Were fees paid to cancel noncancelable equipment leases early subject to South Carolina sales and use tax?

Plain-English summary

South Carolina Private Letter Ruling 88-5 held that fees paid to cancel noncancelable equipment leases early were subject to sales and use tax.

XYZ Leasing Corporation owned equipment and leased it to businesses for fixed terms and periodic rent. After accepting delivery, a lessee could not cancel the contract unilaterally. If the equipment was no longer needed, XYZ could insist on the lease, release the lessee without payment, or agree to end the lease in exchange for a negotiated cancellation fee.

The Commission concluded that the fee was part of the lease's "gross proceeds of sales" and "sales price." The payment remained taxable even though it relieved the lessee from future rent and ended the contract.

How XYZ set the cancellation fee

The lease itself was noncancelable once the lessee accepted the equipment. When a lessee asked for an early release, XYZ had discretion whether to agree and how much to charge.

The ruling said XYZ might consider:

• how readily the equipment could be marketed again;
• the parties' potential future business relationship; and
• the equipment's value compared with XYZ's unrecovered investment.

Once the fee was paid, the lease was cancelled and the lessee had no further obligations.

Why the fee remained part of taxable lease proceeds

Section 12-35-510 imposed sales tax on the gross proceeds of a retail business. Section 12-35-30 defined gross proceeds broadly, without deductions for the seller's costs, interest, losses, or other expenses.

Section 12-35-810 imposed complementary use tax based on the sales price of property purchased at retail. Section 12-35-120 likewise defined sales price broadly, including services that were part of the sale and amounts for which the seller gave the purchaser credit.

The Commission treated the cancellation payment as consideration arising from the taxable equipment lease. Ending the lease early did not separate the payment from that lease transaction.

Authorities cited by the Commission

The ruling compared the fee with several other payments held to be taxable proceeds:

• notes received to settle amounts due under broken leases;
• a property-damage-waiver fee charged by a rental shop;
• nonrefundable layaway fees that would not have existed without the layaway sale;
• California early-termination payments included in lease gross receipts; and
• a Vermont lease-cancellation fee treated as a receipt from renting tangible personal property.

The Vermont ruling's explanation, quoted in PLR 88-5, was that the lessor merely accepted less than it was legally entitled to receive under the lease. Whether the payment was labeled rent or a cancellation fee, it remained consideration for the lease.

What this means for you

Equipment leasing companies

PLR 88-5 treated a negotiated early-termination payment as part of the taxable lease proceeds. The label on the invoice did not control the result.

Business lessees

A fee that buys release from future obligations under a noncancelable equipment lease was not treated as outside the lease. The ruling classified it as taxable consideration connected to the rental.

Contract and finance teams

XYZ's fee varied with remarketability, future relations, equipment value, and unrecovered investment, but the discretionary calculation did not change the tax result.

Accountants and tax professionals

The Commission's analysis linked the payment to the underlying taxable lease and the broad statutory definitions of gross proceeds and sales price.

Readers applying the ruling today

PLR 88-5 addressed a specific early-release payment under 1988 law. Current statutes and guidance should be checked for lease buyouts, true damages, stipulated damages, settlement payments, repossession charges, and other termination arrangements with different facts.

Common questions

Q: Were XYZ's cancellation fees taxable?

A: Yes. The Commission included them in gross proceeds of sales and sales price.

Q: Did the result change because the equipment was returned?

A: No. The fee was paid to cancel the noncancelable lease and relieve the lessee from future obligations, and the Commission treated it as lease consideration.

Q: Did the name "cancellation fee" control?

A: No. The ruling focused on the payment's connection to the lease rather than its label.

Q: Did every lessee have a contractual right to cancel for a fee?

A: No. XYZ could refuse concessions, release the lessee for free, or negotiate a fee in its discretion.

Q: How did XYZ calculate the fee?

A: It could consider remarketability, the future business relationship, and equipment value compared with unrecovered investment.

Q: Does PLR 88-5 decide the treatment of every damage or settlement payment?

A: No. It decided a fee paid for release from a specific noncancelable equipment lease under the stated facts.

Q: Can another lessor rely on PLR 88-5?

A: No. The ruling states that it applied only to XYZ's specific facts, had no precedential value, and was not intended for general distribution.

Citations and references

• S.C. Code section 12-35-30 (1976) — gross proceeds of sales
• S.C. Code section 12-35-510 (1976) — sales tax
• S.C. Code section 12-35-810 (1976) — use tax
• S.C. Code section 12-35-120 (1976) — sales price
• S.C. Code section 12-35-515 (1984) — additional one-percent sales and use tax cited in the ruling
• S.C. Code section 12-3-170 (1976) and SC Revenue Procedure 87-3 — private-letter-ruling authority
• State v. Byrnes, 219 S.C. 485, 66 S.E.2d 33 (1951) — sales tax measured by retail business done
• Meyers Arnold Inc. v. South Carolina Tax Commission, 285 S.C. 303, 328 S.E.2d 920 (1985) — nonrefundable layaway fees
• South Carolina Tax Commission Decision S-D-92 and decision dated May 27, 1986 — broken-lease notes and property-damage-waiver fee
• California State Board of Equalization Ruling 330.3307 and Vermont Department of Taxes Ruling 87-13 — early-termination authorities cited in the ruling

Source

• Landing page: https://dor.sc.gov/advisory-opinion-search
• Original PDF: https://dor.sc.gov/sites/dor/files/policies/PLR88-5.pdf

Original ruling text

SC PRIVATE LETTER RULING #88-5

TO:

XYZ Leasing Corporation

SUBJECT:

Lease Cancellation Fees

REFERENCE:

S.C. Code Ann. Section 12-35-30 (1976)
S.C. Code Ann. Section 12-35-510 (1976)
S.C. Code Ann. Section 12-35-810 (1976)

AUTHORITY:

S.C. Code Ann. Section 12-3-170 (1976)
SC Revenue Procedure #87-3

SCOPE:

A Private Letter Ruling is a temporary document issued to a
taxpayer, upon request, and it applies only to the specific facts or
circumstances related in the request. Private Letter Rulings have no
precedential value and are not intended for general distribution.

