. Scenario
#3: Under the facts presented in
scenario #3, all lease payments are taxable.
However, if the lessee returns the equipment, and terminates the lease,
no additional sales tax is due. In this
case, we agree that payment of a “fee” is equivalent to a penalty provision and
that it is not tied to the purchase or lease of equipment. Therefore, the fee would be nontaxable.
If you have other questions, please
let us know.
For
the Commission,
Joe
B. Pacheco,
Commissioner