Was an equipment sale-leaseback a nontaxable financing arrangement when the company expected to exercise a capped fair-market-value purchase option?

Subject

Sale/Leaseback Transactions

Plain-English summary

The sale-leaseback was a taxable operating lease, not merely a secured loan. The bank kept title through the lease term, the company had to return the equipment if it did not buy it, and the end-of-term option used fair market value capped at 20% of cost rather than a nominal amount under the rule.

Each lease payment was therefore taxable. The company's earlier sale of the equipment to the bank was a separate taxable event unless all occasional-sale requirements were met or the registered bank gave a proper resale certificate for an exclusive leasing purchase.

What this means for you

Financial-accounting classification and economic expectations did not override the rule's specific title-transfer and nominal-option tests.

Common questions

Did the company's intent to exercise the option make the lease financing? No.

Was a 20%-of-cost cap nominal under the cited rule? No. The rule used the lesser of $100 or 1% of total contract price.

Was the initial sale automatically exempt because tax had been paid years earlier? No. It needed its own occasional-sale or resale basis.

Citations and references

• Fla. Stat. § 213.22
• Fla. Admin. Code rr. 12A-1.037(1), 12A-1.038, 12A-1.039, 12A-1.071(1)(d), 12A-1.071(2)(a)1., and 12A-1.071(8)

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 94A-001

Original ruling text

Jan 07, 1994

TAA 94A-001
Re: Technical Assistance Advisement
Sales and Use Tax - Sale/Leaseback Transactions
Rules 12A-1.071(1)(d) and (8) and 12A-1.037(1), F.A.C.

Dear :

This response is in reply to your August 23, 1993, petition
for the Department's issuance of a Technical Assistance
Advisement ("TAA") pursuant to s. 213.22, F.S., concerning the
captioned matter and parties. Your petition 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.
Therefore, the Department is herewith granting your request for
the issuance of a TAA and the ensuing discourse shall embody
said ruling.

DISCUSSION OF FACTS

Your petition and supporting documents impart the following
significant information regarding the issues under advisement
herein:

FROM YOUR PETITION

"On December 20, 1992 the [Company] entered into a Master
Lease Agreement (Master Lease #XXX) (the Master Lease') with [the Bank]. A copy of the Master Lease is attached as Exhibit A. Pursuant to the Master Lease and on the same day the Company also entered into Master Lease Schedule A (Schedule A'). A copy of Schedule A is attached as
Exhibit B. The equipment subject to the Master Lease and
Schedule A (the `Equipment') is equipment which the Company
purchased years ago. The Equipment was subject to sales
and use tax at the time of its original purchase. All of
the Equipment is permanently installed equipment and is an
integral part of the Company's manufacturing process.

"In 1992 the company approached the Bank for a potential
loan. The Equipment, which was then owned by the Company,
was to serve as collateral for the Loan. However, the Bank
suggested, and the Company accepted, a lease in place of
the proposed loan. Accordingly the financing transaction
was structured as a sale' of the Equipment to the Bank, evidenced by a bill of sale, with a simultaneousleaseback' of the Equipment to the Company pursuant to the
Master Lease and Schedule A. Accordingly the transaction,
when viewed as a whole, was a mere secured loan or a
refinancing of the Equipment.

"The Master Lease generally has the characteristics
normally found in `capital' leases. For example, the
Master Lease imposes numerous obligations upon the Company
as Lessee which are duties and obligations normally
associated with the ownership of property and capital
leases:

"1. Paragraph 4 provides that the Master Lease is a
net lease and that the Company's obligation to
pay rent is absolute and unconditional.
Accordingly, even return of the Equipment would
not reduce the Company's obligation to pay rent.
"2. Paragraph 8 requires that the Company keep the
Equipment in good repair and working order.
"3. Paragraph 9 provides that the entire risk of
loss, theft, damage or destruction of the
Equipment is borne by the Company.
"4. Paragraph 10 requires that the Company maintain
all insurance normally associated with the
ownership of property.
"5. Paragraph 12 requires that the Company pay all
taxes and expenses associated with the property,
including any taxes and expenses associated with
ownership of the property, even if the taxes or
expenses are levied against the Bank.
"6. Paragraph 18 makes it clear that in the event of
default the Company is required to pay the Bank
all past and future lease payments and the Bank

is still entitled to the Equipment. Even any
surplus funds are to be retained by the Bank.
"7. Inserted Paragraph 43 requires that the Company
provide additional collateral for the lease
obligation. This additional collateral includes
all of the Company's equipment. The Equipment is
only a small part of the Company's total
equipment.
"8. Inserted Paragraph 44 provides that if the
Company pays off certain other loans with the
Bank then all rentals (past and future) under the
Master Lease become immediately due and payable.

