Were lease amounts recovered through a breach-of-contract judgment or guarantor payment subject to South Carolina sales tax?

Plain-English summary

The South Carolina Department of Revenue ruled that two types of post-default lease recoveries were subject to sales and use tax:

• compensatory damages paid by a lessee after a breach-of-contract judgment; and
• amounts paid by a third-party guarantor after the lessee defaulted.

Both payments were part of the lease's taxable gross proceeds because the lessor would not have received them but for the lease agreement. The result applied to both the stated equipment lease and the capital or finance lease, unless the underlying lease transaction was otherwise exempt.

Facts addressed by the ruling

The ruling considered two noncancellable 60-month arrangements. One was a fair-market-value lease; the other was a finance lease for which tax was paid as monthly installments under § 12-36-2560.

In each situation, the lessee defaulted with a $55,000 deficiency that the lessor charged off. The lessor then recovered $20,000 through a final judgment and $10,000 from a guarantor.

The Department treated both recoveries the same for tax purposes. South Carolina's sale definition included both equipment leases and financed purchases, and each payment traced directly to the original taxable agreement.

The “but for” gross-proceeds test

The ruling applied Meyers Arnold v. South Carolina Tax Commission. Under that decision, a charge belongs in gross proceeds when the seller would not receive it but for the taxable sale.

The litigation damages replaced part of the lessee's unpaid contractual obligation. The guarantor payment likewise satisfied an obligation created to support the lease. Changing the payer or collecting through litigation did not break the connection to the taxable transaction.

The Department compared these recoveries to taxable lease-cancellation fees and a note received in settlement of broken leases in earlier authorities.

Relationship to bad-debt deductions

The ruling also pointed to South Carolina's bad-debt rule. A taxpayer that previously paid tax on an amount later charged off may take a qualifying deduction, but any later payment of that written-off amount must be reported on the first return after collection and taxed.

That rule was consistent with taxing the judgment and guarantor recoveries after the default and charge-off.

What the ruling did not decide

The PLR addressed compensatory amounts arising from the lease obligation. It did not discuss punitive damages, attorney's fees, court costs, or recoveries based on claims independent of the lease.

It also preserved the treatment of an otherwise exempt lease: if the underlying transaction qualified for an exemption, the ruling said the recoveries would not become taxable merely because they were collected through a judgment or guarantor.

Common questions

Q: Does suing the lessee change unpaid rent into nontaxable damages?

A: No. The compensatory judgment remained taxable because it arose from the lease agreement.

Q: Is a guarantor payment taxable even though the guarantor was not the lessee?

A: Yes. The guaranty supported the same lease obligation, so the payment was part of gross proceeds.

Q: Did the ruling distinguish operating and finance leases?

A: No. It reached the same result for both stated arrangements.

Q: Can another lessor rely on this PLR?

A: No. It binds agency personnel only for the requesting taxpayer and exact facts presented.

Citations and references

• S.C. Code Ann. §§ 12-36-910(A) and 12-36-1310(A) — sales and use tax
• S.C. Code Ann. § 12-36-100 — sale includes rental and lease agreements
• S.C. Code Ann. §§ 12-36-90 and 12-36-130 — gross proceeds and sales price
• S.C. Code Ann. § 12-36-90(2)(h) — bad-debt deduction and later collections
• S.C. Code Ann. § 12-36-2560 — installment reporting election discussed for the finance lease
• Meyers Arnold v. South Carolina Tax Commission, 328 S.E.2d 920 (S.C. Ct. App. 1985) — “but for” gross-proceeds test
• SC Private Letter Ruling #88-5 and Commission Decision S-D-92 — lease cancellation and settlement authorities discussed by the ruling

Subject

Sales Tax on Amounts Recovered through Litigation or Guarantor Payments

Source

• Landing page: https://dor.sc.gov/advisory-opinion-search
• Original PDF: https://dor.sc.gov/sites/dor/files/policies/PLR12-3.pdf

Original ruling text

State of South Carolina

Department of Revenue
301 Gervais Street, P. O. Box 12265, Columbia, South Carolina 29211
Website Address: http://www.sctax.org

SC PRIVATE LETTER RULING #12-3

SUBJECT:

Sales Tax on Amounts Recovered through Litigation or Guarantor
Payments
(Sales Tax)

REFERENCES:

