Was a separately documented and separately priced maintenance agreement excluded from taxable equipment rent when every lessee had to buy it from the lessor?

Plain-English summary

An unidentified client's April 9, 1996 letter presented a recent settlement offer before any notice of determination. The Settlement Section could act only after a determination, timely redetermination petition and offer. To pursue that path, the client first had to identify itself for audit and possible determination. The source shows none of those later steps.

R Corp. sold and leased business equipment nationwide, including California, to unrelated customers. It usually placed maintenance inside its leases. Sometimes a customer could exclude those provisions and sign a separate maintenance agreement comparable to the one offered to equipment buyers.

Separate arrangements used different documents, separately stated prices and allegedly arm's-length amounts. But maintenance still had to come from R Corp. The opinion also assumed one lump-sum payment for the separate agreement rather than fractional collection over the lease life. No agreement, price or invoice is included.

R Corp. reportedly paid no California tax on property bought for leases inside the state. Those leases were continuing sales taxed on rentals payable. Lessees owed use tax and the lessor collected and remitted it. Required lease payments were taxable; separately stated, genuinely optional maintenance or warranty amounts were excluded.

Regulation 1546 treated mandatory maintenance as property-sale measure regardless of separate statement. Optional meant the customer was not required to buy from the seller and could contract with anyone. Cited Annotations 490.0580 and 490.0700 supplied optional-maintenance support, but their opinions are absent.

Because R Corp. would not lease unless its customer also bought some form of maintenance exclusively from R Corp., both document choices were mandatory. Separate paperwork and arm's-length pricing did not change that condition. The charge was taxable rental receipts, and the lessor had to collect and remit use tax.

Live Annotation 330.3438 matches the result but says May 17, 1996, while the opinion repeatedly prints May 7. The ten-day difference is unresolved. Live also omits the premature settlement, procedural path, nationwide/unrelated-customer facts, absent contracts and missing outcome. It retains the lump-sum assumption but visibly prints does not effect where the supporting opinion does not use that sentence. The stated Regulation 1546 and 1660 enclosures are not reproduced.

Common questions

Did separate contracts make the maintenance charge nontaxable?

No. Exclusive purchase from the lessor controlled over the document structure.

Did arm's-length separate pricing change the result?

No. Arm's-length separate pricing did not make a required purchase optional.

When would a maintenance charge be optional under the quoted rule?

When the customer is not required to buy from the seller and can contract with anyone else.

Why did the Settlement Section not consider the offer?

No notice of determination had issued. The source required identification, audit and possible determination, a timely petition, and then a settlement offer.

What payment timing did the opinion assume?

One lump sum for the separate maintenance agreement, not fractional payments over the lease term.

Did the source show a completed audit or settlement?

No. It supplies no identity, audit, determination, petition, accepted offer or later outcome.

Citations and references

• Regulation 1660(c) — continuing-sale leases, rentals payable, and optional maintenance charges
• Regulation 1546(b)(3) and (c)(1) — mandatory versus optional maintenance and warranty contracts
• Revenue and Taxation Code sections 6006, 6006.1, 6010, and 6010.1 — lease-as-sale framework
• Revenue and Taxation Code sections 6202-6204 — lessee liability and lessor collection duties
• Business Taxes Law Guide Annotations 490.0580 and 490.0700 — optional maintenance treatment cited by the opinion
• Live Annotation 330.3438 — same result, with a May 17 date conflicting with the supporting opinion's May 7 date
• Request, proposal and every taxpayer, agreement, price, invoice, acquisition-tax, audit, determination, petition, settlement and outcome record — absent

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: Annotation 330.3438
• Original supporting opinion: 330.3438 PDF

Original ruling text

330.3438

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

JOHAN KLEHS
First District, Hayward

LEGAL DIVISION (MIC:82)
450 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0082)
Telephone: (916) 324-2637
FAX: (916) 323-3387

DEAN ANDAL
Second District, Stockton
ERNEST J. DRONENBURG, JR.
Third District, San Diego
BRAD SHERMAN
Fourth District, Los Angeles
KATHLEEN CONNELL
Controller, Sacramento
────────

May 7, 1996

E. L. Sorensen, Jr.
Executive Director

VIA FACSIMILE AND U.S. MAIL

Mr. A--- R. R-----, --- & --XXXX --- --- --- ----- ---, New York XXXXX-XXXX Re:

Unidentified Taxpayer

Dear Mr. R---:
This is in response to your April 9, 1996 letter to the Honorable Ernest J. Dronenburg, Jr. regarding your client’s recent settlement offer. We initially note that settlement offers are administered by our Settlement Section in instances where this Agency has issued a determination of tax liability, the taxpayer has made a timely petition for redetermination of that amount, and the taxpayer has presented a settlement offer. Since a notice of determination has not been issued against your client, the Settlement Section cannot respond to your client’s settlement proposal. Instead, the Legal Division of this Agency can only address your concerns regarding the application of tax to your client’s situation. If you would like the Settlement Section to consider your client’s proposal, you must identify your client so an audit and tax determination (if applicable) may be made. If a determination is made, your client must then make a timely petition for redetermination and submit its settlement offer to: Board of Equalization 450 N Street, MIC:87 P.O. Box 942879 Sacramento, CA 94279-0087 Attn: Settlement Section

