How could an MTE lessor using fair rental value report capital reductions, deficiency payments, and lease termination?

Plain-English summary

A redacted adviser asked how a lessor of unidentified mobile transportation equipment that had elected fair rental value should handle unusual payments during and at the end of a lease.

California did not require the amount reported in each period to match the lessee's payment in that period exactly. A lump-sum capital reduction that lowered later rent could be spread over the remaining lease term. Over the whole term, however, fair rental value was expected to equal the lessee's actual payments for use of the property.

A deficiency payment caused by decline in value through vehicle use also reflected fair rental value. If it became payable only at lease end, it could not be pushed backward into earlier periods; it required a fair-rental-value adjustment at termination and had to be included in the taxable measure then.

The source also said the lease continued until the earlier of repossession by the lessor or sale of the lessor's ownership interest. A contract's earlier defined "termination" did not end the lease for tax purposes while the lessee retained possession with the lessor's acquiescence.

Assumed payment definition and missing transaction

The requester's letter is neither dated nor reproduced. It used “cap reductions,” and counsel expressly assumed that meant a lessee's lump-sum payment during the lease that reduced later installments. The source identifies no lessor, lessee, MTE item, lease dates, ordinary rent, lump sum, later reductions, or method used on any filed return.

The letter says there was no strict requirement for period-by-period FRV to track payments precisely. For unusual high or low payments, a lessor could report based on payments when made or distribute an excess or deficiency across the lease as an FRV reporting method. That flexibility did not let an end-of-lease deficiency be retroactively moved into closed earlier periods; it required a termination adjustment.

Only a deficiency reflecting decline in vehicle value through use was treated as FRV; the source distinguishes decline through catastrophic loss. It supplies no valuation, vehicle-use evidence, loss facts, deficiency formula, end-of-lease statement, taxable measure, tax rate, return, payment, or dollar result.

The possession discussion is separate from payment timing. The source says the tax-law lease continued until repossession or sale of the ownership interest, and while the lessee retained possession with the lessor's acquiescence, notwithstanding an earlier contract-defined termination. No possession, notice, repossession, sale, or contract record is included.

The live 335.0690 annotation substantially tracks the lump-sum, deficiency, rental-receipt, and reporting-method analysis. It omits the requester's missing definition, catastrophic-loss distinction, all transaction records, and the PDF's entire second-page rule that possession rather than an earlier contract label controls when the lease ends.

Common questions

Could a capital-reduction payment be spread over later periods?

Yes. The source allowed the amount to be distributed over the remaining fair-rental-value lease term.

Could a final deficiency payment be allocated back to prior periods?

No. A deficiency payable at lease end required an adjustment upon termination.

Did the contract's termination date necessarily end the tax-law lease?

No. The opinion focused on possession. The lease continued while the lessee retained possession with the lessor's acquiescence.

Did the letter decide a specific payment allocation or tax amount?

No. It gave general methods without the lease, payment schedule, deficiency formula, allocation, return, or computation.

Citations and references

• California Revenue and Taxation Code sections 6006.1, 6006.3, 6011, and 6012
• Requester's undated letter and its specific lease terms — referenced but not included
• Lease, capital-reduction and deficiency-payment provisions, payment history, allocations, repossession or sale records, returns, and tax computations — not included

Verbatim support

From the official December 19, 1980 letter:

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.

Accordingly, our view that while the lessee retains possession with the acquiescence of the lessor, the lease continues.

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/335-0690.pdf

Original ruling text

335.0690

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
335.0690

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