Was an off-balance-sheet real-property lease actually nontaxable mortgage financing?

Subject

Financing Lease Agreement

Plain-English summary

The master lease and related agreements were a mortgage-financing arrangement, so the payments were not taxable rent under section 212.031. The transaction was deliberately structured as a lease for financial reporting but as borrowing secured by a mortgage for tax and commercial-law purposes.

The payments matched interest on the lessor's borrowed funds rather than fair-market rent. The taxpayer bore operating costs and all risk of loss, retained ownership-like tax benefits, had to pay essentially the mortgage balance at termination, and granted mortgage and foreclosure rights in the documents.

What this means for you

The Department looked through the document title to the entire transaction's intent and economic substance. A “lease” label did not establish sales-tax treatment when the arrangement functioned as secured financing.

Common questions

Q: Were the master-lease payments subject to sales tax as rent? No.

Q: What payment fact mattered? The payments equaled interest on borrowed funds rather than fair-market rent.

Q: Did risk of loss matter? Yes; the taxpayer bore it.

Citations and references

• Fla. Stat. § 212.031(1)(a) — tax on leasing real property
• Fla. Stat. § 697.01(1) — instruments intended to secure payment treated as mortgages
• Bridgestone/Firestone, Inc. v. Department of Revenue, DOAH Case No. 92-2483, 15 FALR 4874 (1993)
• Fla. Stat. § 213.22 — Technical Assistance Advisements

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 00A-041

Original ruling text

SUMMARY

QUESTION: Does a set of agreements entered into in
connection with the acquisition or improvement of real
property constitute a lease of the property or a mortgage

financing arrangement?

ANSWER - Based on Facts Below: The set of agreements, even

though one agreement is designated a "lease," constitute a
mortgage financing arrangement when all agreements are
considered together. Some of the relevant factors
considered were that the parties structured the transaction
as a lease in order to secure "off-balance sheet"

financing, the lessee bore all risk of loss, and the rent
charged was not a fair market rent, but rather, equaled the

rate of interest charged on funds borrowed by the lessor.

Jul 25, 2000

Re: Technical Assistance Advisement 00A-041
Sales & Use Tax - Financing Lease Agreement

Sections 212.031(1)(a); 697.01(1), F.S.

Dear:

This is in response to your letter dated May 31, 2000, for the
Department's issuance of a Technical Assistance Advisement
("TAA") concerning the above referenced parties and matter.
Your letter has been carefully examined, and the Department
finds it to be in compliance with the requisite criteria set

forth in Chapter 12-11, F.A.C. This response to your request
constitutes a TAA and is issued to you under the authority of

section 213.22, F.S.

Advisement Requested

You have requested our advisement that the Master Lease

agreement entered into by the Taxpayer and Lessor, when

considered with other relevant agreements pertaining to the same
transaction, constitutes a financing arrangement, rather than a
lease or rental arrangement, and accordingly, payments made
pursuant to the Master Lease are not subject to sales tax under

section 212.031, F.S.

Discussion of Facts

The facts set forth in your letter may be summarized as the
following. The Taxpayer is a corporation that desires to
acquire Florida real property and has a need to finance its
acquisitions. In order to satisfy that need, the Taxpayer
entered into an arrangement with the Lessor, the trustee of a
trust that will acquire and hold title to the real property of

the Taxpayer for the benefit of a consortium of banks and

financial institutions.

The arrangement entered into by the Taxpayer has become a
commonly used financing arrangement sometimes known as a "Tax
Retained Operating Lease," or a "synthetic" lease. The purpose

of structuring a financing arrangement as a synthetic lease is

so that a company acquiring property may treat the transaction,

for financial accounting purposes, as an operating lease and,

for economic and tax purposes, as a purchase of property via a

purchase money mortgage.

A typical synthetic lease arrangement will involve a line of
credit established by a lender (in larger transactions, a group
or consortium of lenders) in favor of a party who acts as
lessor. The lessor is typically a trustee for the benefit of
certain or all of the lenders. The party (the "acquirer") who
ultimately desires to acquire property through such financing
will identify a desired parcel of property and instruct the
lessor-trustee to draw on the line of credit, purchase the
property, and immediately lease the property to the acquirer
under a short-term lease. The lease is structured so that all
incidents of ownership of the property belong to the acquirer,
and all lease payments from the acquirer to the lessor are
identical to the lessor's loan payments to the lender. At the
end of the lease term, the acquirer must either purchase the

property for the loan balance or put the property up for sale

with the proceeds first going to pay off the loan balance (in
which case, the acquirer generally remains liable for the loan
balance in the event that the property does not sell for an

amount sufficient to pay off the balance).

