Who was the retailer when municipal equipment contracts with $1 buyouts were assigned to financial institutions?

Plain-English summary

A redacted lease broker asked counsel to review newly enacted AB 4417 against its municipal-financing operations. It arranged investor contacts, almost all financial institutions, sometimes acted as temporary lessor until funding and assignment, and used vendors that did the same. All contracts reportedly had bargain interim options and a $1 end-of-term buyout. The firm called them tax-free leases: vendors collected sales tax on purchase cost initially, and investors collected tax on an early option price. The request and transaction records are absent.

Counsel explained that AB 4417 made these arrangements sales under security agreements from inception, although the letter continued using lease, lessor and lessee for convenience. Amended section 6006.3 codified concepts previously only in Regulation 1660. It treated a nominal end option as a sale and deemed a governmental lessee fixed-term despite a right to terminate when funds were not appropriated.

For post-September 15, 1986 transactions, the retail sale occurred when property was delivered. If the municipal lessee took possession before the broker assigned rights, the broker was the retailer. If possession followed assignment, the finance company was the retailer and the vendor-to-broker transfer was for resale. The same rule applied when the vendor temporarily held the lessor role: possession before assignment made the vendor the retailer; possession afterward made the finance institution the retailer.

An assignment after the lessee already possessed property transferred intangible rights rather than producing another property sale. Under the new law, later termination or buyout-option exercise caused no additional tax because the sale had occurred at inception.

The transition answers were narrower. A pre-effective-date transaction treated as a lease under prior law stayed a lease until the first quarter of 1987, then became a sale at inception, with prior use tax credited against sales/use tax due. For a fully funded and possessed transaction before September 15, an option exercised September 15 through December 31, 1986 generated tax on the option price; an exercise after December 31 did not.

The PDF includes the full enacted AB 4417, Chapter 825—not merely a citation. The Governor approved it September 14, 1986; it was filed and immediately effective September 15 as an urgency statute. Section 1 reproduces amended section 6006.3, including an unrelated under-one-day/under-$20 premises-use exclusion. Section 1.5 gives the transition. Section 2 makes no appropriation for local reimbursement under section 2230 because the act was intended as a clarification; section 3 states the urgency rationale.

No municipal contract, appropriation clause, option schedule, equipment, vendor invoice, purchase-cost tax, resale certificate, funding or assignment document, delivery/possession evidence, option exercise, return, assessment, credit calculation, claim, appeal or later outcome is supplied. Live 330.2789 publishes only $1 buyout, retailer-at-delivery, intangible-assignment and no-additional-tax result, omitting transition and legislative enclosure.

What this means for you

Map delivery and possession against every assignment: the party holding seller/lessor role then may be retailer. Separately document whether option is nominal, how governmental nonappropriation terms operate, and whether transaction falls before or after historical transition dates.

Common questions

Did assignment alone determine the retailer?

No. Delivery/possession timing determined which party held the retailer role.

Was the finance institution always responsible?

Only when the municipal lessee took possession after assignment to that institution.

What if the vendor delivered before assigning its lessor rights?

The vendor was the retailer and liable for tax under the source's stated approach.

Was tax due again at $1 buyout?

No for a post-amendment transaction already treated as a sale at inception.

How were earlier transactions transitioned?

Qualifying prior-law leases switched in the first quarter of 1987 with credit for use tax already paid; option exercises had a special September 15-December 31 rule.

Did the enclosure include the actual enacted bill?

Yes. It includes legislative digest and sections 1, 1.5, 2 and 3, with approval, filing and urgency language.

Can current municipal lease use these dates?

Not as current operational guidance. They explain 1986 transition; actual current law and transaction documents control.

