Were a lender-required lease and sublease of the same real property taxable even though the borrower called them a financing arrangement?

Subject

Lease and Sublease Pursuant to Note Agreement

Plain-English summary

The lender-required prime lease and sublease were valid taxable real-property leases, not merely dormant financing documents. Each conveyed an enforceable right of occupancy for stated consideration, and the parties had honored both agreements.

To avoid pyramiding, the intermediary lessee could give the property owner a valid resale certificate and collect tax on the full sublease back to the owner. Alternatively, tax could be collected on the prime lease and credited so the intermediary collected additional tax only on the difference between sublease and prime rent.

What this means for you

Florida looked at the rights and obligations created by the signed documents, not only the parties' financing label or their asserted purpose in a future default.

Common questions

Did the owner's continued physical occupancy prevent a lease? No. The prime lease transferred occupancy rights to the intermediary, which reconveyed them through the sublease.

Could tax be charged twice on the same rent? No. The rule allowed resale-certificate or credit treatment to prevent pyramiding.

Was the current full-sublease-tax arrangement accepted? Yes. Florida deemed it appropriate when the intermediary used a valid resale certificate on the prime lease.

Citations and references

• Fla. Stat. §§ 212.02(10), 212.031, and 213.22
• Fla. Admin. Code rr. 12A-1.038 and 12A-1.070(1), (5), (7)-(9)

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 94A-013

Original ruling text

Feb 15, 1994

Re: TAA 94A-013
Lease and Sublease Pursuant to Note Agreement
s. 212.031, F.S.
Rule 12A-1.070(8), F.A.C.

Dear :

This acknowledges receipt of your letter to the Department,
dated June 3, 1993, requesting a Technical Assistance
Advisement, regarding the real estate transaction described
below.

FACTS

As ascertained from your letter, my telephone conversations
with your colleagues XXX and XXX, and a review of the enclosed
documentation, namely, a copy of the proposed loan commitment, a
copy of the lease, a copy of the amendment to the lease, and a
copy of the sublease, the following conclusions of fact have
been reached by the Department. XXX (hereinafter, Realty) is
the 100% owned subsidiary of XXX (hereinafter, Financial).
Financial is the 100% owned subsidiary of XXX (hereinafter,
Corporation).

XXX (hereinafter, Taxpayer) requested and received a loan
from Corporation. The principal amount of the loan is $XX for a
term of 15 years, with an interest rate of 9.5% per annum for
the first 5 years, and adjustable as stipulated in the loan
agreement.

The proceeds of the loan were used by Taxpayer to purchase
real property from a third party. The loan was secured by: (1)
a valid and perfected first mortgage lien on the real property;
(2) a valid and perfected second lien position on all of the
assets of Taxpayer and its subsidiaries; (3) a life insurance
policy in the face amount of at least $XX million; and (4) a
collateral assignment of rents in favor of Corporation, which

rents are paid by Realty to Taxpayer. The monthly principal and
interest mortgage payments are $XX for the first five years,
subject to change thereafter.

Provision #10 (Special Provisions) of the loan agreement
requires Taxpayer to execute a lease agreement with Realty as
tenant; then Realty (a subsidiary of Corporation's subsidiary)
is to execute a sublease agreement with Taxpayer, thereby
leasing the entire premises back to Taxpayer. This lease and
sublease agreement was required by Corporation as part of the
conditions for the loan to Taxpayer for the purchase of the real
property.

The lease agreement provides that Taxpayer is the landlord
and that Realty is the tenant; the rent is $XX per month, for a
term fourteen years and eleven months, beginning March 1, 1993,
and ending January 31, 2008. The sublease agreement, on the
other hand, provides that Realty is the landlord and Taxpayer is
the tenant; the rent is $XX per month, with identical provisions
to those contained in the lease, regarding the term and the
respective dates. Realty, as sublessor, charges Taxpayer the
sales tax and remits it to the Department. Pursuant to the
lease agreement, Taxpayer receives a monthly check from Realty
in the amount of $XX; and pursuant to the sublease agreement
Realty receives a monthly check in the amount of $XX, to which
is added sales tax.