Question:
Are "cancellation fees" subject to the State's sales and use taxes pursuant to Code
Sections 12-35-510 and 12-35-810?
Facts:
XYZ Leasing Corporation (Lessor) enters into lease contracts allowing businesses
(Lessee) to use equipment owned by the Lessor for a fixed term for a specified amount of
periodic rent. Once the Lessee accepts delivery of the equipment, the contract is noncancelable for the term of the lease.
The Lessee may later find that the equipment is no longer needed and may request to
return such equipment and be relieved of any further obligation under the lease. The
lessor has the option to do any of the following:

1

1.

Hold the Lessee to the terms of the contract and refuse all concessions.

2.

Release Lessee from the terms of the lease free and clear.

3.

Agree to release Lessee from the terms of the lease upon the payment of a
"cancellation fee". The amount of the fee is based upon the discretion of the
Lessor and may be determined by such factors as the remarketability of the
equipment, future business relationship with the Lessee and the value of the
equipment versus the unrecovered investment.

Upon payment of a "cancellation fee", the contract is cancelled and the Lessee is relieved
of all future obligations.
Discussion:
Code Section 12-35-510 imposes "upon every person engaged or continuing within this
State in the business of selling at retail any tangible personal property...an amount equal
to four percent of the gross proceeds of sales of the business" (emphasis added). An
additional sales tax of one percent was imposed pursuant to Code Section 12-35-515 in
1984.
Code Section 12-35-30 defines the term "gross proceeds of sales", in part, as:
…the value proceeding or accruing from the sale of tangible personal property
(and including the proceeds from the sale of any property handled on consignment
by the taxpayer), including merchandise of any kind and character without any
deduction on account of the cost of the property sold, the cost of material used,
labor and service cost, interest paid or any other expenses whatsoever and without
any deductions on account of losses;....
Code Section 12-35-810 imposes an excise or 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 four percent of the sales price of such
property" (emphasis added). This tax was also increased by one percent pursuant to Code
Section 12-35-515.
Code Section 12-35-120 defines "sales price", in part, to mean:
The total amount for which tangible personal property is sold, including any
services (including transportation) that are a part of the sale, valued in money,
whether paid in money or otherwise, and includes any amount for which credit is
given to the purchaser by the seller, without any deduction therefrom on account
of the cost of the property sold, the cost of the materials used, labor or service
cost, interest charged, losses or any other expenses whatsoever.
2

In State v. Byrnes 219 SC 485, 66 S.E.2d 33 (1951) the Supreme Court of South Carolina
stated:
In general, the sales tax is an imposition upon the privilege of the business of
selling at retail and measured by the amount of business done, which is a clear
case of an excise tax...(emphasis added).
The use tax is also "measured by the amount of business done" in that the use tax is
complementary to the sales tax.
Commission Decision S-D-92 was an analogous situation that dealt with the "inclusion in
the taxable proceeds of sales of the face value on notes payable to the taxpayer and
received by it in settlement of amounts due of lease agreements that were broken by the
lessee." The Commission ruled that such notes payable a part of the proceeds subject to
the sales or use tax.
In a Commission Decision dated May 27, 1986 it was concluded that a "property damage
waiver fee" charged by a rental shop was part of the taxable lease proceeds. In addition
in Meyers Arnold Inc. v. South Carolina Tax Commission 285 SC 303, 328 S.E. 2d 920
(1985), App) the court held that non-refundable layaway fees were a part of the "gross
proceeds of sales."
The court stated:
But for the layaway sales, Meyers Arnold would not receive the layaway fees.
The fees are obviously charged for the service rendered in making layaway sales.
For these reasons, this court holds the lay-away fees.....subject to the sales tax.
In addition, the California State Board of Equalization in Ruling Number 330.3307 stated
that "amounts paid by a lessee to obtain an early termination of his lease contract are
includable in gross receipts (11/15/78)" Commerce Clearing House California State
Reporter - Paragraph 60-263 (emphasis added).
California's definition of "gross receipts" is very similar to South Carolina's definition of
"gross proceeds of sales", "gross receipts" and "sales price." California defines "gross
receipts" in part as "the total amount of the sale or lease or rental price...of the rental sales
of retailers, valued in money, whether received in money or otherwise, without any
deduction on account of...(2) the cost of the material used, labor or service cost, interest
paid, losses, or any other expense."
The Vermont Department of Taxes in Ruling 87-13 dated September 28, 1987 held that a
"lease cancellation fee" under similar facts was a receipt from the rental of tangible
personal property. The Department stated:

3

...the cancellation fee you have described is a "receipt" from the rental of tangible
personal property and is therefore subject to tax. In effect the Lessor has simply
agreed to accept less than it is legally entitled to receive under the lease
agreement. The amount that is paid, whether it is nominated rental payments or a
"cancellation fee," is subject to tax as part of the consideration for the lease.
Conclusion:
The "cancellation fees" in question are part of the "gross proceeds of sales" and "sales
price" and therefore subject to the State's sales and use taxes.

SOUTH CAROLINA TAX COMMISSION

s/S. Hunter Howard Jr.
S. Hunter Howard, Jr., Chairman

s/John M. Rucker
John M. Rucker, Commissioner

s/A. Crawford Clarkson Jr.
A. Crawford Clarkson, Jr., Commissioner
Columbia, South Carolina
January 27
, 1988

4