The Taxpayer and the Lessor together entered into a number of
agreements, all dated as of March 6, 2000, and the agreements
together constitute a synthetic lease arrangement as described
above. Those agreements include: 1) Master Agreement, 2) Loan
Agreement, 3) Construction Agency Agreement, 4) Master Lease
Agreement, 5) Florida Lease Supplement and Memorandum of Lease,
and 6) Guaranty Agreement. Pursuant to the agreements, the

Taxpayer has thus far acquired one parcel of Florida real

property.

The Master Agreement was entered into by several parties in
addition to the Taxpayer and the Lessor (The Master Agreement
also contemplates that parties related to the Taxpayer may
become lessees). The Taxpayer's parent agreed to guarantee the
obligations of the Taxpayer. The agent of the lending banks,

and all lending banks, signed the Master Agreement, as did banks
acting as documentation agent and syndication agent. The
Preliminary Statement to the Master Agreement describes the

contemplated transactions:

In accordance with the terms and provisions of this Master
Agreement, the Lease, the Loan Agreement and the other
Operative Documents, (i) the Lessor contemplates acquiring
Land and, in certain cases, the Buildings on such Land
identified by [the Taxpayer]... from time to time, and

leasing such Land and Buildings thereon to a Lessee, (ii)
[the Taxpayer]..., as Construction Agent for the Lessor,
wishes, in certain instances, to construct Buildings on

Land for the Lessor and, when completed, the related Lessee
wishes to lease such Buildings from the Lessor as part of
the Leased Properties under the Lease, (iii) [the
Taxpayer]..., as agent, wishes to obtain, and the Lessor is
willing to provide, funding for the acquisition of the Land

and Buildings, or, in certain instances, the construction

of Buildings, and (iv) the Lessor wishes to obtain, and

Lenders are willing to provide, from time to time,

financing of a portion of the funding of the acquisition of
the Land and Buildings and, if applicable, the construction

of the Buildings.

Section 2.4 of the Master Agreement provides that:

With respect to each Leased Property, it is the intent of

the Lessees and the Funding Parties that for federal, state
and local tax purposes and commercial and bankruptcy law
purposes the Lease shall be treated as the repayment and
security provisions of a loan by the Lessor to the Lessees,
and that the related Lessee shall be treated as the legal

and beneficial owner entitled to any and all benefits of
ownership of such Leased Property and all payments of Basic
Rent during the Lease Term shall be treated as payments of

interest and principal...

The Master Lease Agreement provides the terms and conditions
applicable to all property acquisitions made under the financing
arrangement. As an individual property is acquired, a
supplemental lease is entered into containing provisions that
may apply to that particular property. The terms of the Master
Lease differ from those found in a typical operating lease for
real property. The lease term is short and, at the end of the
term, the Taxpayer must either purchase the property or cause
the property to be sold. The rent payable under the Lease (the
term "Lease" encompasses both the Master and any supplemental
leases) is exactly equal to the interest on the Loan made by the
lenders to the Lessor. Amounts received by the Lessor as rent
are assigned and made to the lenders. All obligations of the
Lessor are non-recourse and limited strictly to the funds
received from the properties. The Taxpayer is totally
responsible for all charges, insurance, taxes, and other costs
associated with ownership of the property, but has no recourse
or reduction in rent for property defects, damage to the

property, title defects, offsets, restrictions, or interference

with use or similar conditions. All risk of loss is upon the
Taxpayer. So long as no default has occurred under the Lease,
casualty and condemnation proceeds belong to the Taxpayer with
no reduction in rent. All environmental issues and problems are

at the cost and expense of the Taxpayer. The Taxpayer has

control over the granting of easements, subleases, and other
rights affecting title. If the property is destroyed, the

Taxpayer must purchase the property for the loan balance.

As indicated, at the end of the lease term, the Taxpayer must
purchase the property or cause it to be sold. Specifically, the
Taxpayer has the option to purchase the property for the loan
balance. In the event of a significant condemnation,
environmental problem, or casualty, the Taxpayer is required to
buy the property for the loan balance. Upon a default, if the
property is sold, any shortfall over the funded amounts of the
loan must be paid by the Taxpayer as liquidated damages. The
Lessor may also elect to continue to collect rent or may require

the Taxpayer to purchase the property.

In the event that the Taxpayer elects not to purchase the
property at the end of the lease term, a remarketing option may
be elected. Remarketing sale proceeds are first applied to a
portion of the debt from the Lessor to the lenders in the form
of "B notes." If sale proceeds fall short of the lease balance,
the Taxpayer is required to make up the shortfall up to a
certain level (the amount of "A notes," plus accrued interest
(also referred to as the "recourse deficiency amount’)). If the
sale proceeds are not sufficient to equal the lease balance,
then either the Lessor or the agent for the lenders may reject
the sale and require the Taxpayer to pay the full recourse
deficiency amount, and in addition, the Lessor takes title,
beneficial and legal, to the property. Thus, in almost any
conceivable event, the Taxpayer must pay at least the loan

balance for the property.

