Were payments under a synthetic real-estate lease taxable commercial rent, or were they debt payments under a mortgage financing?

Subject

Real Property Transaction Creates a Lease or a Mortgage

Plain-English summary

The transaction was mortgage financing rather than a taxable commercial real-property lease. The special-purpose lessor held bare title as security, and the agreements expressly treated the business as owner for tax, bankruptcy, commercial-law, and real-estate purposes even though financial accounting called it an operating lease.

The “rent” exactly equaled loan interest and holder yield and went to the financing agent. The lessee paid taxes and operating expenses, maintained the property, bore all risk of loss, granted liens, faced foreclosure remedies, and could purchase the property for the remaining termination value.

Because no true landlord-tenant relationship or market rent existed, the payments were not subject to section 212.031 commercial-rent tax.

What this means for you

The label “lease” did not control. The Department evaluated the entire document set, economics, ownership burdens, remedies, and payoff structure.

Common questions

Q: Were the lease payments taxable rent? No.

Q: What did the Department treat them as? Debt-service payments in a mortgage financing.

Q: Which party bore ownership risk? The taxpayer-lessee.

Citations and references

• Fla. Stat. § 212.031(1)(a) and (c) — commercial real-property rental tax
• Fla. Stat. § 697.01(1) — instruments intended as security
• 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 01A-026

Original ruling text

SUMMARY

QUESTION: Does the subject Lease Agreement between Taxpayer
and Lessor, when considered with all other relevant
documents to the same transaction, constitute a financing
arrangement, rather than a lease or rental of commercial
real property?

ANSWER - Based on Facts Below: Yes. Crucial factors contained
in the documentation of the transaction indicate that the
transaction is in the nature of a mortgage rather than an
operating lease and as such, payments made by Taxpayer,
pursuant to the Lease Agreement, will not be subject to sales
tax imposed pursuant to section 212.031, F.S.

May 21, 2001

Re: Technical Assistance Advisement 01A-026
Sales and Use Tax -- Whether the Subject Real Property
Transaction Creates a Lease or a Mortgage
Sections: 212.031(1)(a), (c), 697.01(1), F.S.
XXX (herein Taxpayer or Lessee)
XXX (herein Lessor)
XXX (herein Lender and Holders)
XXX (herein Agent)
XXX (herein Trustee)

Dear :

This is in response to your request, dated April 6, 2001,
received April 9, 2001, 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.

Documents provided by Taxpayer

You have provided several documents that are relevant to the
transaction. These include the following:

Participation Agreement
Credit Agreement
Guaranty Agreement
Trust Agreement
Mortgage
Security Agreement
Lease Agreement
Lease Supplement Number One
Memorandum of Lease Agreement and Lease Supplement Number One

Facts

The facts as provided in your letter may be summarized as
follows:

Taxpayer proposes to enter into a series of documents with the
Lessor, Trustee, and Lenders in order to finance the acquisition
of the subject real property (herein "property").

The Participation Agreement establishes the overall structure of
the transaction and sets up financing in favor of Trustee to
initially acquire the subject real property. Pursuant to the
Participation Agreement, a Credit Agreement is entered into
among the Trustee, Agent and the Lenders establishing the terms
of the financing arrangement. Subsidiaries of the
Taxpayer/Lessee will guaranty the indebtedness of Lessee
pursuant to a Guaranty Agreement. The Trustee is appointed
pursuant to the Trust Agreement.

The Lessor and Lessee will execute and record a Mortgage,
Assignment of Leases, and a Security Agreement on the property,
collectively granting all of Trustee's and Lessor's rights in
the property to Agent as security for Lenders and Holders.

Finally, the Taxpayer/Lessee will enter into a Lease Agreement
on the property. Mechanically, financing is extended by the

Lenders and Holders to the Trustee in a conduit capacity.
Ninety-seven percent (97%) of the financing is advanced as loans
under the credit facility and supported by Promissory Notes.
Three percent (3%) is advanced as "Holder Advances" by the
Lenders, which are technically an equity advance to Trustee with
a higher fixed yield, but function in the same way as loans.
Thereafter, at Taxpayer/Lessee's direction, the Trustee uses
funds from the credit facility to acquire through Lessor, its
wholly owned single purpose limited liability company, real
property for the benefit of Taxpayer/Lessee. The property is
then immediately leased to the Taxpayer/Lessee by the Lessor
pursuant to the Lease Agreement.

The lease term is for a period of five (5) years. The "rent" on
the Lease (defined in the Participation Agreement as "Basic
Rent") is exactly equal to the interest on the Loan and the
yield on the Holder Advances. Amounts received by the Lessor
are assigned and made to the Agent, for the benefit of the
Lenders. All obligations of the Lessor on the loan are
nonrecourse and limited strictly to the funds received from the
Taxpayer/Lessee.

