Was a 60-month equipment contract a sale from the start when the customer could return the property after month 54?

Plain-English summary

San Jose audit staff asked whether redacted payment-plan contracts were true leases or sales at inception. March 5 request year appears only as 19XX; request, agreement and equipment schedule are absent. Memo describes representative 60-month noncancellable contract with monthly rent and title retained by provider except option.

Customer could elect effective end of month 54 either continue final six payments and receive title at start of that period, or return property. Notice was due 60 days before month 54; no timely notice defaulted to continuation/title.

Regulation 1660(a)(2)(A) analysis asked whether title was contractually certain or option exercise economically certain at no more than $100 or one percent total price. Here customer retained real return right and final six payments were 10 percent, so neither certainty existed prospectively.

Counsel criticized bright line with hypothetical $10,000,000 contract and $101 option: economically obvious sale, yet $100 threshold implied lease. He still applied rule. He analogized same-form lease tax election: lessor could choose purchase-price or rent tax prospectively, but could not pay purchase tax two years late to undo rent tax.

Provider correctly collected use tax on rent for first 54 months. At continuation/no-return election, title passed and final six-month segment became sale; provider correctly reported sales tax on all six remaining payments at its start. Same structure applied first 30 of 36 months and first 42 of 48 months.

Live 330.2482 uses April 16, one day after memo, and publishes core 60-month result. It omits redacted request year, threshold critique, election analogy, shorter-term examples and missing records.

Common questions

Why was contract not sale from day one?

The customer had a real right to return the property after 54 months and avoid the final six payments and title transfer.

What happened if customer gave no notice?

Failure to elect a return was treated as choosing to continue, so title passed and the final six-payment segment became a sale.

Why did 10 percent remaining price matter?

It exceeded Regulation 1660's cited $100-or-one-percent economic-certainty threshold, supporting real choice rather than inevitable purchase.

When was tax due on final segment?

The opinion approved reporting sales tax at the beginning of that six-month segment on all six remaining payments.

How did 36- and 48-month contracts work?

Memo says use tax on rent for first 30 or 42 months, respectively, before same six-month sale segment.

Could lessor switch to purchase-price tax years after first lease?

No under memo's analogy. Election was prospective; late payment could not undo rent-tax treatment.

Did memo approve $100 threshold economically?

No. Its $10 million/$101 hypothetical criticized threshold, while still applying Regulation to actual contract.

May another payment-plan provider rely on this result?

No. It is internal historical advice based on an unproduced representative contract and missing transaction records; actual rights and current law must be checked.

Citations and references

• Regulation 1660(a)(2)(A) — contractual/economic certainty and $100-or-one-percent option test
• March 5, 19XX audit request — absent with year redacted
• Payment-plan agreement/schedule and transaction/tax records — absent
• April 15 Levine memo — actual result, threshold critique, election analogy and shorter terms
• Official Annotation 330.2482 — April 16 excerpt without those source limits

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: Annotation 330.2482
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/330-2482.pdf

Original ruling text

State of California

Board of Equalization
Legal Division (MIC:82)

Memorandum
330.2482

To:

Mr. Norman Jung, Staff Tax Auditor
Mr. Romero Celedon, Supervising Tax Auditor
GH - San Jose, Audit

From:

David H. Levine
Senior Tax Counsel

Subject:

H--- P--- Co.
SY – XX-XXXXXX

April 15, 1992

ATSS 485-5550
(916) 445-5550

This is in response to your memorandum dated March 5, 19XX regarding whether certain H--- P--- contracts should be regarded as true leases or as sales at inception. The contracts in question consist of two parts, a payment plan agreement and a payment plan equipment schedule and payment agreement. The provisions of a representative contract of the type in question are as follows. The term of the contract is for sixty months with a stated amount of rental payment due each month. The contract cannot be cancelled or terminated except as provided in the contract. Title to the property remains with H--- P--- during the entire term of the contract except as provided in the option provision. The option provision provides the customer with two choices, whichever choice is selected becoming effective at the end of the 54th month of the contract term. One choice is that the customer can continue to make payments on the equipment covered by the agreement for the remaining six months, and will obtain title to the equipment at the beginning of that six-month period (i.e., at the end of the 54th month). The second choice is that the customer may return the equipment to H--- P--- at the end of the 54th month. The customer must notify H--- P--- of its election 60 days prior to the end of the 54th month. If the customer fails to so notify H--- P---, then the customer is regarded as having elected the first choice, that is, to continue making payments on the equipment through the remainder of the 60 month term, gaining title at the end of the 54th month.

