Can a lessee switch from tax on prime-lease rent to tax on sublease rent after the prime lease has begun?

Plain-English summary

M--- Corporation leased a computer from I---, paid I--- use tax measured by prime-lease rent and, after that lease began, decided to sublease it to an Arizona customer. M--- took a tax-paid-purchases-resold deduction. The Audit Review official thought tax remained due on the original lease and the deduction failed because M--- did not legally own the computer.

Counsel agreed with the no-deduction result but rejected ownership as its reason. Assuming I--- manufactured the computer, its lease was a continuing sale with no purchase-price election. Regulation 1660(c)(5) could tax a sublease when it preceded lessee use and the prime lease was treated as resale; when tax was instead paid on prime rent, the sublease was not a sale and its rent was untaxed.

The choice paralleled the purchase-price-versus-rent election. After prime-rent tax began, M--- could not retroactively call the prime lease a resale, issue I--- a resale certificate, obtain a tax-paid-purchases-resold refund and shift tax to sublease rent. A timely resale certificate at the outset could instead have let I--- lease tax-free and made qualifying sublease rent taxable.

That method ruling did not decide the periods at issue. The computer was no longer used in California. Unless it was taxable mobile transportation equipment, California use tax did not apply to lease periods outside the state, regardless of the Arizona sublease or a contract clause saying rent carried tax. I--- should not collect California tax on those amounts, and tax already collected/paid for those periods was an overpayment to be refunded.

No leases, use/location evidence, certificate, return, claim or refund disposition is supplied. The live annotation publishes the no-switch method rule but omits the separate out-of-state result that made the actual periods untaxed.

Common questions

Did legal ownership determine the method?

No. The memorandum expressly rejected ownership as the reason. The reporting method already used on the prime lease controlled.

Could the lessee issue a resale certificate after tax began?

No. The memorandum required a timely certificate; it did not allow a retroactive certificate to support a refund.

Was the Arizona sublease itself taxed by California?

Not on these facts. The sublease was not treated as a sale after tax was paid on the prime lease, and California use tax did not apply while the computer was outside the state.

Was the refund denied entirely?

No. It was unavailable as a method-switch/tax-paid-purchases-resold refund, but tax for out-of-state periods was an overpayment that should be refunded.

Could a contract clause require California tax anyway?

No. Counsel said I--- should not collect California use tax on amounts outside the state's tax.

Are the location and refund records supplied?

No. The source states the computer was outside California for periods at issue but includes no location evidence, claim or final refund action.

Citations and references

• Sections 6006(g), 6006.1 — assumed manufacturer-lessor continuing sale
• Regulation 1660(c)(5); Annotation 330.2880 — prime/sublease treatment and timely certificate
• Section 6201; Regulation 1660(c)(1) — lease use tax limited to California use, with stated mobile-equipment caveat
• March 23, 1990 mini-memo — ownership theory described but source absent
• Prime/sublease, manufacture/use/location, certificate, payment/return/claim/contract records — absent
• April 13, 1990 counsel memorandum — no-switch rule plus separate out-of-state refund conclusion
• Official Annotation 330.2170 — no-switch branch without out-of-state controlling result/source limits

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: Annotation 330.2170
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/330-2170.pdf

Original ruling text

State of California

Board of Equalization
Legal Division (MIC:82)

Memorandum
330.2170
To:

Mr. Richard Gerber
Audit Review and Refunds Unit

From:

David H. Levine
Tax Counsel

Subject:

M--- Corporation
SR AS XX-XXXXXX

Date:

April 13, 1990

This is in response to your mini-memo dated March 23, 1990. Taxpayer leases a computer from I--- and pays I--- use tax measured by rentals payable. After the lease began, taxpayer decided to sublease the computer to a customer in Arizona. Taxpayer had taken a taxpaid purchases resold deduction on its return. You belierve that tax is due to I--- on the original lease and that taxpayer is not allowed to take a tax-paid purchases resold deduction because it is not the legal owner of the computer. We agree that taxpayer may not take a tax-paid purchases resold deduction, but not for the reason you state. I assume that I--- manufactured the leased computer. Under such circumstances, I---’s lease of the computer is a continuing sale, and there is no election available to pay tax on purchase price. ( Rev. & Tax. Code §§ 6006(g), 6006.1.) If such leased property is subsequently subleased prior to use by the lessee, the sublease is also a continuing sale if use tax is not paid measured by rentals payable under the prime lease. If use tax is paid on the prime lease, then the sublease is not regarded as a sale and the rentals payable from the sublease are not subject to use tax. (Reg. 1660(c)(5).) The determination of whether tax is due measured by rentals payable under a prime lease or by rentals payable under a sublease is similar to the determination of whether tax is due measured by purchase price or by rentals payable under a prime lease. A lessor who has elected to pay tax measured by purchase price may not change methods after the lease has commenced and obtain a refund in order to collect tax on rentals payable. Similarly, a lessee who has been paying tax measured by rentals payable under the prime lease may not change methods and treat the lease as for resale in order to collect tax measured by rentals payable under a sublease. That is, once the prime lease has commenced and taxes are paid measured by rentals payable, the sublease is not a sale. The lessee may not change methods and issue the lessor a resale certificate. Therefore, a refund is not allowable on this basis (i.e., tax-paid purchases resold). On the other hand, had the lessee issued the lessor a timely resale certificate, the lessor could properly lease the property tax free and taxes would be due on rentals payable under the sublease. (See BTLG Annot. 330.2880 (8/18/65).) Accordingly, if tax is due on these lease and sublease transactions, that tax must be measured by the rentals payable from taxpayer to I---

Mr. Richard Gerber

-2-

April 13, 1990
330.2170

since taxpayer may not change methods. Taxpayer’s sublease would not be a sale under the Sales and Use Tax Law and would not be subject to use tax. Notwithstanding the discussion above, we believe that the lease for the periods at issue is not subject to tax. A lease of tangible personal property outside California is not subject to California sales or use tax (unless it is a taxable lease of mobile transportation equipment). (Rev. & Tax. Code § 6201 (use tax applies to use in this state), Reg. 1660(c)(1) (tax on leases is a use tax on use in this state).) That taxpayer has subleased the computer is irrelevant for this analysis. The property is no longer being used in this state. California use tax is not applicable to the lease for any periods in which the property is not inside California. Use tax collected by I--- from taxpayer and paid to this state with respect to those periods must be regarded as an overpayment of use tax and should be refunded. Regardless of any contractual provisions between I--- and taxpayer (i.e., that the lease is subject to use tax measured by rentals payable), I--- should not collect California use tax on amounts which are not subject to our use tax. If you have any further questions, feel free to write again.

DHL:wak