Pursuant to the Lease Agreement, the Taxpayer/Lessee is
responsible for all of the charges, insurance, taxes, and other
costs associated with ownership of the property, and 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 maintenance
obligations are imposed on the Taxpayer/Lessee, who accepts the
property in its "as is" condition with no warranty of title.
Casualty and condemnation proceeds belong to Taxpayer/Lessee
with no reduction in rent, so long as no default has occurred
under the Lease Agreement. All environmental issues and
problems are at the cost and expense of Taxpayer/Lessee.
Taxpayer/Lessee has control over the granting of easements and
other rights affecting title to the property. If the property
is destroyed, the Taxpayer/Lessee must purchase the property for
the balance owed to the Lenders and Holders. The Lease Agreement
contains language of intent that it is to be treated as a
financing arrangement and also provides the Lessor with remedy
of Foreclosure or Power of Sale.

Upon termination of the Lease, the Taxpayer/Lessee has the
option to purchase the property for the balance owed to the
Lenders and Holders (the "Termination Value") or may elect to
sell the property under a sale option. When the sale option is
selected, sale proceeds are first applied to Lenders. If sale
proceeds exceed the Termination Value, the excess belongs to the
Lessee. If the sale proceeds fall short of the Termination
Value, the Taxpayer/Lessee is required to make up the shortfall
up to the 85% "Maximum Residual Guarantee Amount," which is
defined in the Participation Agreement as the "amount equal to
the product of the aggregate Property Cost for the property
times eighty-five percent (85%) ." If the sale proceeds do not
equal the 85% Maximum Residual Guaranty Amount, then the Lessor
may reject the sale. In the event of significant condemnation,
environmental problem or casualty, the Taxpayer/Lessee is
required to buy the property for the Termination Value. Upon
default, the Lessor may continue to collect rent or may require
the Taxpayer/Lessee to purchase the property at the Termination
Value.

For federal income tax purposes, the Taxpayer/Lessee will treat
the property as its own. The Taxpayer/Lessee will claim all
deductions for depreciation on the property, and interest
expense on the Loans and Holder Advances. The Taxpayer/Lessee
will take no deduction for rental payments. The Taxpayer/Lessee
is treated for federal tax purposes as a conduit, and the Lender
treats the payments as interest income.

Requested Advisement

You have requested an advisement that the subject Lease
Agreement between Taxpayer and Lessor, when considered with all
other relevant documents to the same transaction, constitutes a
financing arrangement, rather than a lease or rental
arrangement. Therefore, payments made in accordance with the
Lease Agreement would not be subject to sales tax pursuant to
section 212.031, F.S.

Law and Analysis

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

It is declared to be the legislative intent 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....

Section 212.031 (1) (c), F.S., provides:

For the exercise of such privilege, a tax is levied in an
amount equal to 6 percent of and on the total rent or
license fee charged for such real 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.

Therefore, it must be determined when analyzing the transaction
as a whole, in light of the parties' intentions, whether the
Lessor is engaged in leasing real property to the
Taxpayer/Lessee, 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, and that, as a result, payments made under the agreement
were not subject to sales tax.

In analyzing the instant transaction in its entirety, an
analogous determination is made. A Landlord/Tenant relationship
does not exist between Taxpayer and Lessor. Thus, there is no
"total rent or license fee" paid by the Taxpayer. The Lessor is
not the landlord, because the transaction represents a financing
arrangement rather than the execution of a lease. This
conclusion is based upon the following factors:

The Taxpayer's principal aim of entering into this complex
transaction is to secure financing for the acquisition of the
subject property that will be treated as an operating lease for
accounting purposes but for all other purposes will be treated
as a borrowing of money secured by a mortgage. The Lessor is
created solely to serve as a single purpose financing entity.
As a consequence, the Lessor is not in the business of engaging
in the conveyance of a lease or the grant of a license to use
real property. Rather, the Lessor is created to serve as an
integral part of the entire financing arrangement. The Lessor
is not a landlord but serves more in the capacity of an
administrator of the transactions. The following language from
the Lease Agreement clarifies the purpose of the transaction:

Section 7.1, of the Lease Agreement, provides:

(a) Lessor and Lessee intend that (i) for financial
accounting purposes with respect to Lessee (A) this Lease
will be treated as an "operating lease" pursuant to
Statement of Financial Accounting Standards No. 13, as

amended, (B) Lessor will be treated as the owner and lessor
or the Property and (C) Lessee will be treated as the
lessee of the Property, but (ii) for federal and all state
and local income tax purposes, bankruptcy purposes,
regulatory purposes, commercial law and real estate
purposes and all other purposes (A) this Lease will be
treated as a financing arrangement and (B) Lessee will be
treated as owner of the Property and will be entitled to
all tax benefits ordinarily available to owners of property
similar to the Property for such tax purposes....

(b) For all other purposes other than as set forth in
Section 7.1 (a) (i), Lessor and Lessee intend this Lease to
constitute a finance lease and not a true lease. In order
to secure the obligations of Lessee now existing or
hereafter arising under any and all Operative Agreements,
Lessee hereby conveys, grants assigns, transfers,
hypothecates, mortgages and sets over to Lessor, for the
benefit of Secured Parties, a first priority security
interest (but subject to the security interest in the
assets granted by Lessee in favor of the Agent in
accordance with the Security Agreement) in and lien on all
right, title and interest of Lessee (now or hereafter
acquired) in and to the Property, to the extent such is
personal property and irrevocably grants and conveys a
lien, deed of trust and mortgage on all right, title and
interest of Lessee (now owned or hereafter acquired) in and
to the Property to the extent such is real property....