The Master Lease provides the following with respect to the

intent of the parties:

ARTICLE XI.
INTEREST CONVEYED TO LESSEES

Each Lessee and Lessor intend that this Lease be treated,
for accounting purposes, as an operating lease. For all
other purposes, each Lessee and Lessor intend that the

transaction represented by this Lease be treated as a

financing transaction; for such purposes, it is the

intention of the parties hereto (i) that this Lease be

treated as a mortgage or deed of trust... and security
agreement, encumbering the Leased Properties, and that each
Lessee, as grantor, hereby grants to Lessor, as mortgagee
or beneficiary and secured party, or any successor thereto,

a first and paramount Lien on each Leased Property in which
such Lessee has an interest, (ii) that Lessor shall have,

as a result of such determination, all of the rights,

powers and remedies of a mortgagee, deed of trust
beneficiary or secured party available under Applicable Law
to take possession of and sell (whether by foreclosure or
otherwise) any Leased Property, (iii) that the effective

date of such mortgage, security deed or deed of trust shall
be the effective date of this Lease, or the related Lease
Supplement, if later, (iv) that the recording of this Lease

or a Lease Supplement shall be deemed to be the recording
of such mortgage, security deed or deed of trust, (v) that

the obligations secured by such mortgage, security deed or
deed of trust shall include the Funded Amounts and all

Basic Rent and Supplemental Rent hereunder and all other
obligations of and amounts due from each Lessee hereunder
and under the Operative Documents and (vi) that the related
Lessee will be treated as the owner of the Leased

Properties leased by such Lessee for tax purposes.

Section 3 of the Florida Lease Supplement and Memorandum of

Lease (the "Supplement") provides that:

Effective upon the execution and delivery of this Lease
Supplement by Lessor and Lessee, the following terms and
provisions shall apply to the Lease with respect to the

Subject Property:

Pursuant to the Lease, the Lessor and Lessee intend that
for all purposes other than accounting purposes that (sic)
the Lease be and the same is hereby agreed to be a Mortgage

and Security Agreement....

The remainder of the Supplement is essentially a mortgage (the

Taxpayer is designated the "Mortgagor," and the Lessee is

designated the "Mortgagee"), rather than a lease, and includes

the following language:

... MORTGAGOR DOES HEREBY GRANT, BARGAIN, SELL, LIEN,

REMISE, RELEASE, CONVEY, ASSIGN, TRANSFER, MORTGAGE,
HYPOTHECATE, PLEDGE, DELIVER, SET OVER, WARRANTY AND
CONFIRM UNTO MORTGAGEE, ITS SUCCESSORS AND ASSIGNS FOREVER
all of the following: [here follows a description of the

real property, including all improvements and fixtures]...

The Supplement also contains language allowing foreclosure by

the Mortgagee in the event of default by the Mortgagor.

Law and Analysis

Section 212.031(1)(a), F.S., provides that:

every person is exercising a taxable privilege who engages
in the business of renting, leasing, letting, or granting a

license for the use of any real property...

The question that we must answer in this case is whether, when
the transaction is analyzed as a whole in light of the parties’
intentions, the Lessor is engaged in leasing real property to

the Taxpayer, or whether the transaction is in substance a
mortgage arrangement under which bare legal title to the

property is held by the Lessor as security for repayment.

Under certain circumstances, for tax purposes, a document
structured as a lease may be treated as a mortgage.
Bridgestone/Firestone, Inc. v. Department of Revenue, DOAH Case

Number 92-2483, 15 FALR 4874 (1993). The Administrative Hearing

Officer in Bridgestone/Firestone stated, "Although a document

may be called a lease on its face, this in itself is not

dispositive of the issue. Rather, in order to properly determine
the true nature of the transaction, it is necessary to examine
the intention of the parties and the substance of the
agreement." (Paragraph 23). Additionally, the hearing officer
stated: "Initially, it is noted that a taxpayer can treat an

item one way for financial recording purposes and another way

for tax purposes...." (Paragraph 24)

In Bridgestone/Firestone, a sale-leaseback transaction was

examined. In that case, it was determined that the transaction
taken as a whole was a mortgage loan transaction (affirmed by
the Department of Revenue in its final order), rather than a
lease. Great emphasis in the case was placed upon the fact that
the transaction was structured specifically to have the
transaction treated as a lease for accounting purposes, yet

still have the overall economic substance of the transaction
treated as financing for federal tax purposes. In particular,

the taxpayer did not treat the sale-leaseback as a sale,
continued to depreciate the property, and reported payments as
principal and interest. Additionally, the rental payments were
based upon the value of the consideration (interest) for the
financing, not upon the fair market value of the property. The
obligations of the tenant continued even in the case of

condemnation, and the risk of loss stayed with the tenant.

