Could one long-term lease of 22 pieces of manufacturing equipment qualify as an exempt occasional sale?

Plain-English summary

A taxpayer brought ex-tax furniture-manufacturing equipment from South Africa to California in 1984, stored it for about a year, and then leased 22 pieces costing $395,863 to a corporation he established to operate the manufacturing business. The lease lasted at least 50 months and generated an accepted $644,915 in receipts, although the protested-item table says $644,913.

The Appeals recommendation rejected the argument that a single lease was not a business or should qualify as an occasional sale. Unlike a one-time title transfer, a lease exercises the selling privilege over time through recurring rent collection, expenses, maintenance or insurance responsibilities, and profit-and-loss accounting.

The equipment lease was therefore a taxable continuing sale. The recommendation also could not recommend relief from the failure-to-file penalty because the taxpayer had not yet submitted the signed, penalty-of-perjury statement required by section 6592; it gave him 30 days after mailing to do so.

Appeal record and limits

Senior Staff Counsel James E. Mahler held an Appeals conference in Culver City on September 24 of a year redacted as 19XX. The petitioner appeared through C--- L. N---, identified as a CPA and attorney, and Senior Tax Auditor Daniel E. Ellsberry appeared for the Department. The liability covered October 1, 1985 through March 31, 1990. The protested table shows $644,913 in unreported rental receipts, $77,847 labeled EQRF, and a 10-percent failure-to-file penalty of $4,146, or $4,211.39 after reaudit.

The lease began on or about November 20, 1985 and covered a gluing machine, drills, sanders, saw, forklift, and other furniture-manufacturing items. Its Appendix A listed 22 items costing $395,863. The rent clause said $12,000 on the blank day of each month for 50 months; the agreement did not clearly state the lease price. The corporation agreed to pay assessed equipment taxes and had a right to make value-adding repairs, while the agreement did not assign insurance or maintenance responsibility.

Audit staff accepted the petitioner's reported $644,915 of receipts, broken down annually but not quarterly. The figures varied: $248,837 in 1987, $144,365 in 1988, and $163,052 in 1989. The source says no explanation was offered and only suggests that equipment additions or deletions may explain the changes. The taxpayer reported lease income on federal Schedule E and claimed depreciation; the source did not know whether he claimed maintenance, insurance, or other business expenses.

The petitioner raised three contentions: the lease was not taxable; Regulation 1595(a) would conflict with statute and be void if it taxed the lease; and the filing penalty should be relieved. The parties agreed the lease was a statutory sale and purchase. The dispute was whether a single lease made the taxpayer a seller engaged in business and whether the occasional-sale exemption could apply.

The recommendation compared a one-time title transfer with an ongoing lease. California case law generally treated one title sale as not a business, but the source found no California case deciding one lease. It catalogued Alabama and Arizona cases treating one lease as not a business, Ohio and New Jersey sources reaching the other result, and federal income-tax authorities treating one lease as a business. It found the federal analysis persuasive but not dispositive because income-tax policy differed.

The recommendation reasoned that a lessor exercises the selling privilege over months or years by collecting rent, maintaining and insuring property, and accounting for receipts and expenses. It distinguished the Florida case printed as Richard Betram & Co. v. Green because that court addressed whether a lease counted as a sale consistently under Florida statutes, not whether one lease was a business. It also rejected the petitioner's Regulation 1599(c) coin-and-bullion factors because they concerned title transfers and were examples of evidence, not mandatory prerequisites.

For this lease, the recommendation emphasized the 22 items, cost, at-least-50-month term, income-tax-savings purpose, ongoing rent and expense activity, $644,915 receipts, and $11,943 monthly average. It called the one-agreement form fortuitous and said the no-business argument bordered on frivolous. It recommended redetermination according to the April 12, 1991 reaudit, which is not in the PDF.

