On a long-term motor-vehicle lease, does the lessee owe Colorado sales or use tax on the lessor's monthly charge for an optional, separately stated maintenance agreement?

Plain-English summary

A company that leases motor vehicles also sells its lessees an optional, separately stated maintenance agreement for a monthly fee. A third party actually performs the covered maintenance and repairs, billing the company (including sales tax on the parts and materials). The question was whether the lessee has to pay sales or use tax on that monthly maintenance fee.

The Department said no. Colorado taxes each payment on a long-term lease (an initial term longer than three years) of tangible personal property, including vehicles. And under § 39-26-105(4), when a retailer's deal bundles tangible personal property with maintenance or servicing of that property, tax normally applies to the full contract price. But there is a key exception: a maintenance charge is left out of the lessee's tax if it is separately stated (or, if not separately stated, the Department grants permission to account for it on a percentage basis).

The Department leaned on its long-standing mandatory-vs-optional rule from FYI Sales 70. A maintenance agreement the buyer must purchase is taxed up front as part of the price of the thing it covers. But an agreement that is optional and sold as a separate item is not taxed at the time of sale — instead, the party responsible for the warranty/maintenance work pays sales or use tax on the materials it uses. When that work is subcontracted, it's the subcontractor who charges tax on the parts and bills the warranty seller for it. That's exactly this company's setup, so the lessee owes nothing on the maintenance fee and the tax lands on the parts.

The ruling adds one wrinkle about short-term leases. Section 105(4) assumes the lease payments themselves are taxable — always true for long-term leases. On a short-term lease (three years or less), the lessor instead pays sales or use tax when it acquires the vehicle (unless the Department permits it to collect tax on the lease payments). In that situation the lessee still owes no tax on the maintenance charge even if it isn't separately stated — but the lessor remains liable for tax on the maintenance parts.

What this means for you

Vehicle leasing companies and other lessors

If you want your lessees' maintenance charges to stay outside their lease tax, make the maintenance agreement genuinely optional and separately state it. Then don't collect tax on the maintenance fee — but make sure tax gets paid on the parts and materials, either by paying it to your third-party repairer (as this company did) or by accounting for it yourself. If maintenance were instead mandatory and baked into the lease, you'd generally tax the full price up front and owe no further tax on the parts.

Fleet managers and lessees

A separately stated, optional maintenance plan on your vehicle lease should not carry sales tax on its own line. If you see tax charged on an optional maintenance fee, that's worth questioning — the tax belongs on the parts, paid by the provider, not on your monthly maintenance charge.

Accountants and tax professionals

The analysis tracks § 39-26-105(4) and FYI Sales 70's mandatory/optional split, which rests on the more general rule that a service charge is pulled into the TPP's tax base only when it is inseparably intertwined with the taxable property. Note the short-term-lease branch: when the lessor paid tax at acquisition, the maintenance charge is non-taxable to the lessee even if not separately stated, but the lessor still owes tax on the parts.

Common questions

Q: Does my lessee owe sales tax on an optional maintenance plan?
A: Not on the maintenance fee itself, as long as the plan is optional and separately stated. The tax instead falls on the parts and materials used to perform the maintenance, paid by the lessor or its repair subcontractor.

Q: What if the maintenance agreement is mandatory?
A: Then it's generally treated as part of the price of the leased property and taxed on the full contract price up front, and no additional tax is due on the materials used. A company can also seek Department permission to split the contract on a percentage basis.

Q: Who pays the tax on the repair parts?
A: The party responsible for the warranty work. If that work is subcontracted, the subcontractor charges and remits the tax on the parts and bills the warranty seller for it — which is what happened here.

Q: Does this apply to short-term (three years or less) leases?
A: The lessee still owes no tax on the maintenance charge, but the mechanics differ: on a short-term lease the lessor typically pays tax when it acquires the vehicle, and remains liable for tax on the maintenance parts.

Q: Can I rely on this ruling for my own leasing business?
A: No. A private letter ruling binds the Department only for the taxpayer and facts it was issued to and cannot be relied on by anyone else. It shows the Department's reasoning, but your facts may differ — and it doesn't cover self-collected home-rule city taxes.

Citations and references

Statutes and rules:
- § 39-26-105(4), C.R.S. (combination contracts supplying TPP plus maintenance/servicing; percentage-basis election by permission)
- § 39-26-102(12), C.R.S. (purchase price; full price on manufactured articles)
- Department Rule 24-35-103.5 (private letter ruling procedure)

Department guidance:
- FYI Sales 70, "Warranty and Maintenance Agreements" (mandatory vs. optional contracts)
- FYI Sales 6 (Contractors and Retailer-Contractors); FYI General 10 (Consumer Use Tax)

Source

• Landing page: Colorado Sales & Use Tax Letter Rulings
• Original PDF: PLR-15-008.pdf

Original ruling text

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

PLR-15-008 — November 16, 2015

Re: Lessee Maintenance Agreements

You submitted on behalf of the Company a request for a private letter ruling to the Colorado Department of Revenue pursuant to Department Rule 24-35-103.5. This private letter ruling cannot be relied upon by any taxpayer other than the taxpayer to whom the ruling is made.

Issue

Is the lessee liable for sales or use tax on lessor's monthly fee for a maintenance agreement?

Conclusion

No, lessee is not liable for sales or use tax on lessor's monthly fee for the maintenance agreement. Lessor is liable for sales or use tax on tangible personal property used to perform the maintenance agreement.