"The Company has determined, after consulting with its
external auditors, XXX, that the Master Lease is a capital
lease for financial accounting purposes because the present
value of all lease payments was greater than 90% of the
fair market value of the Equipment at the inception of the
Master Lease. The Company has accounted for and presented
the Master Lease as a capital lease in its audited
financial statement for the year ended December 31, 1992,
which was reported by XXX to be fairly presented in
accordance with generally accepted accounting principles in
the XXX audit report dated March 5, 1993. A copy of XXX
audit report and the calculation of the 90% test is
attached as Exhibit C.

"Schedule A provides for a purchase option at the end of
the Lease equal to the lesser of the fair market value of
the Equipment or an amount equal to 20% of the Company's
cost basis in property. The Company has determined that
this option is a bargain option for financial accounting
purposes. Furthermore, the Company will have no alternative
except exercise of the option at the end of the lease term,
because:

"1. The Equipment is installed as a part of the plant
assembly line. The dismantling of the Equipment
and the return of the Equipment to the Bank would
result in a shut down of the Company's business
for several months and the cost of the shut down

would cause irreparable damage to the Company;
"2. The Equipment will have a value to the Company
much greater than the option price at the end of
the lease term;
"3. The cost of dismantling the Equipment and
reinstalling new equipment would be prohibitive;
and
"4. The Company has always intended to exercise the
purchase option at the end of the lease term and
has always recognized the economic necessity of
exercising the purchase option.

"A letter signed by the chief financial officer of the
[C]ompany describing reasons why the Company will be
economically bound to exercise the option is attached as
Exhibit D."

The following provisions are found in the document styled
"Master Lease Agreement":

Paragraph 6 of the Master Lease entitled "Expiration of
Term and Return of Equipment" provides in significant part
the following:

"Upon the expiration of the term of this Agreement or
earlier termination of this Agreement, as herein
provided, Lessee shall promptly return the Equipment
at its sole expense and at Lessee's risk, to such
place as Lessor may designate...."

It is express from this paragraph that title to the
Equipment does not pass to the lessee at the end of the lease
term. This is further manifested by Paragraph 7 which provides
that "Title to the Equipment shall at all times remain in
Lessor".

The following provisions are found in the document entitled
"Master Lease Schedule A":

Paragraph 8 of Schedule A sets forth the "End of Lease
Option" which states in pertinent part:

"The option price shall be the then `fair market
value' of the Equipment which shall be an amount
mutually agreed upon by Lessor and Lessee and an
amount not to exceed twenty percent (20%) of Lessor's
cost basis....

"Fair Market Value shall be determined on the basis
of, and shall be equal in amount to, the value which
would be obtained in an arms length transaction
between an informed and willing buyer, each
respectively under no compulsion to buy or sell. Fair
Market Value is synonymous with Fair Market Valuecontinued use. This value is defined as the estimated
amount at which property would be expected to exchange
between a willing buyer and willing seller, neither
being under compulsion, and each having reasonable
knowledge of the relevant facts, with equity to both.
Continued use assumes that the buyer and seller
contemplate retention of the facilities at their
present location for continuation of the current
operations. This definition of fair market value does
not represent the amount that might be realized from a
piece meal disposition of the property in the market
place or from some other use of the property."

Paragraph 9, which covers additional terms and provisions,
and which contains the additional terms relating to the end
of lease option to purchase the equipment provides:

"1. At the end of the lease term, the Lessee may
purchase all, but not less than all, of the Equipment
for its then Fair Market Value. Such Fair Market
Value not to exceed twenty percent (20%) of Lessor's
original cost basis of $1,000,000.00 Fair Market Value
will be defined as Fair Market Value in Use."

There can be no ambiguity in the fact that the above
paragraphs constitute an option for a fair market purchase of
the Equipment at the end of the lease term and by reason thereof
cannot represent a purchase option for a nominal amount.

REQUESTED ADVISEMENT

You endeavor to elicit the following advice from the
Department:

"The taxpayer requests issuance of a technical assistance
advisement finding that the lease of the Equipment pursuant
to the Master Lease and Schedule A to the Master Lease is a
mere financing arrangement and that the payments made to
the Bank under the Master Lease and Schedule A to the
Master Lease are not subject to sales tax because the
payments are in substance merely payments on a loan."

DISCUSSION AND CONCLUSIONS OF LAW

Relevant to the proper sales and use tax treatment of the
sale/leaseback transactions under advisement are the provisions
of Rule 12A-1.071(1)(d), F.A.C., as amended effective October 5,
1992. This paragraph of the rule states:

"Where a contract designated as a lease transfers
substantially all the benefits, including depreciation, and
risks inherent in the ownership of tangible personal
property to the lessee, and ownership of the property
transfers to the lessee at the end of the lease term, or
the contract contains a purchase option for a nominal
amount, the contract shall be regarded as a sale of
tangible personal property under a security agreement
(commonly referred to as a conditional-sale type lease)
from its inception. The purchase option shall be regarded
as a nominal amount if it does not exceed $100 or 1 percent
of the total contract price, whichever is the lesser
amount. (Emphasis Supplied)

Leases fitting this mold might also be referred to as
capital leases, direct financing leases, or leveraged leases.