Mr. A--- R. R---

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May 7, 1996
330.3438

With regard to the application of tax to your client’s leasing operations, you provide the following: “[R Corp.] has determined that it might be responsible for the collection and payment of California sales tax on receipts from maintenance services performed in conjunction with equipment it leases to unrelated customers.... “R Corp. is a company involved in, among other things, the selling and leasing of business equipment. R Corp. sells and leases this equipment to businesses across the country, including California. Although R Corp. generally includes maintenance provisions as part of its equipment leases, it sometimes offers customers the choice of excluding the maintenance provisions from the lease and entering into a separate maintenance contract (which is comparable to maintenance agreements that R Corp. offers for sale to those who have purchased equipment from R Corp.), which must be with R Corp. When a customer chooses the option of excluding the maintenance agreement provisions from the equipment lease and entering into a separate maintenance contract, the equipment lease and the maintenance contract are separate documents, the prices are separately stated, and, perhaps most significantly, the prices are arm’s length in nature and amount. It is the separate lease and maintenance contract situation that is in issue here.” You dispute that tax applies to your client’s sales of its “separate” maintenance agreements under these circumstances. For purposes of this opinion, we assume that R Corp. charges its customers a “one-time” lump sum lease payment for its separate maintenance agreements. That is, we assume that R Corp. does not collect its charge for the separate maintenance agreement by collecting a fractional portion of that amount over the life of the lease. Discussion A lease of tangible personal property in California is a continuing sale and purchase unless the lessor leases it in substantially the same form as acquired and has made a timely election to pay California sales tax reimbursement or use tax measured by the lessor's purchase price of the property. (Rev. & Tax. Code §§ 6006(g)(5), 6006.1, 6010(e)(5), 6010.1, Reg. 1660(c)(2).1/) When the lease is a continuing sale and purchase because either or both of the foregoing conditions are not satisfied, the lease is subject to use tax measured by rentals payable. (Reg. 1660(c)(1).) The lessee owes the tax and the lessor is required to collect it from the lessee and pay it to this Board. (Rev. & Tax. Code §§ 6202, 6203, 6204; Reg. 1660(c).)

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A copy of Regulation 1660 is enclosed for your review.

Mr. A--- R. R---

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May 7, 1996
330.3438

We understand from your letter that R Corp. does not pay California tax or tax reimbursement on its purchase price of the property that it leases to its customers inside this state. This means that R Corp. is required to collect use tax from its lessees measured by the rentals payable on the leased property. “Rentals” subject to tax include any payments required by the lease. (Reg. 1660(c)(1).) Taxable rental payments do not, however, include amounts paid to the lessor for separately stated optional maintenance or warranty contracts. (Id.) The application of tax to R Corp.’s operations is similar to the rules regarding the application of tax on maintenance agreements. Pursuant to Regulation 1546(b)(3)2, the charges for mandatory maintenance contracts are included in the measure of tax (i.e., gross receipts or sales price) whether or not the charges for these types of maintenance agreements are separately stated. That is, the sale of a mandatory maintenance agreement for tangible personal property is regarded as part of the sale of that property and the charges for the agreement are included in the gross receipts or sales price of the property. On the other hand, charges for optional maintenance agreements are not regarded as part of the sale of tangible personal property and are not subject to tax. (Business Taxes Law Guide Annots. 490.0580 (12/13/63); 490.0700 (5/10/60).) The difference between a mandatory and optional warranty contract is set forth in subdivision (c)(1) of Regulation 1546 as follows: “A warranty is mandatory within the meaning of this regulation when the buyer, as a condition of the sale, is required to purchase the warranty or guarantee contract from the seller.... A warranty is optional within the meaning of this regulation when the buyer is not required to purchase the warranty or guarantee contract from the seller, i.e., he is free to contract with anyone he chooses.” We understand that R Corp.’s customers have the option of either leasing your client’s equipment pursuant to lease agreements containing a maintenance agreement or that these customers may purchase the “separate” maintenance agreement from your client. Under either scenario, however, we understand that R Corp.’s customers are required as a condition of leasing of R Corp.’s equipment to purchase some form of a maintenance agreement exclusively from your client. That is, R Corp. will not lease equipment to a customer unless that customer also purchases a maintenance agreement. Under these facts, R Corp.’s “separate” maintenance agreement is regarded as a mandatory maintenance contract and is therefore part of the taxable rental receipts from the lease of its equipment. R Corp. is therefore required to collect use tax from its customers on this amount and remit it to this Board.

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A copy of Regulation 1546 is enclosed for your review.

Mr. A--- R. R---

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May 7, 1996
330.3438

We trust this answers your concerns regarding the application of tax to your client’s operations. If you have any further questions, please write again. Sincerely,

Warren L. Astleford
Staff Counsel
WLA:rz
Enclosure - Regs. 1546, 1660
cc:

Mr. James B. Levinson (via facsimile and U.S. Mail)
Out-of-State District Administrator - (OH)