Could an out-of-state computer lessor avoid tax on California rent by showing Michigan tax had been paid after missing California's timely purchase-price election?

Plain-English summary

A Michigan partnership of two or three individuals, formed in 1979 to lease business computers, conducted most business outside California but leased two systems for use at a San Francisco office. It waived an April 20, 1989 Sacramento hearing and supplied an absent April 18 evidence letter.

The July 1, 1982–June 30, 1985 protested tax was measured by $163,721 of unreported rental receipts. The partnership also challenged a 10% failure-to-file penalty of $1,096.40. It claimed it was not an owner, had paid Michigan acquisition tax and elected credit once it learned of the rule, and deserved penalty relief.

The DEC Ultimate 2000 had first been leased in New Jersey, then sold to a funding party and immediately leased back before the partnership leased it in California in 1982. The file lacked original-purchase, New Jersey lease, sale and California downstream-lease documents. A leaseback agreement used lump-sum monthly rent, left its tax space blank, retained title in the funding party and required the partnership at termination to crate, insure and ship as directed.

The Honeywell Ultimate system, described as intended to replace DEC, entered the California lease in May 1984 after a financing sale and leaseback. A May 8 invoice charged $155,000 for equipment plus $6,200 “sales tax,” totaling $161,200. The partnership's invoice split $145,300 for computer and $9,700 for printer plus $6,200 “Michigan sales tax”; evidence showed the funding party paid the full total directly in satisfaction of the partnership's liability. The leaseback said monthly price included sales/use tax “if applicable,” but no evidence established either party's belief or intent.

The partnership filed no California sales/use returns or tax for the leases. Regulation 1660(a) made the Honeywell funding leaseback a true lease because the funding party kept title at term end. Sections 6006.1 and 6010.1 nevertheless made the partnership, as the downstream lessor granting possession, the responsible seller regardless of legal ownership.

Sections 6006(g) and 6010(e) treated leases for consideration as sales/purchases subject to exceptions. Regulation 1660(c)(2) required a lessor choosing purchase-price tax for untaxed same-form property to report and pay with the return for the period it first entered rental service. The source cites Action Trailer Sales, Inc. v. State Board of Equalization, 54 Cal.App.3d 125, as upholding that timing rule; the citation independently resolved.

Regulation 1660(c)(8) allowed credit for another jurisdiction's retail tax only with a timely purchase-price election unless that tax equaled or exceeded California tax. Without election, no credit reduced use tax on rent imposed on the lessee who did not pay the out-of-state tax; if use tax did not apply, the lessor could not credit it against sales tax on rent. The regulation also limited credit against periodic-payment tax when the other tax was itself lease-payment based.

Honeywell's 4% Michigan tax was below California's applicable tax. The partnership could timely report California purchase-price tax less the Michigan credit or collect/report rent tax. Having filed no timely purchase-price return, it owed rent tax without credit. Small size, primary out-of-state business and unfamiliarity did not excuse the rule.

For DEC, no evidence showed Michigan acquisition tax at all. Even assuming the same 4% payment, the missed election produced taxable rent without credit.

The penalty differed. An absent statement under penalty of perjury met section 6592, so the officer recommended redetermination without tax adjustment but deletion of the failure-to-file penalty. No final Board action appears. Live Annotation 330.3636 publishes ownership and Honeywell election conclusions but omits DEC's missing proof, exact audit amounts, penalty and recommendation posture.

Common questions

Did holding legal title determine who owed lease tax?

No. The partnership was the lessor granting possession and was responsible for the applicable tax.

Could lower Michigan tax automatically exempt the California rent?

No. A timely California election was required because the out-of-state tax was less than the California tax.

Was the late election excused because the lessor was small and out of state?

No.

Was any relief granted?

Yes. The recommendation removed the failure-to-file penalty, but not the tax.

What did the $163,721 and $1,096.40 figures represent?

$163,721 was the measure of unreported rental receipts; $1,096.40 was the stated 10% failure-to-file penalty.

What evidence existed for the DEC system?

Only the described leaseback agreement was identified. Original purchase, New Jersey lease, sale, downstream California lease and Michigan-tax proof were absent from the file.

What showed Michigan tax on Honeywell?

Invoices showed a $155,000 equipment price and $6,200 tax—4%—within a $161,200 total, plus evidence that the funding party paid directly to satisfy the partnership's liability. Most underlying records are not reproduced.

When was a purchase-price election timely?

With the return for the period when property was first placed in rental service under regulation 1660(c)(2).

Why did the penalty come out differently from the tax?

The timing rule applied equally despite unfamiliarity, but an absent sworn statement separately met section 6592's penalty-relief requirements.

Was this a final Board result?

No. It was a hearing officer's recommendation, and no later action appears.

