When a lessor replaces or adds equipment on a long-term lease with under three years left, is it still a long-term lease or a new short-term lease?

Plain-English summary

A company that leases equipment under long-term leases (longer than three years) asked how to handle mid-lease change orders for Colorado sales tax. The key wrinkle: Colorado taxes long-term and short-term leases differently, so when a lessee changes equipment late in a lease, does the changed equipment become a separate short-term lease?

The Department drew a line between replacing and adding:

• Replacing obsolete equipment with new equipment does not convert the lease. "The replacement of existing equipment with new equipment does not alter the fact that the lease is a long term lease." A printer lease doesn't become short-term "simply because near the end of the long term lease, the printer is replaced with a new printer." Colorado treats long-term leases as an installment sale, so the lessor keeps collecting sales tax on each lease payment.

• Adding extra equipment, though, is different. "[I]f the property does not simply replace the existing property but is more correctly viewed as additional property added to the lease, then the addition of the new property in the last three years of a lease is properly viewed as a short term lease." Example: if the original lease was for one printer and the lessee adds a second printer within three years of expiration, the added printer is a short-term lease.

For short-term leases, the lessor is treated as the consumer and must pay sales tax when it acquires the equipment — though "the Department may grant the lessor permission to acquire the leased property exempt from tax and collect the sales tax on the lease payments throughout the lease," and "[t]he Department liberally grants this permission." The Department also noted it would likely treat an addition as short-term even if the original lease said the lessee had an option to add equipment.

This is a General Information Letter — general guidance, not a binding determination on the company's specific facts.

What this means for you

Equipment leasing companies

When a customer swaps out obsolete gear on a long-term lease, keep treating the whole thing as a long-term lease and collect tax on each payment — even if the swap lands in the final three years, and even if the monthly payment goes up. But when a customer adds new equipment within three years of the lease end, treat that addition as its own short-term lease: you, the lessor, owe tax when you buy that equipment. To avoid that, apply for the Department's permission to buy the added equipment tax-free and instead collect tax on the lease payments — the Department grants this "liberally."

Lessees / businesses leasing equipment

How a change order is structured (replacement vs. addition) changes the tax mechanics and potentially who bears the tax and when. If you're upgrading rather than expanding, the lease generally stays on its original long-term footing.

Accountants and tax professionals

The mechanics: long-term lease (initial term > 3 years) = installment sale, collect tax on each payment (§ 39-26-102(23)). Short-term lease = lessor is consumer, pays tax on acquisition unless granted permission to collect on payments (§ 39-26-713(1)(a)). The replacement-vs-addition distinction, and the "last three years" timing for additions, is the analytical core here. Cf. the related lease/credit-sale themes in CO GIL 17-002 and GIL 17-006.

Common questions

Q: I replaced obsolete equipment on a long-term lease that has under three years left. Is it now a short-term lease?
A: No. Replacing equipment doesn't convert a long-term lease; you keep collecting sales tax on each lease payment as an installment sale.

Q: I added extra equipment within the last three years of a long-term lease. How is that taxed?
A: The addition is treated as a new short-term lease. As lessor you're the consumer and owe tax when you acquire that equipment — unless you get the Department's permission to buy it tax-free and collect tax on the lease payments instead.

Q: What's the difference between replacing and adding?
A: Replacing swaps out existing (e.g., obsolete) equipment for new equipment that does the same job. Adding puts additional equipment onto the lease beyond what was originally leased. Replacement stays long-term; an addition in the last three years is short-term.

Q: Does it matter that the monthly payment went up?
A: For a replacement, no — an increase in the payment doesn't convert the lease. What matters is whether you replaced or added equipment.

Q: Is this letter binding?
A: No. A General Information Letter is general guidance and is not binding on the Department; it makes no specific determination. For a binding answer, request a private letter ruling.

Q: Does this cover city sales tax?
A: No. The Department administers state and state-collected local taxes only; self-collected home-rule cities and counties set their own rules.