S.C. Code Ann. Section 12-36-2560 (2000)
S.C. Code Ann. Section 12-36-910(A) (2000)
S.C. Code Ann. Section 12-36-1110 (Supp. 2011)
S.C. Code Ann. Section 12-36-1310(A) (2000)
S.C. Code Ann. Section 12-36-100 (2000)
S.C. Code Ann. Section 12-36-90 (2000 and Supp. 2011)
S.C. Code Ann. Section 12-36-130 (Supp. 2011)

AUTHORITY:

S. C. Code Ann. Section 12-4-320 (2000)
S. C. Code Ann. Section 1-23-10(4) (2005)
SC Revenue Procedure #09-3

SCOPE:

A Private Letter Ruling is an advisory opinion issued to a specific
taxpayer by the Department to apply principles of law to a specific set of
facts or a particular tax situation. It is the Department’s opinion limited to
the specific facts set forth, and is binding on agency personnel only with
respect to the person to whom it was issued and only until superseded or
modified by a change in statute, regulation, court decision, or another
Departmental advisory opinion, providing the representations made in the
request reflect an accurate statement of the material facts and the
transaction was carried out as proposed.

Questions:

1. Are compensatory damages recovered by MNO, Inc. through litigation for breach of a lease
   contract, as described in the facts, subject to sales and use tax?
2. Are amounts recovered by MNO, Inc. from a third party guarantor of a lease contract after the
   lessee defaults, as described in the facts, subject to sales and use tax?
   Conclusions:
3. Compensatory damages recovered by MNO, Inc. through litigation for a breach of contract, as
   described in the facts, are subject to the sales and use tax unless the lease contract is otherwise
   exempt from the tax.

2. Amounts recovered by MNO, Inc. from a third party guarantor of a lease contract, as
described in the facts, are subject to the sales and use tax unless the lease contract is otherwise
exempt from the tax.
Facts:
MNO, Inc. submitted the following two fact situations which each pose two sales tax issues:
Situation 1. Parties enter into a 60-month fair market value lease contract which is noncancellable and irrevocable. The sales tax is paid to the Department based on each monthly lease
charge. The lessee defaults on the lease prior to the end of the contract term leaving a deficiency
balance of $55,000 which is charged off as a bad debt in accordance with generally accepted
accounting principles. Following the default, one or both of the following occur:
(A) The lessor brings legal action against the lessee and as a result of litigation
receives a final judgment of $20,000 which is paid by the lessee.
(B) The lease has been signed by a third party guarantor. That guarantor pays
$10,000 to the lessor.
Situation 2. Parties enter into a 60-month capital/finance lease agreement which is noncancellable and irrevocable. The sales tax is paid to the Department of Revenue based on each
monthly lease charge in accordance with Code Section 12-36-2560. 1 The lessee defaults on the
lease prior to the end of the contract term leaving a deficiency balance of $55,000 which is
charged off as a bad debt in accordance with generally accepted accounting principles.
Following the default, one or both of the following occur:
(A) The lessor brings legal action against the lessee and as a result of litigation
receives a final judgment of $20,000 which is paid by the lessee.
(B) The finance lease agreement has been signed by a third party guarantor and
that guarantor pays $10,000 to the lessor.
Discussion:
Code Section 12-36-910(A) imposes “a sales tax, equal to [six] 2 of the gross proceeds of sales,
… upon every person engaged … within this State in the business of selling tangible personal
property at retail.”
Code Section 12-36-1310(A) imposes a use tax “on the storage, use, or other consumption in this
State of tangible personal property purchased at retail for storage, use, or other consumption in
this State, at the rate of [six] percent of the sales price of the property, regardless of whether the
retailer is or is not engaged in business in this State.

1

A retailer can elect to pay sales tax on each payment provided the sale is made on an installment basis which
conforms to the provisions of the Uniform Commercial Code in which the retailer takes a security interest. Code
Section 12-36-2560.
2
Code Section 12-36-1110 increased the general sales and use tax rate by 1% from 5% to 6%.

