Could optional service agreements, insurance and GAP charges be excluded from taxable vehicle rentals, and did monthly coupons need to itemize them?

Plain-English summary

The corporate tax department of a redacted vehicle finance company asked two questions in an absent April 4, 1994 letter. Auto dealers would enter long-term leases with retail customers. The finance company would buy each vehicle from the dealer, and the dealer would assign the lease to it.

The requester said lessees could optionally buy extended service agreements; life, accident and health insurance; and GAP coverage paying remaining lease liability after theft or destruction. Customers could pay the full cost when entering the lease or add it to monthly payments. No lease, product agreement, policy, cost or payment record appears.

Counsel assumed the described leases were continuing sales and purchases under sections 6006 and 6010. Regulation 1660(c) therefore imposed use tax measured by rentals payable. Assignment from the dealer did not create a purchase-price election: as lessor, the finance company had to collect tax from the lessee when rent was paid.

Required lease payments entered rent, while separately stated optional insurance, maintenance or warranty contracts did not. Counsel accepted the requester's statement that all listed “intangibles” were optional and said the first three examples appeared to be optional insurance or warranty charges. Those characterizations are assumptions rather than supported product findings.

The lease agreement could satisfy separate statement by identifying each optional item and its total cost. A qualifying cost paid in full at the beginning was excluded. For monthly payment, the agreement should also carefully state the allocation method. Assuming equal payments, counsel allowed total optional cost divided by total lease payments. The payment coupon did not have to repeat the item and monthly amount when the agreement supplied them. Charges not separately stated in documentation pertaining to the lease were taxable.

Collected use tax itself still had to be separately stated and measured on full rent less properly excludable charges.

The letter treated the then-existing federal luxury excise tax separately. It quoted Annotation 295.1252: beginning January 1, 1991, a 10% federal tax applied to the first retail sale of specified high-priced vehicles, boats, aircraft, jewelry and furs and was excluded under section 6012(c)(4)(A).

Quoted Annotation 295.1257 treated a qualifying lease as one year or longer. For equal payments, upfront luxury tax could be allocated across rental payments due under the initial lease. Luxury tax imposed on rent was excluded whether separately stated or included, and a lessee's upfront reimbursement of lessor-paid tax was also excluded. The quoted source prints “due under the initial of the lease,” apparently omitting a word; this page leaves that language unresolved rather than supplying one.

Live Annotation 330.3508 matches the optional-item payment and documentation conclusions. It does not supply the request, lease, product terms, costs, allocation, coupons, assignments, tax computation or later outcome.

Common questions

Did optional insurance have to appear on every payment coupon?

No. If the lease agreement stated the optional item, total cost and allocation method, the coupon did not need to repeat the item and monthly share.

What happened if the optional charge was not separately documented?

It was included in taxable rent. Counsel required separate statement somewhere in documentation pertaining to the lease.

What did assignment do to the tax measure?

Rent remained subject to use tax, with no option for the assignee to use vehicle purchase price. The assignee lessor collected tax when the lessee paid rent.

How could equal monthly optional charges be allocated?

By dividing total optional cost by total lease payments, while carefully stating the costs and method in the agreement.

Did counsel independently verify that the products were optional?

No. Counsel accepted the requester's statement and said the first three examples appeared to be optional insurance or warranty charges.

Did the same separate-statement rule govern federal luxury tax?

No. The quoted historical rule excluded luxury tax imposed on rent whether it was separately stated or included.

Is the federal luxury-tax discussion current?

No. It explains the historical tax in effect when the opinion was issued.

Does the source show any actual lease or computation?

No. It supplies no lease, product agreement, policy, cost, allocation, coupon, tax record or later result.

Citations and references

• Revenue and Taxation Code sections 6006 and 6010 — continuing sale and purchase definitions applied to the assumed leases
• Regulation 1660(c) — rentals payable, required payments, optional insurance/maintenance/warranty exclusions, assignment and collection
• Revenue and Taxation Code section 6012(c)(4)(A) — historical federal retail excise tax exclusion quoted through Annotation 295.1252
• Annotation 295.1252 (Dec. 6, 1990) — quoted 1991 federal luxury-tax scope, rate and exclusion
• Annotation 295.1257 (June 22, 1992) — quoted qualifying-lease, allocation, rental and separate-statement treatment; incomplete phrase preserved
• Live Annotation 330.3508 — optional-item payment and documentation results
• April 4 request and every arrangement, lease, option, product, cost, allocation, coupon, assignment, tax and outcome record — absent

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: Annotation 330.3508
• Original four-page supporting opinion: 330.3508 PDF

Original ruling text

330.3508

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

MEMBER
First District

450 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) 322-2976

BRAD SHERMAN
Second District, Los Angeles
ERNEST J. DRONENBURG, JR.
Third District, San Diego

May 16, 1994

MATTHEW K. FONG
Fourth District, Los Angeles
GRAY DAVIS
Controller, Sacramento

Ms. C--- C. H--T--- M--- C--- Corporation
Corporate Tax Department
XXXXX S. --- Avenue
---, CA XXXXX
Re:

────────
BURTON W. OLIVER
Executive Director

APPLICATION OF TAX TO LEASES

Dear Ms. H---:
This is in response to your letter of April 04, 1994 in which you request advice as to the application of tax to charges for various items in connection with leases of motor vehicles by T-- M--- C--- Corporation (TMCC). You state that auto dealers with which TMCC has arrangements will enter into long-term vehicle leases with retail customers. TMCC will then purchase the vehicle from the dealer and the dealer will assign the lease to TMCC. Under the lease agreement, the lessee has the option to purchase "intangibles" such as extended service agreements, life, accident and health insurance, GAP coverage which pays off any remaining lease liability in the event of theft or destruction of the leased vehicle and other charges "which are not part of the cost of the leased vehicle such as the federal excise tax on luxury automobiles." A lessee wanting to purchase these "intangibles" may pay the total cost of these options and other charges at the time the lease is entered into or the lessee may choose to add the cost of these items to the monthly lease payment. The lease agreement includes a description and total cost of each of the intangibles and other charges to be paid by the lessee. If the lessee chooses to add the cost of the intangibles to the monthly lease payment, the payment amounts attributable to the intangibles are not separately stated. The two questions posed in your letter were:

