Was a wastewater filtration contract a nontaxable service when the provider owned and maintained the equipment and replaced its carbon?

Plain-English summary

An activated-carbon-system provider had paid tax on monthly rental receipts, then claimed refund by calling charges nontaxable services and asserting competitors did not charge tax. Internal legal memo responded to audit staff's absent June 17, 1993 request; no refund decision appears.

Standard fixed-term contract provided equipment, maintenance/labor and system reducing wastewater pollutants to allowable level. It said services only and provider retained equipment ownership. Provider removed equipment/carbon after term. No full contract or transaction appears.

Under Regulation 1501 true-object test, label did not control. Memo analogized Culligan: lessee uses/controls property while lessor retains ownership and replacement right; customer water volume/timing controls system use and replacement need. Here influent passed into carbon vessels, filtered effluent into customer piping, and customer use determined reactivated carbon quantity. Source says customers controlled filtering refill, preserved as printed.

Memo found customers had temporary possession/use; object was functioning filtering system, not spent-carbon replacement service. It classified contract as lease. Under Regulation 1660, lease was taxable continuing sale unless property leased substantially as acquired and lessor paid vendor tax or timely elected purchase-price tax. No acquisition-form, tax-payment or election record appears, so memo does not ground actual rental-receipt liability beyond rejecting service theory.

Live Annotation 330.3095 preserves true-object, possession/control, carbon replacement and lease result. It omits prior monthly-tax/refund posture, competitor claim, contract's services only/ownership/removal terms, cited rental-tax exception, internal status and absent outcome.

No June 17 memo, complete contract, filtering system specification, acquisition/invoice/tax-paid proof, election, customer use/flow data, carbon/service log, rental receipts/returns, refund claim/amount, audit workpaper, determination, payment, appeal or later outcome appears.

What this means for you

Substance beats service label. Preserve contract, equipment location/control, flow/use data, maintenance/carbon work and acquisition tax/election. Decide lease classification first, then separately test whether rents or purchase price are tax measure.

Common questions

Did services only label control?

No. California applied the true-object test to the actual possession, use, and control of the equipment.

Why did carbon replacement not control?

Those activities enabled the equipment to deliver the result the customers sought. Once operating, the system filtered wastewater without additional human labor.

What made arrangement a lease?

The customer had temporary possession, used the system by routing wastewater through it, and controlled the amount and timing of that use.

Did provider ownership prevent lease?

No. Memo treated lessor ownership plus customer temporary use as usual lease elements.

Were rental receipts necessarily taxable?

Not on this record. Memo states tax-paid/timely purchase-price-election exception but provides no acquisition/election facts; it rejects only nontaxable-service theory.

Was refund denied?

Not shown. Memo addresses claim but includes no determination, payment, assessment, protest, appeal or outcome.

What does live annotation omit?

Refund posture, services only contract language, competitor claim, rental-tax exception, internal status and absent result.

Citations and references

• Regulation 1501 — property/service true-object test
• Regulation 1660(b)(1)/(c)(1) — lease rule, exception, measure/collection
• Civil Code section 1925 — possession/use/control quote through Culligan
• Culligan Water Conditioning, 17 Cal.3d 86 — controlling analogy; citation verified
• June 17 audit request/complete contract — identified, absent
• Live Annotation 330.3095 — abridged current analysis
• Every acquisition/election/refund/outcome record — absent

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 330.3095
• Original supporting opinion: 330.3095 PDF

Original ruling text

State of California

Memorandum

Board of Equalization
Telephone: 324-2608
Calnet: 454-2608
Legal Division MIC: 85

330.3095
To

:

Out-of-State District (OH)
Auditing EWH

From :

Rachel M. Aragon
Staff Counsel

Subject:

