Did an equipment lease become a conditional sale when customers could not return the equipment and had to make a 10% balloon purchase or trade up?

Plain-English summary

An equipment-financing company proposed an addendum to a fair-market-value lease. The addendum removed the customer's ability to return the equipment at lease end and offered only two choices: buy it for a fixed 10% of original cost or roll the remaining unpaid amounts into a new lease for replacement equipment.

IDOR ruled that the arrangement was a conditional sale from the outset. Under either option, the customer was guaranteed to purchase the equipment, so the agreement functioned as purchase financing. All receipts were subject to Retailers' Occupation Tax.

By contrast, a true lease generally had no buyout or only a fair-market-value buyout. The lessor was the end user, owed Use Tax on cost, and Illinois did not tax lease receipts.

IDOR cautioned that its ruling was not an endorsement of the addendum as the best way to structure a conditional sale; it found only that the agreement met the minimum test.

What this means for you

Calling an agreement a lease does not control. Removing the return option and guaranteeing eventual purchase can convert the transaction into a taxable conditional sale even when the final payment is 10% rather than nominal.

This PLR states that it ceases to bind IDOR ten years after September 15, 2016—September 15, 2026—or earlier if relevant law, rules, case law, or facts change.

Common questions

Was the 10% balloon treated as a true-lease buyout? No.

Were all receipts taxable? Yes.

Did IDOR endorse the addendum's drafting? No.

Citations and references

• 86 Ill. Adm. Code 130.2010.
• 35 ILCS 155/1 et seq.
• 2 Ill. Adm. Code 1200.110(e).

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2016.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2016/st-16-0011-plr.pdf

Original ruling text

ST 16-0011-PLR 09/15/2016

LEASING

This letter addresses whether a finance lease is a conditional sale or a true lease. See 86 Ill.
Adm. Code 130.2010. (This is a PLR.)

September 15, 2016

RE:

Request for Illinois Letter Ruling
Conditional Sale Lease Addendum

Dear Xxxxx:
This letter is in response to your letter dated November 4, 2015 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.
Review of your request disclosed that all the information described in paragraphs 1 through 8
of Section 1200.110 appears to be contained in your request. This Private Letter Ruling will bind the
Department only with respect to COMPANY for the issue or issues presented in this ruling, and is
subject to the provisions of subsection (e) of Section 1200.110, governing expiration of Private Letter
Rulings. Issuance of this ruling is conditioned upon the understanding that neither COMPANY nor a
related taxpayer is currently under audit or involved in litigation concerning the issues that are the
subject of this ruling request. In your letter you have stated and made inquiry as follows:
COMPANY 1, an equipment financing division of COMPANY, which is a bank organized
under the National Bank Act, respectfully requests a Private Letter Ruling regarding our
draft addendum being added to a Fair Market Value Lease at lease inception. Our
intention is for the addendum (Exhibit A) to delete and supersede the end of lease term
of the contract and that the new end of lease term is that of a Conditional Sale. Since
the lessor is guaranteed at the time of the lease that the leased property will be sold,
this transaction would then be considered a conditional sale at the outset of the
transaction, thus making all receipts subjects to Retailers’ Occupational Tax.
Attached is a copy of our standard lease agreement (Exhibit B). Some of our customers
prefer to keep the monthly payment lower throughout the lease and then have a balloon

payment at the end. To accommodate this option, we are proposing the attached
addendum to the contract.
Our proposed addendum was informally reviewed by PERSON, Revenue Auditor 3, and
his supervisor. The response was they agreed it would be treated as a Conditional Sale
since the addendum is modifying the buyout terms to the original lease document.
Based on your review of the standard lease agreement and the proposed addendum,
COMPANY 1 respectfully requests that the Department rule that the use of the
addendum at the commencement of the lease would in fact prove the contract to be a
Conditional Sale and not a True Lease.
DEPARTMENT’S RESPONSE:
Please note that 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 lessors are guaranteed at the time of the lease that the leased property will be sold, this
transaction is considered to be a conditional sale at the outset of the transaction, thus making all
receipts subject to Retailers’ Occupation Tax. See 86 Ill. Adm. Code 130.2010.
A true lease generally has no buy out provision at the close of the lease. If a buyout provision
does exist, it must be a fair market value buyout 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. As end users of tangible personal property located in Illinois, lessors owe Use
Tax on their cost price of such property. The State of Illinois imposes no tax on lease receipts.
Consequently, lessees incur no tax liability. See 86 Ill. Adm. Code 130.2010.
The above guidelines are applicable to all true leases of tangible personal property in Illinois
except for automobiles leased under terms of one year or less, which are subject to the Automobile
Renting Occupation and Use Tax found at 35 ILCS 155/1 et seq.
Based on the assertions in your letter, the attached lease agreement, and the Illinois
Addendum To Lease Agreement, it is our opinion that under these agreements your company
engages in conditional sales. Specifically, the Illinois Addendum supersedes the end-of-term options
contained in the lease agreement and instead provides that the customer will not have the option to
return the equipment. The Addendum then goes on to provide that the customer’s two options are to
purchase the equipment at the end of the lease for a fixed 10% of the original cost of the equipment
(“balloon payment”), or add the remaining unpaid payments into a new lease covering new equipment
(“trade-up to keep”). In both circumstances it is our opinion that the customer is guaranteed at the
outset of the agreement to purchase the equipment – using this lease agreement (with the Illinois
Addendum) to finance the purchase of the equipment. Please be advised that this letter should in no
way be construed as an endorsement of the Illinois Addendum as the most suitable manner in which
to structure a conditional sale. Despite the novelty of this approach, we find that the agreement
meets the minimum requirements to be considered a conditional sale – i.e., that the lessor is
guaranteed at the time of the lease that the leased property will be sold.

The factual representations upon which this ruling is based are subject to review by the
Department during the course of any audit, investigation, or hearing and this ruling shall bind the
Department only if the factual representations recited in this ruling are correct and complete. This
Private Letter Ruling is revoked and will cease to bind the Department 10 years after the date of this
letter under the provisions of 2 Ill. Adm. Code 1200.110(e) or earlier if there is a pertinent change in
statutory law, case law, rules or in the factual representations recited in this ruling.
I hope this information is helpful. If you have further questions concerning this Private Letter
Ruling, you may contact me at (217) 782-2844. If you have further questions related to the Illinois
sales tax laws, 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
Chairman, Private Letter Ruling Committee
RSW:SM:bkl