The result of these lease and sublease agreements is that
both Taxpayer and Realty play various roles in this transaction.
Taxpayer is the mortgagor, lessor and sublessee, while Realty
and its affiliated corporations (Financial and Corporation), is
the mortgagee, lessee and sublessor, as it relates to the
mortgaged property.

TAXPAYER'S POSITION

Taxpayer's position with regard to this transaction is that
the lease and the sublease agreements are a financing
arrangement and not true leases. To support this contention,
Taxpayer points out that Taxpayer is the owner of the real
property; therefore, a sublease back to Taxpayer is a formal

arrangement entered between Taxpayer and Realty, which lacks
substance, but which was nevertheless a formal requirement from
Taxpayer by Corporation in order to comply with the terms of the
loan.

Taxpayer further asserts that Corporation required the
lease and sublease agreements to be implemented only in the
event of default by Taxpayer on the loan. In that manner, if
Taxpayer defaulted on the mortgage payment, Corporation would be
able to obtain immediate occupancy of the premises in order to
continue selling its products from the same site. Therefore,
Taxpayer asserts that this arrangement has a legally binding
effect of providing Corporation with right of reentry without
foreclosure in the event of a loan default or potential sale of
the real property; and to that extent, Taxpayer contends that
only in the event of default or sale, would the lease and
sublease arrangements have any effect. Therefore, these
financial arrangements are only for the future use of property;
accordingly, a taxable privilege does not arise until Taxpayer
defaults on the mortgage and the real property is foreclosed
upon and leased to another party or sold.

ISSUE

1. Will Realty have to pay sales taxes and Taxpayer collect and
   remit taxes on the prime lease?
2. Will Taxpayer have to pay sales taxes and Realty collect and
   remit taxes on the sublease?

DISCUSSION AND DETERMINATION

Section 212.02(10), F.S., provides:
"Lease,'let,' or `rental' means leasing or renting of living
quarters or sleeping or housekeeping accommodations in
hotels, apartment houses, roominghouses, tourist or trailer
camps and real property, the same being defined as follows:

"(h) Real property' means the surface land, improvements thereto, and fixtures, and is synonymous withrealty' and
`real estate.'"

Moreover, Black's Law Dictionary, 5th ed., defines a
"lease" as follows:

"Any agreement which gives rise to a relationship of
landlord and tenant... or lessor and lessee.... Contract
for exclusive possession of lands or tenements for
determinate period."

The Department position is that in order to have a valid
lease three elements must be present: (i) the conveyance of the
right of occupancy or possession, or both, of the real property;
(ii) the flow of consideration in exchange for the right of
occupancy or possession, or both, of the real property; and
(iii) an agreement between the parties as landlord-tenant or
lessor-lessee, which is enforceable.

In terms of the first element, the Department's concludes
that the right of occupancy was conveyed to Realty through the
lease, and then reconveyed to Taxpayer through the sublease.
That is, upon entering into the lease whereby Realty legally
acquired the right of occupancy, the parties subsequently agreed
to enter into a sublease, whereby Taxpayer could again legally
acquire the exclusive right of occupancy of the real property.

As to the second element which must be present in a lease,
the Department concludes that consideration did flow from Realty
to Taxpayer and from Taxpayer to Realty, in the lease and the
sublease as it was expressly stated in each agreement,
respectively. Finally, as to whether the lease and sublease are
enforceable agreements, the Department resolves that the lease
and sublease are enforceable agreements. The Department's
position is supported by all documents reviewed; but, the
Department specifically notes that the parties themselves
intended to enter into enforceable agreements which would
provide rights to remedy any breach of duty by any party, as it
is stated on page 3 (bottom) of your letter.

In conclusion, the Department finds that the lease and
sublease agreements conveyed the right of occupancy to the
lessee and sublessee, in exchange for the stated consideration
in each agreement, and that said agreements are enforceable.