Citations and references

• Cal. Rev. & Tax. Code §§ 6006.1 and 6010.1 — continuing-sale and continuing-purchase definitions focused on the lessor's grant of possession
• Revenue and Taxation Code sections 6006(g) and 6010(e) — leases as sales and purchases subject to exceptions
• Regulation 1660(a) and (c)(1) — true lease and lessor tax/collection responsibility
• Regulation 1660(c)(2) — timely first-rental-period purchase-price election
• Regulation 1660(c)(8) — another-state credit, election and periodic-payment limits
• Action Trailer Sales, Inc. v. State Board of Equalization, 54 Cal.App.3d 125 — timely-election rule, citation verified
• Revenue and Taxation Code section 6592 — penalty relief based on sworn statement
• Live Annotation 330.3636 — title-independent lessor liability and Honeywell election result dated June 12, 1989
• Petition, hearing/evidence records, computer transactions, returns, audit, sworn statement, final action and outcome — absent

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: Annotation 330.3636
• Original supporting opinion: 330.3636 PDF

Original ruling text

STATE OF CALIFORNIA
BOARD OF EQUALIZATION
APPEALS UNIT

In the Matter of the Petition
for Redetermination Under the
Sales and Use Tax Law of:

)
)
)

330.3636
6/12/89

HEARING
DECISION AND RECOMMENDATION

The above-referenced matter was scheduled for hearing before Hearing Officer James E. Mahler on April 20, 1989, in Sacramento, California. Petitioner waived appearance but presented additional evidence by letter dated April 18, 1989.

Protested Items

The protested tax liability for the period July 1, 1982, through June 30, 1985, is measured by;

Item

State, Local County & BART

A. Taxable rental receipts not reported

$163,721

Petitioner also protests a ten percent penalty in the amount of $1,096.40 for failure to file returns.

Petitioner's Contentions

1. Petitioner was not the owner of --- --- --- and thus incurred no tax liability.
2. With respect to the --- --- --- and --- --- --- if petitioner was the owner), petitioner paid tax to
   Michigan upon acquisition of the equipment and elected to receive credit for such taxes as soon as petitioner became aware of the requirement to make such an election.
3. The penalty for failure to file returns should be deleted.

Summary
Petitioner was a partnership of two or three individuals formed in 1979, in Michigan, for the purpose of leasing business computers. Most of its business was conducted outside California, but it did lease two computer systems to --- --- --- for use by that company at its offices in-San Francisco. The first lease to ---began in 1982. The computer was a DEC Ultimate 2000 which petitioner had previously leased to a company in New Jersey. Upon termination of the New Jersey lease, petitioner sold the equipment to --- --- --- and immediately leased it back. About the same time, petitioner leased the system to
--The file includes no documentary evidence regarding petitioner's original purchase of the equipment, the lease to the New Jersey company or the sale to --- nor is petitioner's lease to --- in the file. However, petitioner has presented a copy of the leaseback agreement with --- The agreement provides that petitioner will pay a lump-sum price per month for the lease of the equipment. There is a space on the form to show any tax which might be included in the monthly payment, but no amount is entered in that space. Section 5 of the agreement states: "No title or right in said equipment shall pass to lessee.... Upon termination of the lease period, lessee will immediately crate, insure and ship the equipment to whatever destination lessor shall direct...." The second transaction is a lease of a Honeywell Ultimate Computer System to --- beginning in May 1984. (We understand that this system was intended as a replacement for the DEC Ultimate previously leased to ---) Petitioner purchased the --- from --- and in order to finance the purchase, petitioner sold the equipment to --- and immediately leased it back.
--- invoice to petitioner is dated May 8, 1984. It charges $155,000 for equipment, plus "sales tax" of $6,200, for a total of $161,200. We note that tax of $6,200 is equal to four percent of the charge for the property. Petitioner's invoice to --- also charged $155,000 for the property ($145,300 for the computer and
$9,700 for a printer) plus "Michigan sales tax" of $6,200. Petitioner has presented evidence indicating that --- paid the entire $161,200 directly to --- in satisfaction of petitioner's liability to
---.
The leaseback agreement between --- and petitioner is on a slightly different form than the one discussed above. It does not include a space to show the amount of any tax which might be included in the monthly price, but does include a statement that the monthly price is "including sales/use tax, if applicable". There is no --- evidence to show whether --- believed that tax was applicable to this transaction or to show that the parties in fact intended the monthly price to include any tax or tax reimbursement. Section 6 of this leaseback form is identical to Section 5 on the old form quoted above.

Petitioner did not file California sales and use tax returns and did not report any California tax with respect to the leases to ---. An audit concluded that the lease receipts are taxable and the determination in question was thereupon issued against petitioner. Analysis and Conclusions

