Was a startup's stock-purchase warrant part of taxable equipment rent when it was granted alongside periodic lease payments?

Plain-English summary

An unidentified representative described a proposed three-to-five-year venture lease for a redacted privately held startup. A California lessor would provide equipment for periodic payments based on fair market value plus a warrant to buy a specified number of startup shares at a strike price approximating their issuance-date value.

The warrant ran for a set period without requiring exercise. It generally did not appear on the lessor's financial statements, though an arbitrary $100 per lease might be recorded. Exercise produced restricted securities that the lessee reported under generally accepted accounting principles.

Because the lessor made no California purchase-price tax election, the lease was a continuing sale taxable on rentals payable. The lessee owed the use tax, and the lessor had to collect and pay it. Noncash warrant value at lease commencement joined periodic cash rent.

A determinable amount could come from a value stated in the equipment lease, cash rent reduced in exchange for the warrant, or another reasonable or generally accepted method. The rent-reduction example assumes total warrant value plus periodic payments approximated the equipment's fair rental value.

The proposed Warrant Agreement gave no value, and the referenced Master Lease Agreement was not supplied. The opinion therefore could not determine whether the warrant had grant-date value. If determinable, it entered rent; if sufficiently speculative when the lease began, it did not.

The source says no later sales or use tax would be due on the warrant's “grant or execution” or on a subsequent stock sale as rentals payable. It does not use “exercise” in that conclusion, so this page does not equate those terms.

The March 3, 1995 request, prior October 20, 1994 letter, proposed warrant document, missing master lease, valuation evidence, executed transaction, returns, audit and outcome are absent. Live Annotation 330.4187 omits the bookkeeping and restricted-stock facts, agreement gap, rent-reduction assumption, later-sale conclusion and PDF identifier error. The official URL and first page say 330.4187; pages 2 and 3 misprint 330.4180.

Common questions

Was every stock warrant automatically taxable rent?

No. It had to have a determinable value when granted.

Could reduced cash rent establish the warrant's value?

Yes. The difference between rent with and without the warrant could be included, under an assumption that total warrant-plus-cash value approximated fair rent.

Did the source tax a later stock sale as rent?

No. It excluded the subsequent sale from rentals payable.

Did the opinion also say later warrant exercise was excluded?

Not in those words. It says no tax on the warrant's “grant or execution”; it separately mentions a subsequent stock sale.

Did the Board determine the actual warrant value?

No. The supplied warrant agreement stated no value, and the referenced master lease was missing.

Citations and references

• Revenue and Taxation Code sections 6006(g)(5), 6006.1, 6010(e)(5) and 6010.1 — continuing-sale lease framework
• Sales and Use Tax Regulation 1660(c)(1) and Regulation 1660 — rentals-payable measure
• Revenue and Taxation Code sections 6202-6204 — lessee liability and lessor collection/payment
• Live Annotation 330.4187 — warrant-plus-periodic-rent measure and speculative-value exception
• Requests, warrant agreement, missing master lease, valuation, execution, tax reporting/audit and outcome — absent

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: Annotation 330.4187
• Original supporting opinion: 330.4187 PDF

Original ruling text

330.4187

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)
Tele: (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

April 17, 1995
BURTON W. OLIVER
Executive Director

--Re: --XX.
Dear Mr. ---:
This is in response to your letter dated March 3, 1995 regarding the application of tax to venture leasing transactions by your client, XX. You state: "A venture lease is a transaction wherein a lessor engaged in business in California leases equipment to a privately held startup corporation for a 3 to 5 year period. The lessor does not pay California sales tax reimbursement or use tax measured by the purchased price of the leased equipment. The lease agreement requires the lessee to provide the lessor with a warrant to purchase shares of stock (Warrant') in the lessee corporation and that the lessee make lease payments. Lease payments are based on the fair market value of the leased equipment. The Warrant grants the lessor the right to purchase a specified number of shares of stock in the lessee's corporation at a specified purchase price (theStrike Price"). This Strike Price approximates the value of the lessee's underlying shares of stock at the time of the issuance of the Warrant. These Warrants are exercisable for a set period of time, but the lessor is not required to exercise them. These Warrants are generally not reflected on the lessor's financial statements, but may be reflected at an arbitrary value of $100 per leasing transaction. When a Warrant is exercised, the lessor obtains restricted securities from the lessee. The issuance of these securities is reflected on the lessee's financial statements in accordance with generally accepted accounting principles."

Mr. ---

-2-

April 17, 1995
330.4180

We understand your letter to ask whether tax applies to the granting or execution of a Warrant furnished by XX as part its consideration for an equipment lease. We also understand your letter to ask whether tax applies to a subsequent sale of stock acquired by XX's lessor through the Warrant as part of the rentals payable pursuant to the lease. To facilitate our response, you provided us with a copy of the proposed Warrant Agreement. Discussion A lease of tangible personal property is a continuing sale 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.) A lease that is a continuing sale 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.) In this situation, XX will lease tangible personal property in exchange for the granting of a Warrant and lease payments based on the fair rental value of the equipment. Since XX's lessor did not pay tax or tax reimbursement on the equipment, XX owes tax on the rentals payable for the equipment. The tax due in this situation is measured by the value of the Warrant plus the periodic lease payments for the remainder of the lease period. In your previous letter to us dated October 20, 1994 regarding venture lease transactions, you state that the Warrant granted by a lessee generally does not have a measurable value at the date of the grant. We note that XX's Warrant Agreement provided to us for review provides no indication as to the value of such a Warrant at the time of commencement of that agreement. That does not mean, however, that a value cannot necessarily be assigned to the Warrant. For example, if the equipment lease agreement specifies a value of the Warrant 1 or the rentals payable under the lease agreement are reduced in exchange for the granting of the Warrant, the amount designated for the Warrant (i.e., the amount stated in the lease agreement or the difference in rental amounts between a lease with and without a Warrant Agreement) would be included in XX's rentals payable. 2 The value of the Warrant must also included in XX's rentals payable if the value of the Warrant can be determined by other reasonable or generally accepted means. F

F

F

F

Based on the information provided to us, we are unable to determine whether XX's Warrant maintains any value at the date of its grant to XX's lessor. If the Warrant can be valued 1

A copy of the "Master Lease Agreement" referenced in the Warrant Agreement was not provided to us for our review. 2

If the rentals payable are reduced, we assume that the total rentals payable on the equipment lease (i.e., the value of the warrant plus periodic rental payments) approximate the fair rental value of the equipment.

Mr. ---

-3-

April 17, 1995
330.4180

with a determinable dollar amount, the value of that Warrant must be included in XX's rentals payable for the lease of equipment. However, if the value of the Warrant at the time the lease commences is sufficiently speculative, the Warrant is not included as part of XX's rentals payable for the lease of the equipment. Thereafter, no sales or use tax would be due on the grant or execution of the Warrant, or on the subsequent sale of stock acquired by the lessor through the Warrant as part rentals payable pursuant to the lease. If you have any further questions, please write again. Sincerely,

Warren L. Astleford
Staff Counsel
WLA:plh
cc:

Oakland District Administrator - CH