Did a mandatory $1-per-unit end-of-term purchase make a 500-chassis agreement a sale at inception despite a genuine early-termination right?

Plain-English summary

M--- I--- Corporation's lease arose alongside cancellation of a lessee's original agreement to buy 500 container chassis and a replacement agreement between that seller and the lessor. Counsel did not receive those exhibits and said only that the lease appears to cover the same 500 units.

Article 9 allowed the lessee to terminate early on May 31 of 1987, 1988 or 1989, but only for all equipment, by paying and returning it. Article 10 stopped rent on May 31, 1996, offered annually decreasing per-unit option prices through 1995 and required purchase of every remaining unit at term end for $1 each.

The rule treated a fixed-term agreement as a sale under a security agreement from inception when required payments ended in title or the lessee could buy for a nominal amount. An option was nominal at no more than $100 or one percent of total contract price.

Assuming no units were removed under absent Articles 7/8 and no default/loss occurred, 500 units meant a $500 end price. Counsel called that more than nominal, but emphasized that the clause was mandatory, not optional. Without Article 9, required title after scheduled payments would make the contract a sale from inception.

Article 9 changed the result. Counsel said the early-termination payment was considerably less than the option price and therefore not a sham. A genuine all-equipment payment-and-return exit made the term nonfixed. The agreement was a true lease, leaving the lessor the usual election between purchase-price tax and collecting use tax on rent.

No termination/option figures, total price, full contract, performance or tax outcome is supplied. The live annotation repeats the result, adds an 18-year option-period description and marks (Am. 2002-2) without amendment text/history.

Common questions

Did the $1-per-unit end purchase control classification?

No. The mandatory end-of-term purchase pointed toward a sale, but the genuine earlier return right prevented a fixed term.

Was $500 necessarily nonnominal?

Counsel said so for the assumed 500 units, but the source supplies neither total contract price for the one-percent test nor the underlying schedules.

Why was early termination considered genuine?

The required payment was considerably less than the purchase-option price, so the memorandum did not treat return as economically illusory.

Are the compared payment amounts available?

No. The conclusion describes the relationship but gives neither early-termination nor annual option amounts.

What tax rule applied after classification as a true lease?

The lessor had the usual election between purchase-price tax and use tax on rental receipts.

What did the 2002 amendment change?

The live annotation says (Am. 2002-2) and describes an 18-year option period, but no amendment text/history is supplied, so this page does not infer more.

Citations and references

• Section 6006.3; Regulation 1660(a) — fixed-term sale under security agreement
• Regulation 1660(a) — stated $100/one-percent nominal-option test
• July 6, 1989 Audit memorandum — described but absent
• Lease Articles 7-10, purchase/cancellation/replacement agreements and exhibits — incomplete or absent
• Termination/option calculations, total price, performance/tax and outcome records — absent
• August 9, 1989 counsel memorandum — apparent-facts true-lease conclusion
• Official Annotation 330.2165 — marked (Am. 2002-2) without amendment text/history

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: Annotation 330.2165
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/330-2165.pdf

Original ruling text

State of California

Memorandum

To:

Mr. Morris Verna, Jr.
San Francisco -- Audit

From:

David H. Levine
Tax Counsel

Subject:

M--- I--- Corporation
SY --- XX-XXXXXX

Board of Equalization

330.2165

August 9, 1989

This is in response to your memorandum dated July 6, 1989 regarding whether a lease contract is a sale at inception. As you note, the two provisions especially relevant to this question are Article 9, Early Termination, and Article 10, Purchase Option. Article 9 provides that on May 31 of 1987, 1988, and 1989, the lessee has a right to terminate the lease prior to 1996. Article 10 provides that rent ceases to accrue as of May 31, 1996. The recitals of the lease indicate that the lessee had originally contracted with H--- S--I--- for the purchase of 500 container chassis (referred to in the lease individually as “unit” or together as “equipment”). That agreement was cancelled and H--- and the lessor entered into a replacement agreement. These documents were attached as exhibits to the lease; however, they were not included in the copy sent to us. The lease was entered into on the same date as the cancellation and replacement contracts referred to above. Although not clearly specified in the lease, it appears that the lease is for the same 500 units covered by the original contract. A contract designated as a lease which binds the lessee for a fixed term is regarded as a sale under a security agreement from its inception and not as a lease when the lessee is to obtain title at the end of the fixed term upon completion of the required payments or has the option to purchase the property for a nominal amount. (Rev. & Tax. Code § 6006.3, Reg. 1660(a).) The option price is regarded as nominal if it does not exceed $100.00 or one percent of the total contract price. Article 10 of the lease agreement provides for option prices per unit in decreasing amounts from 1987 through 1995. If the lessee has not exercised the purchase option before the end of the lease term, Article 10 provides that the lessee “shall purchase all of the Equipment then remaining subject to this Lease for a purchase price of $1.00 per Unit….” As mentioned above, it appears that the agreement provides for the lease of 500 units. Unless units are

Mr. Morris Verna, Jr.

-2-

August 9, 1989
330.2165

removed from the lease under Articles 7 or 8, there would be 500 units at the end of the lease since the early termination and purchase option provisions apply to all, but not less than all, of the equipment. In the absence of default or loss, the purchase price would be more than nominal since it would be $500.00. However, this provision is not an option. Rather, the provision requires the lessee to purchase the equipment at the end of the lease term. If not for the inclusion of Article 9, we would conclude that this lease is a sale under a security agreement from its inception because the lessee is to obtain title at the end of the term upon completion of the required payments. Article 9, however, provides that the lessee may terminate the lease early as to all, but not less than all, of the equipment by making a payment and returning the leased equipment. Since the early termination payment is considerably less than the option price, we conclude that this provision is not merely a sham. Rather, we conclude that the early termination provision makes this agreement one which is not for a fixed term. Since the agreement is not for a fixed term, we consider it a true lease with respect to which the lessor had the usual election to pay tax on purchase price or collect use tax on rentals payable. If you have further questions, feel free to write again.

DHL:wak
1469C