Could an equipment lessor claim a defective-merchandise deduction after a lessee exercised a purchase option and received a full-credit replacement?

Plain-English summary

An equipment lessor reported use tax on rental receipts under a lease with a $30,000 purchase option. When the lessee exercised the option, the lessor reported sales tax on the remaining option price.

The equipment later proved unsatisfactory. The lessor took it back, supplied a new machine at the same price, and gave the customer full credit for the original machine—including the rentals and option price previously paid.

California allowed the lessor to claim the defective-merchandise deduction for the original machine's selling price when reporting sales tax on the replacement equipment.

Common questions

Did the earlier lease prevent a defective-merchandise deduction?

No, after the purchase option had been exercised and the customer received full credit on the replacement.

What payments had already been taxed?

Use tax had been reported on rentals, and sales tax had been reported on the option-purchase balance.

What fact supported the deduction?

The lessor gave full credit for the original machine and replaced it at the same price.

Citations and references

• California defective-merchandise deduction — applied to the original machine's selling price when the full-credit replacement sale was reported

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: https://cdtfa.ca.gov/lawguides/vol2/suta/490-0000-all.html
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/490-0780.pdf

Original ruling text

STATE OF CALIFORNIA

490.0780

STATE BOARD OF EQUALIZATION
July 2, 1965
Gentlemen:
This is in reply to your inquiry of June 28, 1965. It is our understanding that two years ago you rented a piece of equipment to a customer with an option to purchase for $30,000 plus sales tax. You collected and remitted use tax measured by rentals and when the option to purchase was exercised, you reported sales tax on the balance of the option price. The equipment proved unsatisfactory in operation. The problem was finally resolved by your agreeing to take back the original machine and replacing it with a new machine. You issued the customer full credit for the original machine and replaced it with a new machine at the same price. On the basis of the foregoing circumstances, it appears to us that you gave the customer full credit for the original machine when you replaced it with a new machine. In our opinion you are entitled to take the deduction for defective merchandise with respect to the selling price of the original machine when you report sales tax with respect to the new machine. Very truly yours, George A. Trigueros Associate Tax Counsel GAT:ls

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