Citations and references

Statutes:
- § 39-26-102(23), C.R.S. (long-term lease of tangible personal property treated as an installment sale; lessor collects tax on each lease payment)
- § 39-26-713(1)(a), C.R.S. (short-term lessor is the consumer and pays tax on acquisition; Department may grant permission to acquire tax-free and collect on payments)

Source

• Landing page: https://tax.colorado.gov/sales-use-tax-letter-rulings
• Original PDF: https://tax.colorado.gov/sites/tax/files/documents/GIL-17-004.pdf

Original ruling text

Office of Tax Policy
P.O. Box 17087
Denver, CO 80217-0087
[email protected]

GIL-17-004

February 17, 2017
XXXXXXXXXXXXXXXX
Attn: XXXXXXXXXXXXX
XXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXX
Re: Change Orders Related to Long Term Leases
Dear XXXXXXXXXX,
You submitted on behalf of your client (“Company”) a request for guidance regarding the
application of sales and use taxes to change orders related to long term leases.
The Colorado Department of Revenue (“Department”) issues general information letters
and private letter rulings. A general information letter provides a general overview of the
relevant tax issues, but is not binding on the Department. A private letter ruling provides a
specific determination for a specific set of facts, is binding on the Department but not on
the taxpayer, and requires payment of a fee. For more information about general
information letters and private letter rulings, please see Department Rule 1 CCR 201-1,
24-35-103.5.
The Department treats this request as a general information letter. It is important to
remember that general information letters, such as this one, are general discussions of tax
law and are not binding on the Department. If Company would like the Department to
issue a private letter ruling on the issue raised here, Company can submit a request and
pay the fee in compliance with Department Rule 1 CCR 201-1, 24-35-103.5.
Issue
What is the proper application of sales and use tax for various types of change orders
relating to long term leases?
Background
Company is in the business of leasing tangible personal property for more than three
years in duration. During the initial term of the lease, the lessee may request certain
changes to the lease, such as replacement equipment (to replace obsolete equipment)
that either increases the amount of the monthly lease payment or has no effect on the
amount of the monthly lease payment. Customer may also request additional equipment
during the original lease period that requires an increase in the lease payment for the
duration of the lease period.

Structure of Analysis
To determine whether Company’s transactions are treated as a short term or long term
lease for sales tax purposes, the Department will examine the following question:
1. When a lessor adds or replaces new equipment to an existing long term lease at a
time when there is three years or less remaining on the long term lease, does the
modification require lessor to treat the replaced or new equipment as a short term
lease, which requires lessor to pay sales tax on such property at the time lessor
acquires the replacement or additional equipment, or can lessor continue to collect
sales tax on the lease payments pursuant to §§39-26-102(23) and 713(1)(a),
C.R.S.?
Discussion
The question presented here is whether the addition of property to a long term lease
(leases for more than three years) at a time when there is three years or less remaining on
the lease means that the new property should be treated as a short term lease or whether
the lessor can treat the property as part of the long term lease. Company represents that
the duration of the initial term of existing lease remains unchanged when property is added
to the lease.
The replacement of existing equipment with new equipment does not alter the fact that the
lease is a long term lease. If a lessor enters into a long term lease for a printer and
guarantees the performance of the printer, the lease is not converted to a short term lease
simply because near the end of the long term lease, the printer is replaced with a new
printer. Colorado treats long term leases of tangible personal property as an installment
sale of the property and requires the lessor to collect sales tax on each lease payment.1
However, if the property does not simply replace the existing property but is more correctly
viewed as additional property added to the lease, then the addition of the new property in
the last three years of a lease is properly viewed as a short term lease. For example, if
the original lease was for a single printer and the lessee decides within three years of the
lease expiration that it would like to add an additional printer under the lease, then the
lease of that additional printer is a short term lease. The Department would likely have the
same view if the original lease expressly stated that the lessee to has the option to add
more leases. Colorado does not treat short term leases of tangible personal property as an
installment sale. Instead, the lessor is treated as the consumer of the leased property and
must pay sales tax when it acquires the leased property. However, the Department may
grant the lessor permission to acquire the leased property exempt from tax and collect the
sales tax on the lease payments throughout the lease.2 The Department liberally grants
this permission.
Miscellaneous
This letter represents the good faith opinion of Department personnel who are
knowledgeable on state taxes issues. However, the Department does not make a specific
determination here on any of the issues raised and the Department is not bound by this
general information letter.
1
2
2

§ 39-26-102(23), C.R.S.
§ 39-26-713(1)(a), C.R.S.
DR 4010A (06/11/14)

The Department administers state and state-administered local sales and use taxes. This
letter does not address sales and use taxes administered by home-rule cities and homerule counties. You may wish to consult with local governments which administer their own
sales or use taxes about the applicability of those taxes. Visit our web site at
www.colorado.gov/tax for more information about state and local sales taxes.
Enclosed is a redacted version of this letter. Pursuant to statute and regulation, this
redacted letter will be made public within 60 days of the date of this letter. Please let me
know in writing within that 60 day period whether you have any suggestions or concerns
about this redacted letter.
Sincerely,

Office of Tax Policy
Colorado Department of Revenue

3

DR 4010A (06/11/14)