Since the Master Lease and Schedule A were entered into on
a date (December 20, 1992) subsequent in time to the October 5,
1992, effective date of the above rule paragraph, the Master

Lease and Schedule A are, thus, governed and controlled by said
paragraph. Applying the above paragraph of the rule to the
Master Lease and Schedule A objectively manifests that the
Master Lease and Schedule A do not transfer ownership of the
property to the Company at the end of the lease term and do not
contain a purchase option for a nominal amount (the lesser of
$100 or 1 percent of the total contract price). Therefore, the
Master Lease and Schedule A do not satisfy the description of a
conditional-sale type lease set out in Rule 12A-1.071(1)(d),
F.A.C. Accordingly, classification of the Master Lease and
Schedule A is forced as that of an "operating lease" pursuant to
Rule 12A-1.071(1)(a), F.A.C., which specifies that "All leases
of tangible personal property other than conditional-sales type
leases as described in paragraph (1)(d) of this Rule, are
operating leases."

As we have established under the applicable administrative
law that the Master Lease and Schedule A constitute an operating
lease with a fair market purchase option, we are, therefore,
compelled to conclude that each payment by the Company to the
Bank under the terms of the Master Agreement and Schedule A is
subject to sales tax pursuant to the provisions of Rule 12A1.071(8), F.A.C., which states:

"Each operating lease payment under a lease purchase or
similar agreement which also grants the lessee an option to
purchase the tangible personal property is taxable. When
the option is exercised and title to the property passes to
the lessee-purchaser, no tax is due on that part of the
purchase price upon which lease tax has been paid. Only the
balance of the purchase price required to be paid by the
purchaser upon the exercise of the option is taxable."

CAVEAT

Moreover, you are further alerted to the fact that the sale
of the equipment from the Company to the Bank which preceded the
lease-back to the Company constituted a taxable event unless the
sale satisfied the requirements of an occasional or isolated
sale or unless the Bank was properly registered with the
Department for sales tax purposes at the time of the sale and

tendered a resale certificate in compliance with Rules 12A1.038, 12A-1.039, and 12A-1.071(2)(a)1., F.A.C., in lieu of tax
to support that the purchase was exclusively for leasing
purposes.

In order for the sale of the Equipment by the Company to
the Bank to be deemed exempt as an occasional or isolated sale
the criteria for an occasional or isolated sale set forth in
Rule 12A-1.037(1), F.A.C., must have been fully satisfied. This
subsection of the rule provides in pertinent part the following:

"(1)(a) Occasional or isolated sales of tangible personal
property made by a person who does not hold himself out as
engaged in business are exempt. However, this exemption
never applies to occasional or isolated sales of aircraft,
boats, mobile homes, motor vehicles, or other vehicles in
this state of a class or type required to be registered,
licensed, titled, or documented in this state or by the
United States Government (see Rule 12A-1.007, F.A.C.), or
to sales made by those persons who hold themselves out as
engaged in a business, notwithstanding the fact that their
sales may be few and infrequent.
"(b) An exempt occasional or isolated sale occurs when the
sale is made by the owner of tangible personal property
under the following circumstances:
"1. The seller does not hold himself out as engaged in
business and such sales or series of sales occur no more
frequently than 2 times during any 12 month period. The
third sale or series of sales of tangible items during any
12 month period makes that person engaged in that business,
and that person is required to register as a dealer and to
collect and remit tax on the third sale or series of sales
and on all subsequent sales.
"2. Such sales or series of sales are not made on the same
commercial premises or from a location in competition with
other persons required to collect tax.
"3. Such sale does not involve an aircraft, boat, mobile
home, motor vehicle, or any other vehicle of a class or
type required to be registered, licensed, titled, or
documented in this state or by the United States
Government...."

This response constitutes a Technical Assistance Advisement
under s. 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 s. 213.22, F.S. Our response is
predicated on 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 than
expressed in this response.

You are further advised that this response and your request
are public records under Chapter 119, F.S., which are subject to
disclosure to the public under the conditions of s. 213.22, F.S.
Your name, address, and any other details which might lead to
identification of the taxpayer must be deleted by the Department
before disclosure. In an effort to protect confidential
information, we request you notify the undersigned in writing
within 15 days of any deletions you wish made to the request or
this response.

Sincerely,

Daniel M. Wagner, Jr.
Tax Law Specialist

DW/pb