Background

Company is in the business of leasing motor vehicles to lessees. Company also offers lessees an optional and separately stated maintenance agreement that covers certain maintenance and repair work. Lessees pay a monthly fee for the maintenance agreement. Company engages a third party to perform the maintenance work. Lessees do not pay the third party for maintenance that is covered under the maintenance agreement. The third party bills Company for the maintenance work, including sales tax on parts and materials used to perform the maintenance.

Discussion

Colorado imposes sales tax on each payment a lessee makes on a long-term lease of tangible personal property, including long-term leases of motor vehicles. Long-term leases are leases whose initial lease term is longer than three years. A lessor who also offers a maintenance or service agreement as part of a lease arrangement must collect tax on both the lease payment and the maintenance charge. In particular, § 39-26-105(4), C.R.S. states, in part:

(4) Every retailer conducting a business in which the transaction between the retailer and the consumer consists of the supplying of tangible personal property and services in connection with the maintenance or servicing of the same shall be required to pay the taxes levied under this article upon the full contract price, […]

However, a lessor's charge for maintenance is not included in the calculation of the lessee's sales tax if the charge is separately stated or, if not separately stated, the Department gives lessor permission to separately account for the maintenance charge. Specifically, § 39-26-105(4), C.R.S. states:

[Tax is collected on the charge for maintenance] unless application is made to the executive director of the department of revenue for permission to use a percentage basis of reporting the tangible personal property sold and the services supplied under such contract. The executive director is authorized to determine the percentage based upon the ratio of the tangible personal property included in the consideration as it bears to the total of the consideration paid under said combination contract or sale that is subject to the sales tax levied under the provisions of this part 1. This section shall not be construed to include items upon which the sales tax is imposed on the full purchase price as designated in section 39-26-102 (12).

The Department has issued guidance on the taxation of warranty and maintenance agreements. In FYI Sales 70 "Warranty and Maintenance Agreements," the Department distinguishes between mandatory maintenance contracts that a lessee is required to purchase as part of a lease (or sale) of tangible personal property, and optional maintenance agreements that the lessee can choose not to purchase. This mandatory/optional rule is premised on the more general rule that a charge for a service is included in the sales tax of the tangible personal property if the service is inseparably intertwined with the taxable tangible personal property.

MANDATORY CONTRACTS — For warranties and maintenance agreements which are mandatory and part of the purchase price of the item the warranty covers, in most cases the seller must collect sales tax on the total purchase price. When the warranty is taxed in this manner, no additional sales or use tax is due from the seller or buyer on the materials used in performing the maintenance. […] Colorado sales tax regulations allow an exception […] only for companies that receive permission to enter into a written agreement with the Department of Revenue [to use a percentage basis]. […] An example of a company that might find such an arrangement useful would be a computer company that sells hardware packages bundled with a standard service contract for equipment maintenance.

OPTIONAL CONTRACTS — If the maintenance agreement is optional, and is sold to the customer as a separate item, tax is not normally charged on the contract at the time of sale. The seller responsible for the warranty work must then pay sales or use tax on the cost of the materials used in performing the maintenance. However, a warranty or maintenance agreement seller may elect to charge sales tax on the warranty contract or maintenance to avoid having taxable and nontaxable warranty parts or maintenance components. If the warranty seller contracts with a third party to perform the maintenance work, it is the subcontractor who is responsible for charging and remitting any tax on the materials used. The third party maintenance contractor would normally bill the warranty seller for actual maintenance costs, including sales tax on parts, supplies and materials. […] sales tax is due to the local jurisdictions where the warranty work is being performed, regardless of where the original warranty contract was purchased.

In the present case, Company leases motor vehicles and offers lessees the option to purchase maintenance service that is set forth in a separate contract. Because the maintenance agreement is separately stated and is optional, a lessee's payment for this maintenance contract is not included in the amount on which the lessee's sales tax obligation for the lease of the motor vehicle is calculated.

In general, a lessor that does not collect sales tax on the maintenance contract pays sales tax to the third party for the parts and materials used in connection with the maintenance work. Company represents that it pays sales tax to the third parties for parts and materials used for maintenance.

Finally, subsection 105(4) is premised on the assumption that lease payments are subject to tax. Although this is always the case for long-term leases, sales tax does not apply to lease payments on short-term leases (three years or less), except as noted below. Instead, a lessor of a short-term lease pays sales or use tax when the tangible personal property is acquired. However, the lessor of a short-term lease can acquire the property without paying sales or use tax if the Department gives the lessor permission to collect sales tax on lease payments. In the context of this ruling, if the lessor paid sales or use tax when it acquired the motor vehicles, the lessee is not liable for sales tax on the lessor's charge for maintenance even if the maintenance charge is not separately accounted for or separately stated. The lessor is still liable in such a case for sales tax for the parts supplied pursuant to the maintenance agreement.

Miscellaneous

This ruling is premised on the assumption that Company has completely and accurately disclosed all material facts. […] This ruling is binding on the Department to the extent set forth in Department Regulation 24-35-103.5. It cannot be relied upon by any taxpayer other than the taxpayer to whom the ruling is made. This ruling applies only to sales and use taxes administered by the Department, which administers state and state-collected city, county, and special district sales/use taxes, but does not administer taxes for self-collected home-rule cities and counties.

(Condensed from the official PDF; see the linked source for the complete text and footnotes.)