How did Illinois tax computer servers leased for 24 months with a $1 purchase option and then rented to another customer?

Plain-English summary

A technology provider leased computer servers for 24 months with a $1 purchase option, then rented those servers to its customer under a separate contract with another purchase option.

IDOR gave the classification rules rather than expressly tracing tax through both contracts. A nominal or $1 option generally created a conditional sale. The lessor-retailer owed Retailers' Occupation Tax as installment payments were received, and a purchaser acquiring property for resale could give its supplier a resale certificate.

A true lease required no buyout or a fair-market-value option. In that case, the lessor owed Use Tax on equipment cost, Illinois imposed no tax on rental receipts, and the lessee owed no tax. The downstream agreement therefore depended on the terms and price of its own purchase option.

Common questions

Was the upstream $1 option a true lease? Generally no; it indicated a conditional sale.

Could the technology provider buy for resale? A buyer under a conditional-sale chain could provide a valid resale certificate.

Was the downstream rental automatically a true lease? No. Its own purchase option had to be evaluated.

Citations and references

• 86 Ill. Adm. Code 130.2010 and 130.1405
• 86 Ill. Adm. Code 130.220
• 86 Ill. Adm. Code 150.310(a)(3)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2013.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2013/st-13-0008.pdf

Original ruling text

ST 13-0008-GIL 02/05/2013 LEASING
Information regarding the tax liabilities in lease situations may be found at 86 Ill. Adm.
Code 130.220 and 86 Ill. Adm. Code 130.2010. (This is a GIL.)
February 5, 2013
Dear:
This letter is in response to your letter dated November 8, 2012, in which you request information.
The Department issues two types of letter rulings. Private Letter Rulings (“PLRs”) are issued by the
Department in response to specific taxpayer inquiries concerning the application of a tax statute or
rule to a particular fact situation. A PLR is binding on the Department, but only as to the taxpayer
who is the subject of the request for ruling and only to the extent the facts recited in the PLR are
correct and complete. Persons seeking PLRs must comply with the procedures for PLRs found in the
Department’s regulations at 2 Ill. Adm. Code 1200.110. The purpose of a General Information Letter
(“GIL”) is to direct taxpayers to Department regulations or other sources of information regarding the
topic about which they have inquired. A GIL is not a statement of Department policy and is not
binding on the Department. See 2 Ill. Adm. Code 1200.120. You may access our website at
www.tax.illinois.gov to review regulations, letter rulings and other types of information relevant to your
inquiry.
The nature of your inquiry and the information you have provided require that we respond with a GIL.
In your letter you have stated and made inquiry as follows:
COMPANY1 is a CITY-based technology solutions provider comprised of certified
expert consultants and engineers. We are writing to you regarding a sales tax issue
that just came up and we need your guidance on how to conduct this business
transaction correctly.
Our company entered a 24-month lease agreement with COMPANY2 to lease computer
servers with an option to buy these servers at the end of the lease period for one dollar.
Our company is then renting these computer servers to one of its customers for a period
of 24 months with an option to buy these servers at the end of the rental period.
Can you please advise us on the sales tax issue? Can COMPANY2 charge us sales
tax? Do we charge our customer sales tax?
DEPARTMENT’S RESPONSE:
The State of Illinois taxes leases differently for Retailers’ Occupation Tax and Use Tax purposes than
the majority of other states. For Illinois sales tax purposes, there are two types of leasing situations:
conditional sales and true leases. A conditional sale is usually characterized by a nominal or one
dollar purchase option at the close of the lease term. Stated otherwise, if a lessor is guaranteed at
the time of the lease that the leased property will be sold to the lessee, that transaction is considered
to be a conditional sale at the outset of the transaction. Persons who purchase items for resale under
conditional sales contracts can avoid paying tax to suppliers by providing certificates of resale that
contain all the information set forth in 86 Ill. Adm. Code 130.1405. All receipts received by a
lessor/retailer under a conditional sales contract are subject to Retailers’ Occupation Tax. See 86 Ill.
Adm. Code 130.2010. The lessors/retailers generally owe Retailers’ Occupation Tax on any
installment payments when they are received by the lessors/retailers. The lessees/purchasers owe

ST 13-0008-GIL
February 5, 2013
Page 2
corresponding Use Tax on the amount of the installment payments that are collected by the
lessors/retailers.
A true lease generally has no buy out provision at the close of the lease. If a buy-out provision does
exist, it must be a fair market value buy-out option in order to maintain the character of the true lease.
Lessors of tangible personal property under true leases in Illinois are deemed end users of the
property to be leased. See 86 Ill. Adm. Code 130.220. As end users of tangible personal property
located in Illinois, lessors of a true lease owe Use Tax on their cost price of such property.
The State of Illinois imposes no tax on rental receipts. Consequently, lessees incur no tax liability.
As stated above, in the case of a true lease, the lessors of the property being used in Illinois would be
the parties with Use Tax obligations. The lessors would either pay their suppliers, if their suppliers
were registered to collect Use Tax, or would self-assess and remit the tax to the Department. If the
lessors already paid taxes in another state with respect to the acquisition of the tangible personal
property, they would be exempt from Use Tax to the extent of the amount of such tax properly due
and paid in such other state. See subsection (a)(3) of 86 Ill. Adm. Code 150.310.
I hope this information is helpful. If you require additional information, please visit our website at
www.tax.illinois.gov or contact the Department’s Taxpayer Information Division at (217) 782-3336.
Very truly yours,

Richard S. Wolters
Associate Counsel