1. In the absence of a breakdown on the monthly payment coupon and no
   separate disclosure in the lease agreement of the portion of the lease payment attributable to intangibles and other charges, and the portion attributable to the

Ms. C--- C. H---

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May 16, 1994
330.3508

lease of the vehicle, is the total monthly payment or only the portion attributable to the lease of the vehicle subject to sales tax.

2. If a breakdown of the monthly lease payment between amounts attributable to
   intangibles and other charges and the amount attributable to the lease of the vehicle are disclosed in the lease agreement but not on the monthly payment coupon, or in the monthly payment coupon but not the lease agreement, is the total monthly payment or only the portion attributable to the lease of the vehicle subject to sales tax? Discussion I assume that your inquiry relates only to the application of tax to the "intangibles" listed in your letter. I also assume that you are aware that, unless certain requirements are satisfied, the lease of the vehicle in California is a continuing "sale" and "purchase" as these terms are defined in Revenue and Taxation Code sections 6006 and 6010, respectively. Your questions indicate that the leases in question are continuing sales. As such, the leases are subject to use tax measured by the rentals payable. (Sales and Use Tax Regulation 1660(c).) When the lease is assigned from the dealer to TMCC, the rental payments remain subject to tax, without any option to measure tax by the purchase price, and as the lessor, you must collect the tax from the lessee at the time that the rentals are paid by the lessee. Under Regulation 1660(c), the rentals subject to tax include "any payments required by the lease." The rentals subject to tax do not include "separately stated optional {insurance charges}, maintenance or warranty contracts." You state that all of the "intangibles" listed in your letter are optional (not required by the lease). The first three examples of "intangibles" listed in your letter (extended service agreements, life, accident and health insurance and GAP coverage) appear to be optional insurance or warranty charges and as such, would not be included in the "rentals payable" subject to tax if separately stated. The separately stated requirement is fulfilled when the lease agreement lists the optional "intangible" and its cost. If the lessee chooses to pay the entire cost of the "intangibles" at the beginning of the lease term, that cost would not be subject to tax. If the cost is allocated to each monthly payment during the term of the lease, the amount attributable to the "intangibles" is excluded from the measure of tax. This calculation may be made similar to the calculation for the luxury tax (discussed below) by dividing the total cost of the "intangibles" by the total number of lease payments (assuming all payments will be equal). The lease agreement should carefully set forth the costs of the "intangibles" and the method used to calculate the amounts attributed to such. If the lease agreement separately states the cost of the optional insurance, maintenance or warranty contracts, we do not believe it is necessary that each monthly payment coupon also set forth the item and its pro rata cost for that month. Of

Ms. C--- C. H---

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330.3508

course, the use tax collected from the lessee must be separately stated, and must be measured by the correct rentals payable (i.e., the full amounts payable less any properly excludable charges). Please note that in order to exclude the charges for the "intangibles" from the rentals payable, those charges must be separately stated in the documentation pertaining to the lease. If the charges are not separately stated, they will be subject to tax. The last item about which you inquire are "charges which are not a part of the cost of the leased vehicle such as the federal excise tax on luxury automobiles". The Board's position on this issue is found in Annotation 295.1252 (12/6/90) which states: "Luxury Tax. Effective January 1, 1991, the United States has imposed a new retail excise tax, on the first retail sale of vehicles, boats, aircraft, jewelry and furs, to the extent that the price for such goods exceeds certain specified amounts. The rate of tax is 10 percent. The new tax is excludable from 'gross receipts,' under Revenue and Taxation Code section 6012(c)(4)(A). The amount of any such tax is nontaxable under the Sales and Use Tax Law, whether imposed with respect to a sale involving a transfer of title or a lease transaction which is treated as a 'sale' and 'purchase' under Revenue and Taxation Code sections 6006 and 6010." Sales and Use Tax Annotations is 295.1257 (6/22/92), further clarifies the treatment of the luxury tax. "Revenue and Taxation Code Section 6012 excludes taxes imposed by the United States upon or with respect to retail sales. The federal luxury tax is a tax on retail sales which includes leases. When a lessor of a qualifying lease elects to pay the luxury tax up front, he or she is paying a federal excise tax on the lease which is a retail sale. Qualifying lease is a lease with a term of one year or more. Thus, the luxury tax on the lease is a tax imposed by the United States upon or with respect to retail sale, and is excluded from gross receipts. Assuming that the lease is a continuing sale and purchase, the amount excluded is a portion of each rental payment which, if the rental payments are equal, is calculated by dividing the total amount of the luxury tax by the number of rental payments due under the initial of the lease. "Where the luxury tax is imposed on rental payments, the amount of the luxury tax on each rental payment is excludable from the measure of tax whether the luxury tax is separately stated or included in the rental payments set forth in the lease. Also, if the lessor elects to pay the luxury tax up front and the lessee

Ms. C--- C. H---

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330.3508

reimburses the lessor for the tax at the beginning of the lease, the reimbursement is not included in the measure of tax." If you have any further questions, please do not hesitate to write again. Sincerely,

Sukhwinder K. Dhanda
Staff Counsel
SKD:plh

cc:

--- District Administrator - --