2

Code Section 12-36-100 defines a sale, in part, to mean “any transfer, exchange, or barter,
conditional or otherwise, of tangible personal property for a consideration including … a rental,
lease, or other form of agreement.…”
Situation 1 involves leasing tangible personal property. Situation 2 involves a capital lease in
which the tangible personal property is purchased through a financing agreement. Since South
Carolina imposes the sales and use tax on both leases of tangible personal property and sales of
tangible personal property under financing agreements, for purposes of the questions presented,
the answers and legal analysis for Situation 1 and Situation 2 are the same.
The first issue in each situation is whether amount received from the lessee as a payment of a
judgment from litigation is subject to sales and use tax. The second issue in each situation is
whether amount received from a third party guarantor after the default of the lessee is subject to
sales and use tax. The legal authority and analysis for both of these issues is the same.
Under Code Section 12-36-910 the sales tax is computed based on “the gross proceeds of sales.”
Code Section 12-36-90 defines the term “gross proceeds of sales,” in part, as:
Gross proceeds of sales, or any similar term, means the value proceeding or
accruing from the sale, lease, or rental of tangible personal property.
Under Code Section 12-36-1310, the use tax is computed based on the sales price of tangible
personal property. The term “sales price” is defined in Code Section 12-36-130, in part, as:
…the total amount for which tangible personal property is sold, without any
deduction for the cost of the property sold, the cost of the materials used, labor or
service cost, interest paid, losses, or any other expenses….
In Meyers Arnold v. South Carolina Tax Commission, 285 S.C. 303, 328 S.E.2d 920 (1985), the
Court of Appeals, in interpreting the definition of “gross proceeds of sales” with respect to layaway fees paid in conjunction with lay-away sales, held:
Section 12-35-30 [now Section 12-36-90] defines gross proceeds of sales as “the
value proceeding or accruing from the sale of tangible personal property …
without any deduction for service costs.” But for the lay away sales, Meyers
Arnold would not receive the lay away fees. The fees are obviously charged for
the services rendered in making lay away sales. For these reasons, this court holds
the lay away fees are part of the gross proceeds of sales and subject to the sales
the tax.
Applying the test in Meyers Arnold to the current fact situation, but for the lease agreement, the
lessor would not have received the judgment as a result of litigation or the third party guarantor
payment. As a result, under the Meyers Arnold test, compensatory damages received as a result
of litigation and payments from a third party guarantor as a result of the failure of the lessee to
make lease payments would be part of the gross proceeds that are derived from the lease
agreement.
3

The Department has also addressed issues similar to the one presented in this ruling request. In
Private Letter Ruling #88-5 the Department found that lease cancellation fees are subject to the
sales tax. In Private Letter Ruling #88-5, the lessee returned equipment to the lessor before the
end of the lease term. The lessor had the option to hold the lessee to the terms of the lease,
release the lessee from the lease, or release the lessee from the lease upon payment of a
cancellation fee. The amount of the cancellation fee was within the discretion of the lessor.
Upon payment of the cancellation fee the lease was cancelled and the lessee was relieved of
future payments. The issue in this private letter ruling was whether the cancellation fee was
subject to sales tax. Citing, in part, Meyers Arnold, the private letter ruling concludes that
amounts paid by a lessee to obtain cancellation of the lease are gross proceeds of sales and
subject to the State’s sales and use tax.
Similarly, in Commission Decision S-D-92, the Department found that the face value of a note
payable received by a retailer in settlement of amounts due on lease agreements that were broken
by the lessee were taxable proceeds of sale subject to the sales tax.
In both fact situations presented in this ruling, the proceeds received from litigation ($20,000)
and from the third party guarantor ($10,000) are considered part of the gross proceeds of sale or
sales price and subject to the sales and use tax, unless the lease contract is otherwise exempt
under the tax. 3
SOUTH CARLINA DEPARTMENT OF REVENUE

s/James F. Etter
James F. Etter, Director
June 22
, 2012
Columbia, South Carolina

3

This conclusion is also consistent with the bad debt provision in Code Section 12-36-90(2)(h) which provides that
gross proceeds of sale does not include:
[T]he sales price, not including sales tax, of property on sales which are actually charged off as
bad debts or uncollectible accounts for state income tax purposes. A taxpayer who pays the tax on
the unpaid balance of an account which has been found to be worthless and is actually charged off
for state income tax purposes may take a deduction for the sales price charged off as a bad debt or
uncollectible account on a return filed pursuant to this chapter, except that if an amount charged
off is later paid in whole or in part to the taxpayer, the amount paid must be included in the first
return filed after the collection and the tax paid. (Emphasis Added).

4