Did a boat dealer-lessee owe tax on a 51-foot sailboat lease or its transfer to replacement lessees?

Plain-English summary

A boat dealer leased a 51-foot sailboat with an option to buy after two years, originally planning to exercise the option and resell the vessel. The lessee later accepted payment to cancel its lease so new parties could lease the boat with the same option.

California treated a 51-foot sailboat as mobile transportation equipment. Assuming the original agreement was a true lease, the lessor was the MTE consumer. Because the lessor apparently had not made a timely fair-rental-value election, it owed tax based on the vessel's purchase price.

The lessee did not owe sales or use tax on its lease or assumed sublease because an MTE lease was not a sale or a taxable use by the lessee. If the original agreement was actually a sale at inception, tax instead could have applied when possession transferred based on the contract-price rules. The replacement lessees' later exercise of the purchase option would be taxable based on the option sale price.

Amounts, characterization, and evidence limits

The taxpayer said it paid $11,000 cash and owed another $4,750 under its original lease. It later agreed, for $55,630, to have that lease canceled so another party could lease the sailboat with the option; the reported new lease payments totaled $4,120. The letter does not allocate the $55,630 or decide that it was itself a taxable sale price. Its tax answer instead turns on MTE lease rules and the assumed sublease characterization.

The undated inquiry reached the Legal Division on February 16, 1996. The taxpayer reportedly supplied copies of an undated Lease/Option to Purchase Agreement in which the parties called the change an assignment, the lessor entered a new lease directly with replacement parties, and the taxpayer was released from all obligations. Those documents are not reproduced in the official PDF. Based on the reported information, counsel understood the arrangement as a sublease rather than an assignment; the page preserves that as the letter's characterization, not as an independently verified contract finding.

Counsel said it was “not entirely clear” whether the original lease-option was a true lease or a sale at inception and assumed a true lease for the rest of the answer. If it was a sale at inception, the source says tax was due when possession transferred on the full contract price unless adequate records separately established the sailboat sales price and insurance, interest, finance, and carrying charges. The PDF provides neither the full agreement nor those records.

The lessor only “appears” not to have made a timely fair-rental-value election. The letter says the lessor owed sales-tax reimbursement or use tax on purchase price but expressly notes that the taxpayer did not state whether the lessor had already paid it. The PDF also ends after listing an enclosure of Regulation 1661; that enclosure is not present.

The live annotation preserves the $55,630 cancellation payment, MTE classification, apparent election failure, lessee result, and purchase-price measure. It omits the original and new lease-payment totals, the staff's sublease characterization, the unresolved sale-at-inception branch, and whether the lessor already paid tax.

Common questions

Did the lessee's resale certificate make its lease payments tax free?

The letter did not rely on the certificate. It placed MTE lease tax responsibility on the lessor under the assumed true-lease facts.

Was the lease-option definitely a true lease?

No. The letter expressly assumed that point for its remaining analysis.

Did the letter establish that the lessor still had unpaid purchase-price tax?

No. It said the lessor owed sales-tax reimbursement or use tax on purchase price unless that tax had already been paid, and noted that the taxpayer supplied no answer on prior payment.

Citations and references

• California Revenue and Taxation Code sections 6006(g)(4), 6023, 6051, 6094(d), 6201, and 6244(d)
• California Sales and Use Tax Regulations 1641(a), 1660(a)(2)(A), and 1661(e)(2)(A)
• Business Taxes Law Guide Annotations 335.0050 and 335.0075
• Undated inquiry and Lease/Option to Purchase Agreement copies — described but not included
• Regulation 1661 enclosure — listed but not included

Verbatim support

From the official April 30, 1996 letter:

It is not entirely clear whether the transaction between you and --- designated as a lease constitutes a true lease, or instead constitutes a sale at inception.

You do not state whether or not --- has already paid the tax reimbursement or use tax.

