Could an MTE lessor stop an FRV election when a later lease and all equipment use moved outside California?

Plain-English summary

An MTE lessor made a timely FRV election for a five-year California lease. After the equipment was returned, the lessor entered a second lease three months later, delivered the MTE to the new lessee outside California, and kept it outside the state.

California said the FRV election was irrevocable. The lessor had to continue reporting tax on fair rental value during the second lease regardless of where the equipment was located.

The lessor could not switch to purchase-price tax at the second lease or claim an offset for FRV tax paid during the first lease. The taxable event had occurred at the original sale to or use by the lessor; later reentry into California would not create a new taxable event. Because the taxpayer was unidentified, the letter did not qualify for statutory reliance protection.

Conditions and separate hypothetical

Staff Counsel Kelly W. Ching's May 7, 1996 letter answers a February 22 request about an unidentified seller-lessor. The request described a 1990–1995 California lease, proper FRV reporting, return of the equipment, and a new out-of-state lease three months later. Those are the adviser's stated facts; purchase, lease, tax-return and location evidence is not attached.

Regulation 1661(b)(2), as described in the letter, required use limited to leasing and an election on or before the return due date for the period when the equipment was first leased. Fair rental value meant rentals required by the lease. An earlier payment of purchase-price tax or reimbursement would prevent that election. Because the original lessee returned the unit, the author assumed a true lease rather than a sale at inception under Regulation 1660(a)(2)(A); no contract is provided to verify that assumption.

The first two questions concerned the described second lease entirely outside California. The third changed the facts: assume the second lessee used the equipment outside California for six months and then brought it back. The response says tax had fully accrued on the original sale to or use by the lessor. The FRV election spread payments of that liability; it did not defer the taxable event until reentry. Since the lessor could not switch to cost at the second lease, no credit against such a cost payment was applicable.

The live annotation summarizes continuing FRV treatment and the unavailable cost switch but omits the distinct reentry hypothetical, original taxable-event explanation, election deadline, true-lease assumption and section 6596 denial. No equipment type, cost, rental amount, actual second-lease return or later ruling is supplied.

Common questions

Did a new lease contract create a new tax election?

No. The original FRV election attached to the MTE and continued.

Did keeping the equipment outside California stop FRV reporting?

No. The letter required reporting regardless of location.

Citations and references

• California Revenue and Taxation Code sections 6006(g)(4), 6010(e)(4), 6051, 6094(d), 6201, 6244(d), and 6596
• California Sales and Use Tax Regulations 1660(a)(2)(A) and 1661(b)(2)

Verbatim support

From the official May 7, 1996 letter:

Since your client is not identified, this opinion does not come within the provisions of section 6596.

we assume that the lease was a true lease, and was not a sale at inception.

since the taxpayer does not have the option to pay use tax measured by purchase price at the beginning of the second lease, no offset is applicable.

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: https://cdtfa.ca.gov/lawguides/vol2/suta/335-0000-all.html
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/335-0016-980.pdf

Original ruling text

335.0016.980

STATE OF CALIFORNIA

JOHAN KLEHS
First District, Hayward

STATE BOARD OF EQUALIZATION
LEGAL DIVISION - MIC: 82
450 N STREET, SACRAMENTO, CALIFORNIA
(P. O. BOX 942879, SACRAMENTO, CA 94279-0082)
TELEPHONE: (916) 322-2976
FAX: (916) 323-3387

DEAN F. 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

Mr. D--- M. D--A--- S--- T--- C--- Incorporated
XXXX --- Road, Suite XXX
---, CA XXXXX
Re:

Unidentified Taxpayer

Dear Mr. D---:
This is in response to your letter dated February 22, 1996 regarding the application of tax to leases of mobile transportation equipment (MTE). I note that the only basis for the Board to relieve a person of otherwise properly due taxes is pursuant to the provisions of Revenue and Taxation Code section 6596. To come within the provisions of that section, the taxpayer must have reasonably relied on the Board's written advice which was in response to a written request for advice that disclosed all relevant facts, including the identity of the taxpayer. Since your client is not identified, this opinion does not come within the provisions of section 6596. You state: “Taxpayer corporation is a seller and lessor of MTE. The corporation buys MTE without paying or reporting tax on its initial cost, choosing instead to report use tax measured by fair rental value when it enters into leases. “In 1990 the taxpayer leased a unit to a California lessee for a five year term. Use tax was properly reported on fair rental value throughout the term of the lease. In 1995, at the end of the lease, the lessee returned the unit to the taxpayer. Three months later, the taxpayer leased the same equipment to a different lessee under a new contract. The taxpayer delivered the equipment to the new lessee’s out-of-state headquarters. Thereafter, the equipment was used outside California and did not enter the state at any time.

Mr. D--- M. D---

-2-

May 7, 1996
335.0016.980

“QUESTIONS
“1.

Must the taxpayer report use tax measured by fair rental value throughout the second (out-of-state) lease?

“2.

If so, does the taxpayer have the option to report use tax measured by cost at the inception of the second lease? Would an offset be allowed for the use tax measured by rental receipts which was paid throughout the term of the first lease?

“3.

Assume now that the unit is used outside the state by the second lessee for six months and then brought into California. Will the unit’s reentry into California be considered a taxable event, and, if so, how will the tax apply?”

DISCUSSION
As you know, a lease of MTE is excluded from the definition of "sale" and "purchase" for purposes of the Sales and Use Tax Law. (Rev. & Tax. Code §§ 6006(g)(4), 6010(e)(4).) The sale of MTE to a person who will lease it is the retail sale; therefore, the sale to the lessor, or the use by the lessor (by leasing), is subject to sales or use tax. (Rev. & Tax. Code §§ 6051, 6201.) The lessor is the consumer of the MTE it leases. With respect to the MTE that is leased, if the use of the MTE will be limited to leasing and the lessor makes a timely election to do so, the lessor may pay its tax liability measured by the fair rental value of the MTE, meaning the amount of rentals required by the lease, if the election is made on or before the due date of a return for the period in which the equipment is first leased. (Reg. 1661(b)(2).) Of course, if the lessor has already paid tax or tax reimbursement measured by the purchase price, the election to pay tax on fair rental value is not available. I note that some agreements characterized by the parties as leases are actually sales. However, in the situation about which you inquire, since the first lessee returned the unit to the taxpayer, we assume that the lease was a true lease, and was not a sale at inception. (See Reg. 1660(a)(2)(A).) When the lessor elects to pay tax measured by fair rental value, the election is irrevocable and the lessor must continue to report tax on that basis whether the MTE is inside or outside of California. (Rev. & Tax. Code §§ 6094(d), 6244(d).) Thus, the answer to your first question is “yes,” because once a lessor has made a timely election to pay tax on fair rental value, tax must be paid on that basis without regard to where the MTE is. In answer to your second question, since the taxpayer does not have the option to pay use tax measured by purchase price at the beginning of the second lease, no offset is applicable. In answer to your third question, the taxable event took place at the time of the original sale to or

Mr. D--- M. D---

-3-

May 7, 1996
335.0016.980

use by the lessor and the tax fully accrued at the time of that sale or use, and not upon reentry of the MTE into California. Since the lessor elected to spread out the payments on its liability and pay tax on fair rental value rather than on purchase price, the lessor must continue to pay tax on fair rental value regardless of the location of the MTE. If you have further questions, please feel free to write again. Sincerely,

Kelly W. Ching
Staff Counsel
KWC:cl
---

cc:

Ms. Cathy McKowen
--- District Administrator