C--- C--- Corporation

Date: October 6, 1993

SS --- XX-XXXXXX

This is in response to your memorandum of June 17, 1993. The taxpayer is making a claim for refund of tax it has paid on rental receipts. Although taxpayer had been treating its monthly fees as taxable, it is now taking the position these are non-taxable services. Taxpayer claims other providers of filtration equipment/service are not charging tax for the same service. C--- is in the business of renting activated carbon treatment systems. C---'s standard contract provides for equipment, maintenance, and labor. C--- offers a filtering system that reduces the amount of pollutants in the wastewater to an allowable level. C---'s agreement is for a fixed term, and C--- removes the equipment and carbon from the property of customer at the end of that term. A standard contract includes the following provision: "This agreement is for services only and therefore all equipment supplied pursuant to this contract remain the property of C---...." (Section 1.) The question is whether C--- is leasing tangible personal property to its customers or transferring tangible personal property incidental to a service. The basic distinction in determining whether a particular transaction involves a sale of tangible personal property or the transfer of tangible personal property incidental to the performance of a service is one of the true object of the contract; that is, is the real object sought by the buyer the service per se or the property produced by the service. (Reg. 1501.)

C--- C--- Corporation
SS --- XX-XXXXXX

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October 6, 1993
330.3095

A lease of tangible personal property in any manner whatsoever for consideration is a taxable continuing sale and a purchase, unless the property is leased in substantially the same form as acquired and the lessor has paid sales tax reimbursement or use tax to its vendor or made a timely election to pay tax measured by the purchase price. When a lease is a continuing sale, the lessor is required to collect tax from the lessee, measured by the rentals payable, at the time rentals are paid. (Reg. 1660(b)(1), (c)(1).) In circumstances similar to those here, the true object test was applied in Culligan Water Conditioning v. State Board of Equalization (1976) 17 C.3d 86. Culligan had furnished water conditioning units to its customers which converted hard water to soft water by removing hardness. The water supply passed through a conditioning unit along lead-in pipes, and thereafter throughout the household water system. Culligan argued that transfer of these units to its customers was not a lease of tangible personal property because the customer did not have use of it, nor dominion or control over it, although the customer had possession of the unit. Culligan further argued that even if the elements of a lease were present, its providing the conditioning units should have been classified as a service business because it provided a water conditioning service. Culligan processed, regenerated, and installed ion-exchange material which required the skill and labor of its employees. Culligan alleged that the water conditioning exchange unit was merely the vehicle by which such service was provided. In addition, similar to the C--- contract, the Culligan water conditioning contract was called a service. The Supreme Court, addressing the lease issue, stated Civil Code section 1925 provides that "`the chief characteristic of a renting or a leasing is giving up possession to the hirer, so that the hirer and not the owner uses and controls the rented property'". The Court stated: "Certainly, the customer uses the exchange unit by having the water pass along the lead-in pipes, through the conditioning unit, and thereafter throughout the entire water system of his residence. He also has dominion and control over the unit." The Court further noted that the customer controlled how much and when customer used it and reasoned that simply because Culligan had owner's control and the exclusive right to replace one unit with another did not derogate the customer's right to use and control the unit while on its premises. The Court concluded there was present the requisite elements of a hiring, namely the temporary possession and use of the exchange water condition for reward. There was also present all the requisite elements of a lease, mainly the giving up of possession to the hirer so that he uses and controls the rental property. The Court found that the true object of the water conditioning contract was furnishing the exchange unit. The Court further stated that although human labor or service was involved in regenerating the material, realistically the customer's purpose in entering the contract was to obtain a properly generated and efficiently functioning water conditioning unit, not personal services. Once the unit was regenerated, it softened the water without requiring any additional performance of human labor. The service of regenerating

C--- C--- Corporation
SS --- XX-XXXXXX

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October 6, 1993
330.3095

and installing was required in order to provide the desired tangible personal property to the customer. The C--- filtering system works in very much the same way as the Culligan Water System and the same rationale would apply. The customer uses the filtering system by allowing the unfiltered influent to flow into the carbon vessels and the filtered effluent to flow out of the vessel into customer's piping. This reduces the pollutants in the wastewater to an allowable level. The carbon is replaced as needed. C---'s customers have dominion and control of the filtering refill. The customer's use determines how much reactivated carbon is replaced. Although C--- owns the equipment while it is in its customer's premises, its customer has temporary possession and use of the filtering system. These elements are generally present in all leases of tangible personal property (ownership by the lessor and use by the lessee). In our opinion, as in Culligan Water, the object of the contract is for use of the filtering system and not for the service C--- provides by replacing the spent carbon. C---'s customers seek tangible personal property, and C--- provides that tangible personal property under a lease of tangible personal property to its customers.

RMA:jlh

cc:

Tom Glab - ---