The PDF does not include the petition, notice, audit or reaudit workpapers, September conference record, October 2, 1992 representative letter identified as an attached exhibit, lease or Appendix A, invoices, ex-tax purchase evidence, import or storage records, corporation records, rent receipts, annual or quarterly schedules, tax returns, Schedule E, depreciation or expense records, maintenance or insurance evidence, penalty calculation, sworn penalty statement, redetermination, payment, appeal, Board action, or later outcome. Citation checking found Alvary at 302 F.2d 790, while the PDF prints 302 F.2d 290 at 796, and Richard Bertram with the r omitted by the PDF's Betram. The original tail preserves both source forms.

The live annotation preserves the foreign-country purchase, ex-tax status, California move and storage, income-tax motive, 22 items, $644,915 receipts, five-year scale, continuing-lessor rationale, Regulation 1595(a)(1), and single-lease conclusion. It dates the item May 27, 1993 rather than the signed May 6 source. It omits the petition and conference posture, redacted conference year, period, protested-table and accepted-receipt difference, equipment cost and types, unclear rent clause, annual fluctuations, Schedule E treatment, three contentions, statute and case analysis, Regulation 1599 argument, $11,943 average, fortuitous and frivolous characterizations, penalty issue, missing reaudit and exhibit, and absent final Board action. It also says a lessor must maintain and insure property without noting that this taxpayer's agreement did not specify who had those duties.

What this means for you

Owners leasing equipment to a related business

Using one lease document does not make a substantial multi-year rental occasional. Duration, receipts, number of assets, and ongoing management can establish a leasing business.

Accountants and tax professionals

Analyze leases separately from isolated asset sales. Also satisfy procedural requirements for penalty relief; here, the hearing officer could not recommend relief before receiving the required sworn statement.

Common questions

Q: How extensive was the lease?
A: It covered 22 equipment items costing $395,863, ran at least 50 months, and produced an accepted $644,915 in receipts; the protested table instead says $644,913.

Q: Why did one lease count as a business?
A: It required continuing rent collection, expense payment, accounting, and other lessor activity over several years.

Q: Did the occasional-sale exemption apply?
A: No. Regulation 1595 treated the taxable lease as a continuing sale rather than an occasional sale.

Q: Was the failure-to-file penalty removed?
A: No recommendation for relief could yet be made because the taxpayer had not filed the required sworn explanation; he was given 30 days after mailing to submit it.

Q: Did the lease agreement clearly state the rent?

A: No. It mentioned $12,000 and a 50-month term but left the monthly payment-day blank and did not clearly set out the total lease price.

Q: Was the recommendation the final Board action?

A: No final action appears. The recommendation directed redetermination under an absent April 12, 1991 reaudit.

Citations and references

• California Revenue and Taxation Code §§ 6006(g), 6006.5(a), 6010, 6013, 6014, 6015(a)(1)–(2), 6051, 6201, 6367, and 6592
• California Sales and Use Tax Regulations 1595(a)(1), 1595(a)(4), 1599(c), and 1660
• Market Street Railway Co. v. State Board of Equalization, 137 Cal.App.2d 87, 95
• State v. GM&O Land Co., 275 So.2d 687; State v. Selby, 544 P.2d 717; Hayes-Albion Corp. v. Kosydar, Ohio Board of Tax Appeals, May 21, 1975
• New Jersey State Tax News, April–May 1974, reported at 2 CCH N.J. Tax Reporter ¶ 60590.70
• Guggenheimer v. Commissioner, 209 F.2d 362, 365; Gilford v. Commissioner, 201 F.2d 735; Reiner v. United States, 222 F.2d 770, 772–773
• Alvary v. United States, 302 F.2d 790, 796 — the PDF prints 302 F.2d 290 at 796; Post v. Commissioner, 26 T.C. 1055
• Cooper Tire & Rubber Co. Employees' Retirement Fund v. Commissioner, 36 T.C. 96, affirmed 306 F.2d 20
• Richard Bertram & Co. v. Green, 132 So.2d 24 — the PDF prints Richard Betram
• RIA, United States Tax Reporter, volume 4, paragraphs 1624.002 et seq.; Mertens, Law of Federal Taxation, volume 7, sections 28.49 et seq.
• Petition, audit, reaudit, conference, representative exhibit, lease, equipment, receipt, return, expense, penalty, redetermination, Board-action, and outcome records — implicated but not included

Verbatim support

From the official May 6, 1993 Decision and Recommendation:

However, no California case has decided the precise question before us here, that is, whether a single lease is a business.