There is no economic substance to the Lease Agreement beyond
insuring amortization of the debt. The Lessor does not receive a
rental or license fee in the ordinary sense of the economic
owner of property attempting to maximize income from an
investment by charging a rent or fee determined by the market
value of the improvements. Rather, the "rent" payments here are
exactly equal to the interest on the Loan and the yield on the
Holder Advances. See Participation Agreement, Appendix A-20.
Furthermore, the Taxpayer/Lessee makes all rental payments to
the Agent, who in turn disburses the proceeds to satisfy the
debt owed to Lenders and Holders. See Participation Agreement,
sections 5.5, 8.4, 8.7, and Lease Agreement, sections 3.1 and

3.3.

Finally, the Lease Agreement provides the Lessor with the
default remedies of Foreclosure and Power of Sale, remedies
typically not seen in lease agreements between Landlords and
Tenants. Specifically, section 17.5 of the Lease Agreement
provides:

Without limiting any other remedies set forth in this
Lease, Lessor and Lessee agree that Lessee has granted,
pursuant to Section 7.1 (b) hereof and each Lease
Supplement, a Lien against the Property WITH POWER OF SALE,
and that, upon the occurrence and during the continuance of
any Lease Event of Default, Lessor shall have the power and
authority... to foreclose its interest (or cause such
interest to be foreclosed) in all or any part of the
Property.

Furthermore, the Taxpayer is not a tenant of the Lessor for the
following reasons:

As part of the total financing arrangement, Guarantor will
guaranty the Lessee's rental/payment obligations under the Lease
Agreement. Such a pledge is not typically provided on behalf of
a Tenant in a lease agreement. See Guaranty and Participation
Agreement, section 5.7

As rent, the Taxpayer/Lessee pays monies the sum of which is
directly equal to the interest on the Loan and yield on the
Holder advances rather than a sum that is representative of fair
market rent.

Upon the expiration of the Lease Agreement, Lessee shall have
the option to purchase the property for the Termination Value,
which is an amount equal to the balance owed to Lenders and
Holders. See Lease Agreement, section 20.2

Typical obligations of ownership, risk and maintenance are with
the Taxpayer/Lessee, rather than the Lessor. This is
illustrated in the following sections of the Lease Agreement:

Section 4.1, of the Lease Agreement provides:

Lessee shall pay or cause to be paid all Impositions with
respect to the Property and/or the use, occupancy,
operation, repair, access, maintenance or operation
thereof....

Section 10.1(a), of the Lease Agreement provides:

Lessee, at its sole cost and expense, shall maintain the
Property in good condition, repair and working order... and
make all necessary repairs thereto and replacements
thereof, of every kind and nature whatsoever
...
Section 10.1 (f), of the Lease Agreement provides:

Lessor shall under no circumstances be required to... make
any repairs, replacements, alterations,... make any
expenditure whatsoever in connection with this Lease or
maintain the Property in any way....

All risk of loss for the property, including "damage or
destruction thereof by fire, the elements, casualties, thefts,
riots, wars or otherwise is assumed by Lessee.... See Lease
Agreement, section 24.1

Lessee's payment obligations under the Lease Agreement are
"absolute and unconditional." Section 6.1, of the Lease
Agreement provides:

This Lease shall constitute a net lease, and the
obligations of Lessee hereunder are absolute and
unconditional. Lessee shall pay all operating expenses
arising out of the use, operation and/or occupancy of the
Property. Any present or future law to the contrary
notwithstanding, this Lease shall not terminate, nor shall
lessee be entitled to any abatement, suspension, deferment,
reduction, setoff, counterclaim, or defense with respect to
the Rent, nor shall the obligations of Lessee hereunder be
affected... for any reason whatsoever, including without
limitation by reason of: (a) any damage to or destruction

of the Property... (b) any taking of the Property or any
part thereof or interest therein by Condemnation or
otherwise... (e) any eviction by paramount title or
otherwise; (f) any default by Lessor hereunder... (h) the
impossibility or illegality of performance by Lessor,
Lessee or both... (m) any other cause or circumstance
whether similar or dissimilar to the foregoing....

Upon the detection of hazardous substances on the property,
Lessee is required to either clean up the property, bearing all
such costs, or provide Termination Notice. See Lease Agreement,
section 15.2 If Termination Notice is given, Lessee must
purchase the property for the Termination Value. See Lease
Agreement, section 16.1

Lessee's default or surrender of the property does not reverse
Lessee's rental payment obligations pursuant to the Lease
Agreement. See Lease Agreement, section 17.4 Upon default,
Lessor may require Lessee to purchase the property for the
Termination Value.

Response

Based on the facts, law, and analysis as presented, a
determination is made that the subject transaction is in the
nature of a mortgage rather than an operating lease and, as
such, payments made by Taxpayer, pursuant to the Lease
Agreement, will not be subject to sales tax imposed pursuant to
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 advice, 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., and 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 that 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 that 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,

Shehla A. Milliron
Senior Attorney

Control # 44844