Mr. Norman Jung

-2-

April 15, 1992
330.2482

You believe that this contract is a sale at inception under subdivision (a)(2)(A) of Regulation 1660 since the customer will obtain title at the end of the term, by notifying H--- P--or by doing nothing, and continuing to make the last six payments. H--- P--- believes that this contract is a true lease since the customer may timely notify H--- P--- and return the equipment, thereby precluding a finding that the lessee is bound for a fixed term to obtain title to the property at the end of that term. Prior to discussing the specific analysis applicable to this case, it may be helpful to provide you my view on a different type of contract. It is my opinion that a contract designated as a lease with a total contract price of $10,000,000 and an option price of $101 at the end of the lease term is clearly a sale at inception and should be taxed accordingly. Obviously, however, I am mistaken since subdivision (a)(2)(A) of Regulation 1660 says that such a contract is a sale at inception if the option price does not exceed $100, implying that my example is a true lease. In my opinion, the contract about which you inquire is much closer to being a true lease than is the example I have just provided. Since I am in an comparison-type mode, I wish to provide you another analogy. As you are well aware, when a lessor is leasing property in substantially the same form as acquired, he has an election to pay tax up front and be treated as a consumer of the leased property with no tax on the rentals, or may elect to not pay tax on the purchase price and be regarded as making taxable continuing sales. Looking at it on a prospective basis, at the time of the original purchase of the property by the lessor, the lessor may elect either of two manners of reporting tax. On the other hand, looking back at it two years later, if the lessor failed to pay any tax that lessor has no election. Under such circumstances, we would regard the lease as subject to tax measured by rentals payable, and the lessor may not avoid that result by paying tax on purchase price two years after the property was first leased. I believe that the contract under review is a direct analogy to this scenario. Looking at the option in the H--- P--- contract on a prospective basis at any time prior to 60 days before the end of the 54th month, the customer may elect to return the property at the end of the 54th month. The customer is not contractually bound to continue paying for 60 months, obtaining title to the property at the end of the 54th month, unless the customer so elects or fails to timely notify H--- P---. The theory of the sale at inception analysis is that the customer is contractually certain to obtain title to the property at the end of the contract term or is economically certain to exercise the purchase option (that is, when the option price does not exceed $100 or one percent of the total contract price). Here, the customer is not economically certain to exercise the option, which is ten percent of the total contract price when the term is 60 months, nor is the customer contractually required to continuing making payments for the entire sixty-month period unless the customer so chooses (or fails to choose). This contract is an unusual type of contract (I have never seen one structured in the same way). I assume your gut reaction to reviewing it is similar to my reaction to a contract structured as my example to start this opinion: it sure doesn't look like a lease. However, when

Mr. Norman Jung

-3-

April 15, 1992
330.2482

we examine the actual rights of the customer to return the property if so electing to do so, we must conclude that this is a lease contract. Therefore, we conclude that H--- P--- is correct in collecting use tax measured by rentals payable during the first 54 months (or first 30 months of a 36 month contract or first 42 months of a 48 month contract). With respect to the remaining 6 months of the contract, H--- P--- regards that portion of the contract as a sale at inception, and actually passes title to the customer at the beginning of that six-month period. We again agree with H--- P---'s handling of this in reporting sales tax on the full amount of payments due for the remaining six months of the contract at the beginning of that six-month period. If you have further questions, feel free to write again.

DHL:cl
4010E

330.2482.doc