The Department responds to Taxpayer's argument that the
lease and the sublease agreements are a financing arrangement
and not true leases by pointing out that all elements needed for
a valid lease or sublease are present. Furthermore, the
Department is not persuaded that Corporation required the lease
and sublease agreements to be implemented only in the event of
default by Taxpayer on the loan and that therefore these
financial arrangements are for the future use of property and a
taxable privilege does not arise until the real property is
foreclosed upon and leased to another party or sold. These
leases represent the parties' mutual assent, and have been
honored by the parties, since March 1, 1992, (the beginning date
of the lease and sublease). Therefore, the Department recognizes
these agreements as a valid lease and a valid sublease.

Since it has been established that there is a valid lease
and a valid sublease, this discussion will turn to the tax
consequences of this arrangement.

Rule 12A-1.070, F.A.C. provides, in pertinent part, as
follows:

"(1)(a) Every person who rents or leases any real property
or who grants a license to use, occupy, or enter upon any
real property is exercising a taxable privilege...."

"(5) Only one tax on the rental or license fee payable from
the occupancy or use of any real property from which the
rental or license fee is subject to taxation under s.
212.031, F.S., shall be collected, and the tax shall not be
pyramided by a progression of transactions; however, the
amount of tax due the State of Florida shall not be
decreased by any such progression of transactions.

"(7)(a) Where a tenant or person occupying, using, or
entitled to use any real property which is subject to tax
sublets or assigns and collects rentals or license fees on
a taxable portion of the leased or licensed premises, such
tenant or other person shall be required to register as a
dealer and collect and remit the tax on all such sub-

rentals or assignments.

"(9) If a tenant or other person sublets or assigns his
interest in all of the leased or licensed premises, or
retains only an incidental portion of the entire premises,
then such tenant or other person may elect not to pay tax
on the prime lease or license, provided that such tenant or
other person shall register as a dealer and collect and
remit tax due on the sub-rentals or assignments and pay the
tax due on the portion of the rental charges or license
fees pertaining to any taxable space which he retains. If
the tenant or licensee elects not to pay the tax to his
landlord, or other person granting the right to occupy or
use such real property, he should extend to his landlord or
such other person a resale certificate."

As provided in Rule 12A-1.070(7), F.A.C. the person
actually occupying the premises shall collect and remit the tax
on the sublease; however, subsection (8) of that rule permits
the lessee who then sublets the property to take credit for the
tax that he paid to his landlord on the subleased space; and
subsection (9) permits such lessee to elect not to pay tax on
the prime lease, provided that he registers as a dealer and
collects and remits tax on the sublease.

Therefore, when Realty leases the property from Taxpayer,
to then sublease the same property back to Taxpayer, Realty may
elect to extend to Taxpayer a valid resale certificate, in
compliance with Rule 12A-1.038, F.A.C. In such a case, Taxpayer
would then be liable to remit to Realty the entire sales tax
owed on the sublease, and Realty would remit the revenues
collected to the State. This is the current arrangement between
the parties, and the Department deems this arrangement to be
appropriate.

In the alternative, Taxpayer, as Realty's lessor, may
collect from Realty and remit to the State any applicable taxes
on the prime lease monthly rent payments of $XX (i.e., Realty is
the Tenant and Taxpayer is the Landlord). Then, Realty may
collect from Taxpayer any applicable taxes on the $XX difference
between the lease and the sublease and remit it to the State.

That is, Taxpayer would remit to the State any applicable sales
tax collected on $XX, the prime lease, which is the monthly rent
payment on the prime lease; and, Realty would remit to the State
any applicable sales tax on $XX, the sublease, which is the
difference between the prime lease and the sublease rent
payments, taking credit for the tax already paid on the prime
lease.

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
based 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 the confidentiality
of such information, we request you notify the undersigned in
writing within 15 days of any deletions you wish made to the
request or the response.

Sincerely,

Nydia Men‚ndez
Technical Assistant

NM/pb
Con. #9240