In contrast, a lessor exercises the privilege over a period of months or years. A lessor must regularly collect the rent, take steps to maintain and insure the property and account for receipts and expenses.

Even a single lease is therefore a significant exercise of the selling privilege and justifies the tax.

We find that petitioner's lease to ML is properly classified as a business.

Petitioner has not as yet filed the required statement and we are therefore unable to recommend relief.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 395.0075
• Original supporting opinion: 395.0075 PDF

Original ruling text

STATE OF CALIFORNIA

395.0075

BOARD OF EQUALIZATION
BUSINESS TAXES APPEALS REVIEW SECTION

In the Matter of the Petition
for Redetermination Under the
Sales and Use Tax Law of:
A--- J---

Petitioner

)
)
)
)
)
)
)
)

DECISION AND RECOMMENDATION

No.

SN -- XX XXXXXX-010

The Appeals conference in the above-referenced matter was held by Senior Staff Counsel James E. Mahler on September 24, 19XX, in Culver City, California. Appearing for Petitioner:

C--- L. N---, CPA
Attorney at Law

Appearing for the
Sales and Use Tax Department:

Daniel E. Ellsberry
Senior Tax Auditor

Protested Item
The protested tax liability for the period October 1, 1985, through March 31, 1990, is measured by: Item

Unreported taxable rental receipts
(including reaudit adjustment)

State, Local,
County & Transit

EQRF

$644,913

$77,847

The determination includes a ten percent penalty in the amount of $4,146 ($4,211.39 after reaudit adjustment) for failure to file returns.

A--- J--SN -- XX XXXXXX-010

-2-

May 6, 1993
395.0075

Petitioner's Contentions

1. The lease of equipment is not subject to tax under the Sales and Use Tax Law.
2. If Sales and Use Tax Regulation 1595(a) were construed to mean that the lease is
   taxable, the regulation would conflict with the statute and thus be void.
3. Relief from the penalty for failure to file returns should be allowed.
   Summary
   On or about November 20, 1985, petitioner contracted to lease certain equipment to M--- L---, Inc. (later called P--- I---, Inc., hereinafter "ML"). Appendix A of the lease agreement listed 22 pieces of equipment subject to the lease, with a total "cost" of $395,863. The equipment included a gluing machine, drills, sanders, a saw, a forklift and other items intended for use in manufacturing furniture. The principal issue is whether tax applies to petitioner's lease receipts. The lease price was not clearly set out in the agreement. Section 3 stated that ML would day of each " for a term of 50 months, but the blanks were pay rent of $12,000 "on the not filled in. ML also agreed to pay any taxes which might be assessed on the equipment. The agreement did not specify who would be responsible for insuring or maintaining the equipment, but did provide that ML had a "right" to add to the value of the equipment by making repairs. Petitioner advised the audit staff that his lease receipts totalled $644,915 for the period October 1, 1985, through March 31, 1990, and the staff accepted this figure as correct. Petitioner's figure was broken down by years, but not by quarters. The yearly receipts varied greatly. For example, petitioner received $248,837 in 1987, $144,365 in 1988 and $163,052 in 1989. No explanation for these fluctuations has been offered, but they may reflect additions to or deletions from the number of items being leased. According to petitioner, he originally purchased the equipment for use in manufacturing furniture in South Africa. (The audit staff found that the purchases were ex-tax, and petitioner does not dispute this finding.) Petitioner emigrated to California and brought the equipment with him in 1984. He stored the equipment in this state for about a year while he looked for an opportunity to open another furniture-manufacturing business, and ultimately set up ML to conduct the business. On the advice of an accountant, he decided to minimize his income taxes by retaining ownership of the equipment and leasing it to ML, rather than contributing it to the corporation. (For federal income tax purposes, petitioner has reported the lease receipts on Schedule E of his returns as supplemental income, and has claimed depreciation deductions, but we do not know whether he has also claimed other business expense deductions such as maintenance and insurance.)