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/335-0044-175.pdf

Original ruling text

335.0044.175

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

April 30, 1996
Dear
This is in response to the undated letter you sent to our ---, District Office regarding the application of tax to the lease of a vessel. Your inquiry, which was forwarded to the Legal Division for response, was received by the Legal Division on February 16, 1996. You state: "I hold a California resale certificate and 1 am in the business of acquiring, repairing and selling boats. "I obtained a lease with an option to buy (after a two year period) on a 1976 model, 51 foot sailboat. The lease was obtained from the --- ---. As I was planning on exercising the option after the two year period and reselling the boat 1 have not paid tax on any of the lease payments made to date. "I have recently decided not to exercise the option. For the consideration of
$55,630.00 I have agreed to have my lease with the --- canceled so that another party may obtain the lease on the boat including the option to buy at the end of the two year period. "My original lease with the --- required me to pay $11,000.00 in cash plus
$4,750.00 in future lease payments.
"The new lease between the --- and the party referred to above requires lease payments totaling $4,120.00." You provided copies of the undated “--- --- --- Lease/Option to Purchase Agreement" in which the --- --- --- acknowledges what it refers to as the assignment of your lease to --- and --- in which the --- executes a new lease directly between it and the --- and in which the --- releases you from "any and all obligation, present and/or future with regard to said lease." Although the agreement you have enclosed with your letter characterizes the agreement between you and the --- as an assignment of a lease, it is my understanding from the information you have provided that the agreement is actually for a sublease, rather than an assignment. Since the sailboat measures 51 feet in length, it is included in the definition of Mobile Transportation Equipment (MTE) provided in Revenue and Taxation Code section 6023. (See Reg. 1661(copy enclosed); Business Taxes Law Guide Annotations 335.0050 (1/31/73), 335.0075 (2/21/73).) Therefore, the rules applicable to leases of MTE apply. It is not entirely clear whether the transaction between you and --- designated as a lease constitutes a true lease, or instead constitutes a sale at inception. (See Reg. 1660(a)(2)(A).) If the

transaction is a sale at inception, then tax was due at the time possession of the property was transferred to you, measured by the full contract price, unless --- has kept adequate and complete records to show separately the sales price of the sailboat, and the insurance, interest, finance, and carrying charges made in the contract. (Reg. 164Ha).) If --- --- has kept such records, the insurance, interest, finance, and carrying charges may be excluded from the computation of the tax. (Id.) For the remainder of this opinion, we assume that the transaction between you and --- is not a sale at inception, but is instead a true lease. A lease of MTE is never a sale. (Rev. & Tax. Code § 6006(g)(4).) Rather, the sale of MTE to a person who will lease it is a retail sale, and 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.) If, however, the use of the MTE will be limited to leasing and the lessor makes a timely election to do so, the lessor may pay his or her tax liability measured by the fair rental value of the MTE, which means the amount of rentals required by the lease. (Reg. l661(e)(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 California. (Rev. & Tax. Code §§ 6094(d), 6244(d).) Where the lessor does not make such a timely election, the lessor owes tax on the purchase price of the MTE. Thus, in the situation about which you inquire, the retail sale was the sale of the sailboat to ---, and --- is the consumer of MTE it leases. Based on the facts you have provided, it appears that --did not make a timely election to pay tax measured by fair rental value. This means that --- owes sales tax reimbursement or use tax on the purchase price of the MTE. You do not state whether or not --- has already paid the tax reimbursement or use tax. Without regard to whether --- has already paid the tax it owes on its purchase of the sailboat, since the lease to you is not a sale or use by you for purposes of the Sales and Use Tax Law, you are not liable for tax on your lease or or --- sublease of the sailboat. Please note, however, that the sale to the --- when they exercise their option to purchase the sailboat will be subject to tax, measured by the sale price of the option. If you have further questions, please feel free to write again.

Sincerely,

Kelly W. Ching
Staff Counsel

KWC:cl
Enclosure (Reg. 1661)
cc:
--- District Administrator
Mr. Robert Reichmuth, --- District Office
Ms. Oveta Riffle, Supervisor (Consumer Use Tax Section - MIC:37) Ms. Louise Null (Consumer Use Tax Section - MIC:37)