1. Petitioner sold the Honeywell Computer System to --- and leased it back. The leaseback was a
   true lease and not a sale at inception because GFG retained title in the equipment at the end of the lease term. (See subdivision (a) of Sales and Use Tax Regulation 1660.) Petitioner then leased the equipment to·---. Petitioner contends that it cannot be held liable for any tax on the lease to --- on the ground that --- and not petitioner was the "owner" of the equipment. However, Revenue and Taxation Code Sections 6006.1 and 6010.1 define the terms "continuing sale" and "continuing purchase", respectively, as follows: "The granting of possession of tangible personal property by a lessor to a lessee, or to another person at the direction of the lessee, is a continuing sale [purchase] in this state by the lessor for the duration of the lease as respects any period or time the leased property is situated in this state, irrespective of the time or place of delivery of the property to the lessee or such other person." (Emphasis added.) Under these statutes, the lessor is the seller and is thus the person responsible for any tax.¹ Nothing in either statute conditions the lessor's responsibility for tax on holding legal title to the leased property. Petitioner leased a computer system to --- and is therefore the seller responsible for any applicable tax, regardless of whether petitioner was the "owner" of the property.
2. Lease receipts are subject to sales or use tax only if the lease is a "sale" or "purchase".
   Revenue and Taxation Code Sections 6006(g) and 6010(e) provide that leases of tangible personal property for a consideration are "sales" and "purchases", respectively, with certain exceptions. One of the exceptions is for tangible personal property acquired tax-paid and leased in substantially the same form as acquired. Subdivision (c)(2) of Sales and Use Tax Regulation 1660 provides that where a lessor purchases property without paying tax or tax reimbursement, and wishes to pay tax on the purchase price in order to avoid tax on lease receipts, the tax on the purchase price "must be reported and paid timely with the return of the lessor for the period during which the property is first placed in rental service." This rule has been upheld by the California Court of Appeals. (Action Trailer Sales, Inc. v. State Board of Equalization, 54 Cal.App.3d 125.) Petitioner contends that it paid Michigan tax or tax reimbursement with respect to both computer systems leased to ---. Accordingly, petitioner argues that the leases to --- were not taxable "sales" or "purchases". Petitioner admits that it did not file California returns electing to pay tax on cost rather than on lease receipts. However, petitioner believes it should be relieved of the requirement for filing such returns on the ground that it was a small out-of-state company unfamiliar with California law. ¹ Depending on the circumstances, the lessor may be directly liable for sales tax or may have a duty to collect use tax from the lessee. See subdivision (c) (1) of Sales and Use Tax Regulation 1660

With respect to the lease of the Honeywell Ultimate System, it appears that Michigan tax or tax reimbursement was in fact paid on the acquisition of the equipment. The problem is that the tax was paid at the rate of four percent, which is less than the applicable California tax. On this point, subdivision (c) (8) of Sales and Use Tax Regulation 1660 provides: "A lessor who leases property in substantially the same form as acquired and who has paid a retail sales or use tax, or reimbursement therefor, imposed with respect to that property by any other state, political subdivision thereof or the District of Columbia prior to leasing the property in this state may credit the payment against any use tax imposed on him by this state because of such lease. However, to be entitled to the credit the lessor must make a timely election to measure any tax liability for the property by· its purchase price, unless the out-of-state tax equals or exceeds the tax imposed on him by this state. If the out-of-state tax equals or exceeds the tax imposed on him by this state, the lessor will be deemed to have made a timely election and the rental receipts will not be subject to tax provided the property is leased in substantially the same form as acquired. If a timely election is not made, no credit will be allowed because the tax due will be a use tax measured by rental receipts and imposed directly against the lessee, a person other than the one who paid the out-of-state tax or tax reimbursement. If the lessee is not subject to use tax and the lessor does not make a timely election to pay tax measured by his purchase price, he may not credit the amount of the outof-state tax against the tax due on the rental receipts because the tax due is a sales tax rather than a use tax. "A credit otherwise permitted by the foregoing provisions shall not be allowed against taxes which are measured by periodic payments made under a lease, to the extent that taxes imposed by any other state, political subdivision or the District of Columbia were also measured by periodic payments made under a lease prior to the lease of the property in this state." (Emphasis added.) Since the amount of Michigan tax or tax reimbursement was less than the applicable California tax, petitioner had two options when it placed the equipment into rental service in California: it could fild a return reporting California tax on the purchase price, less a credit for the Michigan tax or tax reimbursement actually paid; or it could collect and report tax on the rental receipts. Since petitioner failed to file a timely return reporting tax on the purchase price, petitioner no longer has an option. Tax is due on the rental receipts without credit or deduction for the Michigan tax or tax reimbursement. This rule applies equally to all taxpayers engaged in the business of leasing tangible personal property in California. We cannot make an exception for petitioner merely because petitioner was a small company doing business primarily outside the state. When petitioner began doing business in California by leasing tangible personal property here, it incurred an obligation to discover and comply with all applicable California laws. Petitioner failed to do so, and we see no reason why this failure should entitle petitioner to special treatment not available to other taxpayers. With respect to the DEC Ultimate System, there is no evidence whatsoever to indicate that petitioner paid Michigan tax or tax reimbursement upon acquisition of the property. If Michigan tax or tax reimbursement was paid, it was presumably at the rate of four percent, and what we

have just said regarding the Honeywell System applies with equal force. Petitioner failed to make a timely election to report California tax on the purchase price and the lease receipts are therefore subject to tax.

3. Petitioner has filed a statement under penalty of perjury explaining the reasons California
   returns were not filed. The statement meets the requirements of Revenue and Taxation Code Section 6592 and we therefore recommend that relief from the penalty for failure to file returns be granted. Recommendation Redetermine without adjustment to the tax, deleting the failure-to-file penalty.

6/12/89
James E. Mahler, Hearing Officer

Date