A--- J--SN -- XX XXXXXX-010

-3-

May 6, 1993
395.0075

Analysis and Conclusions
Subdivision (a)(1) of Sales and Use Tax Regulation 1595 provides, in the third paragraph: "Tax does not apply to a sale of property held or used in the course of an activity not requiring the holding of a seller's permit unless the sale is one of a series of sales sufficient in number, scope and character to constitute an activity for which the seller is required to hold a seller's permit or would be reburied to hold a seller's permit if the activity were conducted in this state. If tangible personal property is leased under a lease which is a 'sale' as defined in Section 6006 or a 'purchase' as defined in Section 6010, tax applies to the lease as provided in Regulation 1660. The lessor is making a 'continuing sale' which is not an 'occasional sale'." (Emphasis added.) The parties agree that petitioner's lease to ML was both a "sale" and a "purchase" as defined in the statutes cited in the regulation. In the staff's view, the lease is therefore subject to tax under the express terms of the regulation. Petitioner attacks the staff's position on two fronts. He contends, first, that the regulation does not apply to him, and second, that the regulation would be void if it were construed as applying to him. Petitioner's arguments on these points are set out in detail in his representative's letter dated October 2, 1992, which we have attached hereto as an exhibit. Briefly summarized, petitioner's first argument runs as follows. Sales and use taxes apply only when property is sold by a "retailer". (Rev. & Tax. Code §§ 6051 and 6201.) With certain exceptions not relevant here, a vendor is not a "retailer" unless he or she is also a "seller" or a "person engaged in the business of making sales [at retail]." (Rev. & Tax. Code § 6015, subds. (a)(1) and (a)(2).) Similarly, "seller" means a person "engaged in the business of selling" taxable property. (Rev. & Tax. Code § 6014.) "[T]he term `business' requires that the seller engage in more than one isolated sale." (Market Street Railway Co. v. State Bd. of Equalization, 137 Cal.App.2d 87 at 95.) A lease of the type in question is a "sale". (Rev. & Tax. Code § 6006, subd. (g).) Petitioner concludes that a person who makes a single lease is not "engaged in the business" of selling, and thus is not a "seller" or "retailer", so tax does not apply. The second argument, again briefly summarized, is based on Revenue and Taxation Code section 6367, which authorizes an exemption for "occasional sales". Subdivision (a) of section 6006.5 defines that term to mean a sale of tangible personal property not held or used by a "seller" in the course of activities requiring a seller's permit. Using the same chain of reasoning just described, petitioner argues that he was not a "seller" because he was not "engaged in

