Did a mobile-equipment lease end for sales and use tax when the contract called it terminated but the lessee kept possession?

Plain-English summary

A redacted correspondent asked about the reportable measure for a mobile transportation equipment lessor that elected fair rental value. The letter supplies no taxpayer, equipment, contract, amount or completed transaction and does not reproduce or date the request.

Tax Counsel assumed “cap reductions” meant a lessee's lump-sum payment during the lease that reduced later rent. The agency expected total fair rental value over the whole term to equal actual payments, but had not imposed a strict rule requiring the reported fair-rental-value amount to match payments period by period.

Amounts attributable to a capital reduction could be spread across the remaining fair-rental-value term. More generally, when payments were unusually high or low, a fair-rental-value lessor could report based on payments when made or distribute the excess or deficiency over the lease term. The source identifies no chosen method, payment or return.

A deficiency caused by decline in vehicle value through use reflected fair rental value; the letter expressly distinguished catastrophic loss. When a deficiency first became payable at lease end, it could not be redistributed backward over prior periods. It instead became a fair-rental-value adjustment at termination included in the tax measure.

Sections 6011 and 6012 focused ordinary rental receipts on actual payments made and billed when the amounts were determined. Counsel said that concept did not control a fair-rental-value election.

Termination depended on the tax law, not an earlier “termination” label in the contract. Section 6006.3 included rental, hire and license within lease, while section 6006.1 focused continuing-sale status on the lessor granting possession. Thus, the lease continued while the lessee retained possession with the lessor's acquiescence and ceased at the earlier of lessor repossession or sale of the lessor's ownership interest.

No lease, payment schedule, return, deficiency computation, repossession, sale, adjustment, audit or later outcome appears. Live Annotation 330.3775 publishes only the termination and possession analysis; it omits the PDF's capital-reduction, use-loss, deficiency and reporting-method guidance.

Common questions

Did the contract's own definition of termination control?

No. The opinion applied the tax law's focus on possession rather than an earlier contractual termination label.

When did the tax lease end?

At the earlier of repossession by the lessor or the lessor's sale of its ownership interest.

Could a lump-sum capital reduction be spread over later periods?

Yes. Under the fair-rental-value method, the letter allowed reporting when paid or distributing the amount over the remaining lease term.

Did Counsel know the contract's definition of “cap reduction”?

No. The letter expressly assumes the correspondent meant a lump sum that reduced later payments.

Did each period's fair-rental-value report have to match the actual payment?

No strict period-by-period rule was administered. Unusual payments could be reported when made or their excess or deficiency distributed over the lease term.

How was an end-of-lease deficiency payment treated?

A use-related deficiency reflected fair rental value, but an amount first payable at termination had to be included as a termination adjustment rather than reallocated to closed earlier periods.

Did catastrophic loss create the same kind of deficiency?

The letter expressly limited this discussion to decline in value through use rather than catastrophic loss.

Did the source show an actual repossession or ownership sale?

No. It states the rule without an agreement, event date, return, adjustment or outcome record.

Does live Annotation 330.3775 include the payment guidance?

No. It publishes only the contract-versus-tax-law termination rule and the role of possession, repossession and ownership sale.

Citations and references

• Revenue and Taxation Code sections 6011 and 6012 — actual-payment rental receipts distinguished from fair rental value
• Revenue and Taxation Code section 6006.3 — lease includes rental, hire and license, subject to one unspecified exclusion
• Revenue and Taxation Code section 6006.1 — continuing sale based on the lessor's grant of possession
• Live Annotation 330.3775 — termination/possession rule dated December 19, 1980; payment guidance omitted
• Request, transaction, lease, payments, returns, termination event, adjustment and outcome — absent

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: Annotation 330.3775
• Original supporting opinion: 330.3775 PDF

Original ruling text

330.3775

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION
1020 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) 445-2705

December 19, 1980

Mr. C--- C. B--B---, C---, H--- & S--XXX --- ---, Suite XXX
---, CA XXXXX
Dear Mr. B---:
Mr. Hennessy has asked me to respond to the questions in your letter relating to the proper measure reportable by a lessor of mobile transportation equipment who has elected fair rental value as the measure of tax. You have asked whether or not “cap reductions” would be treated as balloon rentals and taxable when due. By the term “cap reductions” I assume that you are referring to a lump sum payment by a lessee during the term of the lease, which will have the effect of reducing the individual amounts of the further rental payments over the remaining term of the lease. We would expect that over the whole term of the lease the fair rental value would be equivalent to the actual payments by the lessee for the use of the property. We have not administered any strict rule that the amounts reported as fair rental value during the lease must vary precisely according to the amounts paid by the lessee from time to time during the lease. So the amounts attributable to capital reductions could be spread out over the remaining term of the (fair rental value) lease. Likewise, deficiency payments, which occur because of the decline in value through use of the vehicle (rather than a decline in value through catastrophic loss) would be a reflection of the fair rental value of the equipment under that lease. But the deficiency payable at the end of the lease could not be redistributed over the prior term and so would result in a fair rental value adjustment upon termination, and that adjustment must be included in the amount upon which tax is computed. As you have noted, the concept of rental receipts applicable under 6011 and 6012 focuses on the actual payments made and billed as the measure of the tax due at the time payments are determined. That concept does not apply to fair rental value. Therefore, where the lessor experiences unusual high or low payments by the lessee, the lessor measuring use tax liability by the fair rental value may report the tax based upon those payments when made or may distribute the excess or deficiency over the term of the lease as a method of reporting fair rental value.

B---, C---, H--- & S---

-2-

December 19, 1980
330.3775

We would agree with you that the lease ceases upon the earlier of repossession of leased property by the lessor or the time the lessor sells its ownership interest in the property. We do not think the lease terminates for sales or use tax purposes at an earlier time which may constitute “termination” as that term is defined in the lease contract. The reason for this, is that the lease for sales and use tax purposes is defined by the sale and use tax law and not by the contract definitions. While the direct definition of lease in Revenue and Taxation Code Section 6006.3 simply recites that “lease” includes rental, hire and license, with one specific exclusion, Revenue and Taxation Code Section 6006.1 defines continuing sale to be granting of possession of tangible personal property by a lessor to a lessee….” Therefore, the Code focuses intention upon the granting of possession. Accordingly, our view that while the lessee retains possession with the acquiescence of the lessor, the lease continues. Very truly yours,

Phillip R. Dougherty
Tax Counsel

PRD:ba
cc:

Mr. D. J. Hennessy