Citations and references

• Section 6006.3 — short-use exclusion, fixed/nominal-option sale at inception and governmental nonappropriation term, reproduced as amended
• AB 4417, 1986 Statutes chapter 825, section 1 — September 15 amendment/effective date
• AB 4417 section 1.5 — first-quarter-1987 transition and prior-use-tax credit
• AB 4417 section 2; section 2230 — no local reimbursement, clarification rationale
• AB 4417 section 3; California Constitution article IV — urgency effect
• Regulation 1660 — prior administrative source of codified concepts, identified but not reproduced
• Request and contracts, options, equipment, tax/certificates, assignment/funding, delivery/possession and reporting records — absent
• Live Annotation 330.2789 — post-amendment sale, retailer and assignment branch only

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 330.2789
• Original opinion and enacted-bill enclosure: 330.2789 PDF

Original ruling text

330.2789

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

November 13, 1986

Dear
Effective September 15, 1986, Revenue and Taxation Code Section 6006.3 was amended to include within the definition of "lease" certain concepts theretofor articulated only in Board Regulation 1660. As you know the legislative vehicle for these changes in the law was AB 4417 (copy enclosed). You asked that we review AB 4417 and render our views as to how the changes in the law affect ---. We will reiterate your description of ---'s current operations and then respond to your questions as to how AB 4417 applies to such operations. Rather than quote at length from the bill, we will cite you to relevant portions of it as necessary in the course of our discussion. You stated: "First, for background, we are a lease brokerage firm arranging financing for municipal lessees through our various investor contacts, nearly all of whom are financial institutions. We do often act as Lessor on a temporary basis, assigning our rights to the investor upon funding of the lease. We also have various vendors who often act as Lessor on the same basis, assigning their rights upon funding of the lease contracts. At present: all of our leases include bargain purchase options, with a $1 buy-out at the end of the lease term, and all are tax-free leases, with sales tax collected by the vendor on the purchase cost at the beginning of the lease. If purchase options are exercised before the end of the lease term, sales tax is charged on the purchase option amount and is collected and paid to the Board of Equalization by the investor." A final observation is in order prior to stating and responding to your inquiries. One affect of AB 4417 is to treat transactions such as --- as sales rather than leases, however, for purposes of discussion herein and to minimize confusion we will utilize the terms "lease", "lessor" and "lessee" as you did in describing --- operations.

Questions/Responses
Question 1.
Assuming --- purchases the property to be leased to the municipal entity ex-tax by issuing a resale certificate to the vendor, will --- be deemed the retailer and be responsible for payment of sales tax? (These transactions presumably occur after September 15, 1986). Response 1: Assuming there is possession of the leased property by the lessee pursuant to its lease with --- prior to --- assignment of its rights under the lease co the financial institution, --- will be deemed the retailer and will be liable for the tax. The subsequent assignment to the financial institution would be considered an assignment of intangible rights. The rationale for this approach is that the retail sale of the property occurs upon delivery of the property to the lessee. Assuming the lessee obtains possession after the assignment occurs, the financing entity would be considered the retailer liable for reporting the tax. The sale by the vendor to --- under such circumstances would be a sale for resale. We note that the same general approach applies when the vendor leases the property to the municipal entity and subsequently assigns its rights as lessor to the financial institution. That is to say, assuming possession of the leased property by the lessee prior to the assignment, the vendor is the retailer liable for tax. On the other hand, if the lessee obtains possession after the assignment, the financial institution is the retailer and must pay the tax. Finally, we note that under the new law, no additional tax will be due upon exercise by the lessee of his option to terminate or buy-out the lease. Question 2: Under the above described methods of operations, would it be possible for --- to be the entity always responsible for reporting the tax? (These transactions presumably occur after September 15, 1986.) Response 2: As indicated in responding to Question 1 above, if the lessee obtains possession under the lease with ---, --- will be deemed the retailer and will be responsible for the sales tax. If possession by the lessee occurs under the lease with the vendor, the vendor is the retailer/taxpayer. And, if the lessee comes into possession after assignment of the lease to the financial institution, the financial institution is the retailer and must report the tax.

Question 3:
If the property is received by the lessee prior to the effective date of AB 4417 but payment to the lessor occurs after the effective date, how does the tax apply? Response 3: Pursuant to Section 1.5 of AB 4417, if the lessor treated the transaction as a lease under prior law, then the transaction will continue to be treated as such until the first quarter of 1987 at which time it will be treated under the new law as a sale under a security agreement from the inception. Any use tax previously paid with respect to the lease will be credited against sales or use tax due on the sale. Question 4: If the transaction is complete, i.e., lease funded with lessee in possession, before September 15, 1986, will exercise by the lessee of his option to purchase after September 15, 1986 result in tax liability? Response 4: If the lessor has treated the transaction as a lease under prior law and if the option to purchase is exercised by the lessee between September 15 and December 31, 1986, the lessor is liable for tax based on the option price. No tax would be due as a result of exercising the option after December 31, 1986.