Those factors are also present in the instant case. The sole
purpose of entering into this very complex transaction,

requiring hundreds of pages of documentation, was to secure
financing for the Taxpayer that would be treated as a lease for
accounting purposes but for all other purposes would be treated
as a borrowing of money secured by a mortgage. The Master Lease
clearly states in Section 2.4 that "for federal, state and local

tax purposes and commercial and bankruptcy law purposes the
Lease shall be treated as the repayment and security provisions
of a loan by the Lessor to the Lessees, and that the related
Lessee shall be treated as the legal and beneficial owner
entitled to any and all benefits of ownership of such Leased
Property and all payments of Basic Rent during the Lease Term

shall be treated as payments of interest and principal."

The Supplement further states that the Lease is agreed to bea
mortgage and security agreement and contains standard mortgage
transfer language in that the mortgagor grants, bargains, sells,
conveys, etc., its interests to the mortgagee as security for

its loans. The Supplement also contains language allowing
foreclosure by the Mortgagee in the event of default by the

Mortgagor.

As indicated, the Administrative Hearing Officer in

Bridgestone/Firestone also focused on other factors in reaching

his decision, such as whether the rent charged is a fair market
rent or some mix of interest and principal; and which party

bears the risk of loss and certain expenses.

As in Bridgestone/Firestone, the payments being made under the

Lease, although described as rent for accounting purposes, bear
no relationship to what might be the fair rental value of the

real property. Instead, the payments are precisely equal to the
interest due on the funds borrowed by the Lessor for acquisition

of the property.

The Administrative Hearing Officer in Bridgestone/Firestone also

focused on the fact that the Taxpayer bore the risk and expense
of certain obligations. Here, the Taxpayer pays all costs for
using and operating the property, and upon termination of the
Lease, has the absolute obligation to pay to the Lessor an
amount that is essentially the balance due on the mortgage loan.
Such obligation survives condemnation. Additionally, all risks

of loss of the property, including damage or destruction by

fire, the elements, casualties, thefts, riots, wars, or

otherwise, are assumed by the Taxpayer.

Accordingly, under the terms and conditions of all of the

documents presented, as in Bridgestone/Firestone, it is our

conclusion that the Lease between Lessor and Taxpayer more
closely resembles a mortgage loan than it does an arrangement

for the use of property.

Section 697.01(1), F.S., provides:

All conveyances, obligations conditioned or defeasible,
bills of sale or other instruments of writing conveying or
selling property, either real or personal, for the purpose

or with the intention of securing the payment of money,

whether such instrument be from the debtor to the creditor
or from the debtor to some third person in trust for the
creditor, shall be deemed and held mortgages, and shall be
subject to the same rules of foreclosure and to the same

regulations, restraints and forms as are prescribed in

relation to mortgages. (Emphasis added)

Section 697.01(1), F.S., thus provides that even though the
documentation of a transaction may not be denominated as a
"mortgage," it will be treated as such if entered into for the

purpose of securing the payment of money. Here, the transaction

is denominated as a lease for financial accounting purposes, but

is also specifically denominated, in the Supplement, as a

mortgage. Payments made by Taxpayer under the Master Lease are
therefore not considered lease payments and are not subject to

sales tax under section 212.031, F.S.

This response constitutes a Technical Assistance Advisement
under section 213.22, F.S., which is binding on the Department
only under the facts and circumstances described in the request
for this advise, as specified in section 213.22, F.S. Our
response is predicated upon those facts and the specific
situation Summarized above. You are advised that subsequent
statutory or administrative rule changes or judicial
interpretations of the statutes or rules upon which this advice

is based may subject similar future transactions to a different

treatment from that which is expressed in this response.

You are further advised that this response, your request and
related backup documents are public records under Chapter 119,
F.S., which are subject to disclosure to the public under the
conditions of section 213.22, F.S. Confidential information
must be deleted before public disclosure. In an effort to
protect confidentiality, we request you provide the undersigned
with an edited copy of your request for Technical Assistance
Advisement, the backup material and this response, deleting
names, addresses and any other details which might lead to
identification of the taxpayer. Your response should be
received by the Department within 15 days of the date of this

letter.

Sincerely,

Robert D. Heyde

Senior Attorney

Technical Assistance & Dispute Resolution

Control #41577