In a sale-leaseback financing transaction, is the original purchase taxable, and is the leaseback to the lessee taxable?

Plain-English summary

A representative asked how Kansas sales/use tax applies to a sale-leaseback - a transaction called a "lease" that is really a financing arrangement - involving steel trash containers and a vehicle. The Department ruled the financing purchase is untaxed but the leaseback is taxable, if certain conditions are met.

Leases are normally taxed - but financing "leases" are treated as sales. Under K.S.A. 79-3603(h), Kansas taxes "the gross receipts from the service of renting or leasing tangible personal property." But the Department has ruled that 79-3603(h) "does not apply to any transaction which is required to be reported as a sale and purchase by the lessor and lessee . . . for federal income tax purposes." If the subject is tangible personal property, such a transaction "would be considered a sale of such property, subject to the tax imposed by K.S.A. 79-3603(a)." For a "lease" that is really a sale, gross receipts are the federal-income-tax sales price (accrual basis) or each lease payment minus interest/other charges (cash basis).

How the sale-leaseback is taxed here. The Department determined the described sale-leaseback "will be considered a financing transaction," so "the original purchase by the lessor of the steel trash containers and the vehicle would not be subject to Kansas sales or use tax, but the leaseback to the lessee would be subject to Kansas sales or use tax," if it meets three criteria: (1) one document, agreement, or contract controls both the sale and the leaseback; (2) the leaseback is properly accounted for and reported as a sale and purchase by lessor and lessee for federal income tax purposes; and (3) the lessor (a third-party bank) is properly registered to collect and remit Kansas sales/use tax.

The raw materials are separately exempt. The Department added that the client "would be able to purchase the raw materials to manufacture the steel trash containers exempt from sales tax pursuant to K.S.A. 79-3606(m), as tangible personal property which becomes an ingredient or component part of property manufactured for ultimate sale at retail."

Bottom line: in this sale-leaseback financing, the lessor's original purchase is not taxed, the leaseback to the lessee is taxed (subject to the three conditions), and the manufacturer's raw materials for the containers are exempt as ingredient/component parts.

What this means for you

Businesses using sale-leaseback financing

Where a "lease" is really a financing transaction - reported as a sale/purchase for federal income tax - Kansas treats it as a sale, not a rental. In the structure here, the original purchase by the financing lessor was untaxed, but the leaseback to the operating lessee was taxable.

Meet the three conditions

The treatment depends on: one controlling document for the sale and leaseback; the leaseback being reported as a sale/purchase for federal income tax; and the lessor (e.g., a third-party bank) being registered to collect and remit Kansas tax. Missing any of these can change the result.

Manufacturers: raw materials can be exempt

If you manufacture the property (here, steel trash containers) for ultimate retail sale, the raw materials can be purchased exempt under K.S.A. 79-3606(m) as ingredient or component parts.

Common questions

Q: Is the original purchase in a sale-leaseback financing deal taxable in Kansas?
A: No. The Department treated it as a financing transaction, so the lessor's original purchase of the containers and vehicle was not subject to Kansas sales or use tax.

Q: Is the leaseback to the lessee taxable?
A: Yes, if one document controls both the sale and leaseback, the leaseback is reported as a sale/purchase for federal income tax, and the lessor is registered to collect Kansas tax.

Q: Can the manufacturer buy the raw materials tax-free?
A: Yes. Raw materials that become an ingredient or component part of the manufactured containers are exempt under K.S.A. 79-3606(m).

Citations and references

• K.S.A. 79-3603(h) - imposes sales tax on the gross receipts from renting or leasing tangible personal property; it does not apply to a transaction required to be reported as a sale and purchase for federal income tax purposes.
• K.S.A. 79-3603(a) - imposes sales tax on retail sales; a "lease" that is really a sale of tangible personal property is taxed under this subsection, with gross receipts measured by the federal-income-tax sales price (accrual) or each lease payment minus interest/charges (cash basis).
• K.S.A. 79-3606(m) - exempts raw materials that become an ingredient or component part of property manufactured for ultimate retail sale; applied to the raw materials used to make the steel trash containers.

Source

• Landing page: Kansas Department of Revenue Policy Information Library
• Original document: P-2001-028

Original ruling text

Private Letter Ruling

Body:

Office of Policy & Research

March 27, 2001

TTTTTTTTTTTTTTT

Dear Mr. TTTTTT:

We wish to acknowledge receipt of your letter dated February 16, 2001, regarding the application of Kansas Retailers’ Sales tax.

K.S.A. 79-3603(h) imposes a sales tax upon: “the gross receipts from the service of renting or leasing tangible personal property. . .”

In your letter you have raised the question as to whether certain transactions referred to as “leases” but in fact are in the nature of financing transactions, should be subject to the tax imposed by K.S.A. 79-3603(h).

On this regard, the Department of Revenue has ruled that K.S.A. 79-3603(h) does not apply to any transaction which is required to be reported as a sale and purchase by the lessor and lessee respectively for federal income tax purposes. However, if the subject of such transaction is tangible personal property, the transaction would be considered a sale of such property, subject to the tax imposed by K.S.A. 79-3603(a).

In the case of a transaction which is referred to as a “lease” but which constitutes a “sale” for sales tax purposes, the gross receipts upon which any Kansas sales or use tax may be due must equal to whichever of the following situations is applicable:

1) When reporting sales or use tax on an accrual basis, gross receipts are defined as the sales price, as determined for federal income tax purposes.

2) When reporting sales or use tax on a cash basis, gross receipts are the amount of each lease payment, minus interest or other charges, as determined for federal income tax purposes.

The department has determined that the sale-leaseback transaction that you have described in your letter will be considered a financing transaction, and the original purchase by the lessor of the steel trash containers and the vehicle would not be subject to Kansas sales or use tax, but the leaseback to the lessee would be subject to Kansas sales or use tax, if it meets the following criteria:

1) Both the sale and the leaseback are contracted for and controlled by one document, agreement or contract.

2) The leaseback is property accounted for, and reported as, a sale and purchase by the lessor and lessee respectively for federal income tax purposes.

3) The lessor (third party bank) is properly registered to collect and remit the appropriate Kansas sales or use tax.

In closing, your client would be able to purchase the raw materials to manufacture the steel trash containers exempt from sales tax pursuant to K.S.A. 79-3606(m), as tangible personal property which becomes an ingredient or component part of property manufactured for ultimate sale at retail.

This is a private letter ruling pursuant to K.A.R. 92-19-59. It is based solely on the facts provided in your request. If it is determined that undisclosed facts were material or necessary to an accurate determination by the department, this ruling is null and void. This ruling will be revoked in the future by the operation of law without further department action if there is a change in the statutes, administrative regulations, or case law, or published revenue ruling, that materially effects this private letter ruling. If I may be of further assistance, please contact me at your earliest convenience at (785) 296-7776.

Sincerely yours,

Thomas P. Browne, Jr.
Tax Specialist

TPB

Date Composed: 04/03/2001 Date Modified: 10/11/2001

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