Sincerely,

E. Leslie Sorensen, Jr.
Tax Counsel

ELS: rar
Enclosure

Assembly Bill No. 4417
CHAPTER 825
An act to amend Section 6006.3 of the Revenue and Taxation Code, relating to taxation, and declaring the urgency thereof, to take effect immediately.
[Approved by Governor September 14, 1986. Filed with Secretary of State September 15, 1986.] LEGISLATIVE COUNSEL'S DIGEST AB 4417, Cortese. Sales and use taxes: leases. Under the existing Sales and Use Tax Law, the terms "sale" and "purchase" include, with certain exceptions, any lease of tangible personal property for a consideration. For those purposes, a lease is a continuing sale and possession of the leased property by the lessee is a continuing purchase. Existing regulations provide that 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. This bill would codify that regulation, and would further provide that in the case of a contract designated as a lease with any state or local governmental body, or any agency or instrumentality thereof, the lessee shall be treated as bound for a fixed term notwithstanding any right of the lessee to terminate the contract in the event that sufficient funds are not appropriated to pay amounts due under the contract. The bill would provide that if a transaction entered into prior to the effective date of this bill has been treated by the lessor as a lease, the full term of which has not expired or been earlier terminated, then that transaction shall be classified as a sale under a security agreement occurring in the first calendar quarter commencing more than 90 days after the effective date of this bill, and shall be classified as a lease for all earlier periods. It also would provide that any use tax previously paid on a transaction described in the preceding sentence shall be credited against any sales or use tax due. Counties and cities are authorized to impose local sales and use taxes in conformity with state sales and use taxes. Exemptions from state sales and use taxes enacted by the Legislature are automatically incorporated into the local taxes.

Section 2230 of the Revenue and Taxation Code provides that the state will reimburse counties and cities for revenue losses caused by the enactment of sales and use tax exemptions. This bill would provide that no appropriation is made and the state shall not reimburse local agencies for sales and use tax revenues lost by them pursuant to this bill for a specified reason. The bill would declare that it is to take effect immediately as an urgency statute. The people of the State of California do enact as follows: SECTION 1. Section 6006.3 of the Revenue and Taxation Code is amended to read: 6006.3. "Lease" includes rental, hire and license. "Lease" does not include a use of tangible personal property for a period of less than one day for a charge of less than twenty dollars ($20) when the privilege to use the property is restricted to use thereof on the premises or at a business location of the grantor of the privilege. 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 the completion of the required payment or has the option at that time to purchase the property for a nominal amount, the contract shall be regarded as a sale under a security agreement from its inception and not as a lease. In the case of a contract designated as a lease with any state or local governmental body, or any agency or instrumentality thereof, the lessee shall be treated as bound for a fixed term notwithstanding any right of the lessee to terminate the contract in the event that sufficient funds are not appropriated to pay amounts due under the contract. SEC. 1.5. If a transaction entered into prior to the effective date of this act has been treated by the lessor as a lease, the full term of which has not expired or has been earlier terminated, then that transaction shall be classified as a sale under a security agreement occurring in the first calendar quarter commencing more than 90 days after the effective date of this act, and shall be classified as a lease for all earlier periods. Any use tax previously paid on a transaction described in the preceding sentence shall be credited against any sales or use tax due. SEC. 2. Notwithstanding Section 2230 of the Revenue and Taxation Code, no appropriation is made by this act and the state shall not reimburse any local agency for any sales and use tax revenues lost by it under this act because this act is intended as a clarification of existing law, rather than as a change in the law. SEC. 3. This act is an urgency statute necessary for the immediate preservation of the public peace, health, or safety within the meaning of Article IV of the Constitution and shall go into immediate effect. The facts constituting the necessity are:

In order to ensure that transactions entered into by governmental entities proceed without any uncertainty regarding the classification of those transactions for purposes of the California sales and use tax, it is necessary that this act take effect immediately.