Can a California computer lessee switch a taxed prime lease to resale treatment after subleasing the computer outside California?

Plain-English summary

An absent March 23, 1990 Audit Review and Refunds mini-memo described a taxpayer paying IBM use tax on computer rent. After prime-lease commencement, it decided to sublease the computer to an Arizona customer and claimed a tax-paid-purchases-resold deduction on its return. The unit believed IBM tax remained due and denied the deduction because the taxpayer did not legally own the computer.

Counsel agreed with the result but rejected the ownership rationale. He assumed IBM manufactured the computer, making the prime lease a continuing sale without purchase-price election. If manufacturer-leased property was subleased before lessee use, the sublease was also a continuing sale when no prime-rent tax was paid; payment on prime rent instead made the sublease nontaxable.

Once the lease began and prime-rent tax was paid, the lessee could not change methods, issue a late resale certificate and obtain a tax-paid-purchases-resold refund. Under a timely-certificate counterfactual, the source says IBM could lease tax-free and tax would be due on sublease rent. Fresh cited 330.2880 backup supports that sentence through a separate Illinois-corporation letter requiring the sublessor to collect/remit tax.

The 330.2880 backup combines two 1965 letters, one about 30 weekly rental trailers after purchase-price tax and one about the certificate/rent method. It identifies an amended Ruling 70 enclosure not reproduced and supplies no computer facts.

Official 330.2877 is a near-duplicate April 13 source. It differs materially: its initiating mini-memo is March 28 instead of March 23, it redacts IBM, and it says counterfactual sublease tax would not be due. The remaining analysis is substantially the same. This page preserves the 330.2885 wording and discloses the official variant rather than harmonizing it.

Location independently controlled the actual periods. Unless the computer was taxable mobile transportation equipment, its lease outside California was not taxable. The memo says it was no longer used in California but provides no dates or movement evidence. IBM's tax collected/remitted for those periods was an overpayment that should be refunded. Contract language requiring rent-based tax could not make nontaxable amounts taxable.

Live Annotation 330.2885 publishes only the manufacturer, pre-use sublease, prime-rent/sublease-rent method rule. It omits the actual IBM/Arizona facts, method-change denial, tax-paid-purchases-resold claim, official 330.2877 conflicts, out-of-state use, mobile-transportation exception and refund result.

No mini-memo, computer description/classification, manufacturer proof, prime lease, pre-sublease use evidence, Arizona sublease, certificate, return/deduction, contract, exact location periods, tax invoice/payment, audit, refund claim/payment, assessment, petition, appeal or later outcome appears.

What this means for you

Preserve manufacturer/acquisition facts, property classification, prime/sublease timing, any pre-sublease use, resale certificate, elected method, daily location and tax invoices/payments. Treat the two official source variants explicitly; do not silently choose the phrase that favors a position.

Common questions

Why was the tax-paid-purchases-resold deduction denied?

The problem was not that the lessee lacked legal title. The lessee had already paid tax measured by prime-lease rentals and could not change reporting methods after the lease began.

When would a sublease itself be a continuing sale?

For manufacturer-leased property subleased before the lessee's use, the memorandum says the sublease is a continuing sale when use tax is not paid on the prime-lease rentals. If tax is paid on the prime lease, the sublease is not treated as a sale.

What does 330.2885 say after a timely resale certificate?

Tax would be due on sublease rent. Cited 330.2880 supports that method.

How does official 330.2877 differ?

It says tax would not be due and dates the mini-memo March 28 instead of March 23.

Did moving the computer to Arizona eliminate every tax issue?

The memorandum decided only that California use tax did not apply for periods when the computer was outside California. It did not determine another state's tax.

Did the source establish exact out-of-state periods?

No.

Was any refund actually paid?

The memo says it should be refunded; no claim or payment record appears.

Citations and references

• Sections 6006(g), 6006.1 — assumed manufacturer-lessor continuing sale
• Regulation 1660(c)(5) — prime/sublease method
• Section 6201; Regulation 1660(c)(1) — California use periods
• Annotation 330.2880/1965 backup — trailer/Illinois-company method letters
• Official 330.2877 PDF — near-duplicate with date and not conflicts
• Mini-memo, property, agreements, return, location, tax/refund and outcome records — absent
• Live Annotation 330.2885 — method rule without actual out-of-state/refund branch

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 330.2885
• Original supporting memorandum: 330.2885 PDF
• Cited supporting opinion: 330.2880 PDF
• Official near-duplicate source: 330.2877 PDF

Original ruling text

State of California

Board of Equalization
Legal Division (MIC:82)

Memorandum
330.2885
To:

Mr. Richard Gerber
Audit Review and Refunds Unit

From:

David H. Levine
Tax Counsel

Subject:

M--- Corporation
S- -- XX-XXXXXX

Date:

April 13, 1990

This is in response to your mini-memo dated March 23, 1990. Taxpayer leases a computer from IBM and pays IBM 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 IBM 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 IBM manufactured the leased computer. Under such circumstances, IBM’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 IBM

Mr. Richard Gerber

-2-

April 13, 1990
330.2885

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 IBM 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 IBM and taxpayer (i.e., that the lease is subject to use tax measured by rentals payable), IBM 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
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