A--- J--SN -- XX XXXXXX-010

-4-

May 6, 1993
395.0075

business". Therefore, he concludes that he must qualify for the occasional sales exemption under the statute and, if the regulation is to the contrary, the regulation must be void. While petitioner's two contentions are analytically separate, they both boil down to the same question. Is a person who makes a single lease (of a type which qualifies as a "sale" and a "purchase") engaged in "business" as a seller? The term "business" is broadly defined in Revenue and Taxation Code Section 6013 to include "any activity engaged in by any person ... with the object of gain, benefit, or advantage, either direct or indirect." This definition is consistent with the income tax rule that an activity for profit is a trade or business. (See RIA, United States Tax Reporter, Vol. 4, ¶¶ 1624.002 et seq.; Mertens Law of Federal Taxation, Vol. 7, §§ 28.49 et seq.) As petitioner correctly notes, despite the broad statutory definition, the California courts have held that a single sale by way of title transfer is generally not a business for sales and use tax purposes. However, no California case has decided the precise question before us here, that is, whether a single lease is a business. The issue has been litigated in other states. The courts of Alabama and Arizona have concluded that a single lease is not a business activity. (State of Alabama v. GM&O Land Co., 275 So.2d 687; Arizona, et al. v. Selby, 544 P.2d 717.) Ohio and New Jersey, on the other hand, have held that a single lease is a business. (Hayes-Albion Corp. v. Kosydar, Oh. Bd. Tx. App., May 21, 1975; New Jersey State Tax News, April-May 1974 [2 CCH N.J. Tx. Rptr. ¶60590.70].) The issue has also been litigated under the federal income tax law. As in California, the federal courts do not view a single sale by way of title transfer as a business. (See Guggenheimer v. Commissioner, 209 F.2d 362 at 365.) A single lease, however, is classified as a business activity. (Gilford v. Commissioner, 201 F.2d 735; Reiner v. United States, 222 F.2d 770 at 772-773; Alvary v. United States, 302 F.2d 290 at 796; Rosalie W. Post v. Commissioner, 26 T.C. 1055.) Most of these cases deal with leases of real property, but the rule has also been applied to a single lease of equipment for use in manufacturing. (Cooper Tire & Rubber Co. Employees Retirement Fund v. Commissioner, 36 T.C. 96, aff'd. per curiam, 306 F.2d 20.) The appellate court in the last cited case explained its holding as follows: "We do not think that a trust must necessarily engage in more than one venture in order to be regularly engaged in the business.... Here was a transaction of considerable magnitude involving 21 pieces of equipment and extending over a period of 10 years or even additional periods of time. The trust was required to purchase tire manufacturing machinery, borrow money and execute a chattel mortgage to finance the purchase price. Mere purchase of the machinery did not produce the income. The trust had to lease the machinery, collect the rentals and make monthly payments on the bank note. To us the deal looks more like one to finance the entire purchase price of machinery needed by the tire company rather

A--- J--SN -- XX XXXXXX-010

-5-

May 6, 1993
395.0075

than a conventional investment for the trust. The statute prohibited loans by the trust to the tire company without adequate security...." (306 F.2d at 21, citations omitted.) Of course, the income tax has different goals and policies than our Sales and Use Tax Law, so federal authorities are not necessarily dispositive. In this case, however, the federal decisions are persuasive. The sales tax, which is complimented by the use tax, is imposed for "the privilege of selling tangible personal property at retail" in this state. (Rev. & Tax. Code § 6051.) A person who makes a single sale by transferring title has arguably not exercised the privilege to an extent sufficient to warrant imposing the tax. In contrast, a lessor exercises the privilege over a period of months or years. A lessor must regularly collect the rent, take steps to maintain and insure the property and account for receipts and expenses. Even a single lease is therefore a significant exercise of the selling privilege and justifies the tax. Petitioner's arguments are based on the assumption that title transfers and leases must be treated identically because they are both defined as "sales". This assumption ignores the obvious differences between the two types of transactions. As just noted, a title transfer may be an isolated event completed in a short time, while a lease endures for long periods and requires the continuous involvement of the lessor. Further, while profit undoubtedly motivates many title transfers, such sales are sometimes also made simply to dispose of the property. A lease, however, is almost by definition undertaken for profit. While a single sale by title transfer may thus not be a business venture for profit, a single lease is almost invariably so. Petitioner draws our attention to Richard Betram & Co. v. Green, 132 So.2d 24, a case decided in 1961 by the Florida Court of Appeal under that state's sales tax law. Plaintiff therein was a broker who listed yachts for lease. He collected the rentals and remitted the money (less a commission) to the yacht owners. Tax was asserted against the broker in part because of a regulation which provided that a rental could not qualify for exemption as an occasional sale. In order to support this regulation under Florida law, the taxing authorities argued that a lease was a "sale" only for purposes of imposing the tax, not for purposes of the exemption statutes. The court rejected this distinction and concluded that a lease is a "sale" for all purposes. Thus, the court invalidated the regulation and determined that the broker did not owe tax. The Florida case is readily distinguishable. First, Florida law appears to differ greatly from our Sales and Use Tax Law in this area. The yacht leases would apparently have been nontaxable under California law for reasons independent of the occasional sales exemption. Second, there is no doubt that petitioner's lease was a "sale" under California law for purposes of both the imposition statutes and the exemption statutes. The problem addressed by the Florida court (inconsistent definitions of the word "sale") is therefore not present here. Third, and most important, the Florida court did not review the question which does concern us here (whether a single lease would be a "business") nor did it express any opinion on that subject. Accordingly, we find the Florida case of no relevance.

A--- J--SN -- XX XXXXXX-010

-6-

May 6, 1993
395.0075

To sum up, subdivision (a)(1) of Sales and Use Tax Regulation 1595 reflects a finding by the Board that a single lease is a "business", which requires imposition of the tax and precludes the claimed occasional sales exemption. The Board's finding is supported by the income tax precedents and is consistent with the sales and use tax statutes. Petitioner's arguments to the contrary are without merit. Petitioner next contends that his particular lease to ML was not a business, even if the general rule would classify most leases as business activity. He points out that the Board generally looks to the "number, scope and character" of an activity to determine whether it requires the holding of a seller's permit. (See Sales & Use Tax. Reg. 1595, subd. (a)(4).) He alleges that his lease to ML bears none of the indicia of "business" as set out in subdivision (c) of Sales and Use Tax Regulation 1599, which provides: "PURCHASE OF COINS AND BULLION AS INVESTMENT. Purchases of coins and bullion as investments are purchases at retail. It is immaterial that a gain, benefit, or advantage may not be realized until the resale of the coins and bullion. A resale certificate may not be issued for purchases for this purpose. "A person purporting to hold coins or bullion solely for resale in the regular course of business must be able to prove that he actively engages in business as a seller of coins and bullion. The following are some examples of relevant evidence: "(1) The number, scope, and character of the person's purchases and sales of coins or bullion. "(2) Evidence of the person's continuing efforts to advertise and sell coins or bullion. "(3) Evidence that the person held out to the public that he was engaged in business as a seller of coins or bullion at an identified place of business. "(4) The manner in which income from transactions in coins or bullion was reported by that person for income tax purposes. "(5) Whether a local business license was issued to that person to engage in sales of coins or bullion. "Seller's permits may be held only by persons actively engaging in the business of selling tangible personal property."

A--- J--SN -- XX XXXXXX-010

-7-

May 6, 1993
395.0075

We are not impressed with this argument. Regulation 1599 deals with sales and purchases of coins and bullion, that is, with title transfers. While it is true that the factors listed in the regulation have also been applied in cases involving other types of property, the regulation was not drafted with the unique problems of leases in mind, and the factors listed in the regulation are not particularly relevant to leasing businesses. More importantly, the regulation expressly states that the listed factors are "examples of relevant evidence." The regulation does not even remotely suggest that the listed factors are requirements which must be met before an activity can be classified as a business. We find that petitioner's lease to ML is properly classified as a business. The lease included 22 individual pieces of equipment with a total cost of $395,863. (It is fortuitous that petitioner chose to draft the transaction as a single lease instead of having 22 separate lease agreements.) The lease continued for at least 50 months, perhaps longer. The admitted purpose of the lease was to create income tax savings. Throughout the term of the lease, petitioner had to take actions typical of a business, such as collecting rents, paying expenses, and accounting for profits and losses. The lease generated receipts of $644,915 during the periods at issue, an average of $11,943 per month. In our view, it borders on the frivolous to argue that an activity of such "number, scope and character" was not a business. We find that the tax was properly asserted. With respect to the penalty, Revenue and Taxation Code Section 6592 provides that the Board may grant relief only if the taxpayer files a statement, signed under penalty of perjury, explaining the reasons for the failure to file returns. Petitioner has not as yet filed the required statement and we are therefore unable to recommend relief. If petitioner wishes to file a statement, signed under penalty of perjury, he should do so within 30 days from the date this Decision and Recommendation is mailed. Recommendation Redetermine in accordance with the reaudit dated April 12, 1991.

5/6/93

James E. Mahler, Senior Staff Counsel

Date