Were rent-to-own agreements true leases or contingent sales for Texas's historical prior-contract exemption?

Plain-English summary

A rent-to-own company asked Texas to treat its customer agreements as contingent sales eligible for a historical prior-contract exemption. The Comptroller's Legal Services Division reviewed the sample contract and concluded the agreements were true leases, not contingent sales.

The customer was not obligated to buy the property. For each period, the customer could renew by making the scheduled payment, return the property, or buy it for the stated cash selling price. Only renewal periods already in effect before July 21, 1987 qualified for the prior-contract exemption.

The attached request emphasized customer intent, eventual ownership rates, repair service, and an IRS Technical Advice Memorandum that treated the contracts as contingent sales for federal purposes. The Texas response did not adopt those arguments.

What this means for you

Under the 1988 ruling, the customer's lack of an obligation to continue payments or purchase the property supported lease treatment. A federal characterization did not change the Texas Comptroller's conclusion on the reviewed contract.

Common questions

Were the contracts contingent sales? No.

How did Texas classify them? As true leases.

Which periods qualified for the prior-contract exemption? Only renewal periods in effect before July 21, 1987.

Did Texas follow the IRS technical advice memorandum? No. The request cited it, but the Texas response reached the opposite classification.

Citations and references

The attached request cited 34 Tex. Admin. Code Rule 3.319 and several historical session-law provisions for the prior-contract exemption. The Comptroller's operative response did not cite a specific provision by number.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/8804L0879D01

Original ruling text

COMPTROLLER OF PUBLIC ACCOUNTS
STATE OF TEXAS
AUSTIN, 78774

BOB BULLOCK
Comptroller April 14, 1988

Dear ***:

Please accept my apology for the delay in responding to your letter of
February 15, 1988 concerning a prior contract exemption for "Rent-to-Own"
contracts.

You had requested that this office rule that the contracts between cor-
poration X and its customers are contingent sales which qualify for prior
contract exemptions. Bob Frederick in our Legal Services Division
reviewed
the sample contract and the information presented in your letter and he
has determined that the contracts are "true leases" rather than
"contingent
sales."

The customer is under no obligation to purchase the tangible personal
property, he is only required to "renew" his agreement by making each
payment as scheduled; return the property; or buy the property for a
"cash selling price." Only those renewal periods in effect prior to
July 21, 1987 will qualify for a prior contract exemption.

This opinion is based on the facts presented. If there are additional or
different facts, the opinion may change.

If you have any questions or need more information, please call our toll-
free number 1-800-531-5441. The regular number is 512/463-4600. You may
write me at the Tax Policy Division.

Sincerely,
Julie Pesl
Tax Policy Division

February 15, 1988

BY MESSENGER

Ms. Julie Pesl
Tax Administration Division
Comptroller of Public Accounts
111 West 6th Street
First Floor
Austin, Texas 78701

Dear Ms. Pesl:

We respectfully request your office to rule on the applicability of
Texas Sales and Use Taxes to the following facts.

Corporation X is in the business of providing "rent-to-own" tangible
personal property to the general public. Corporation X also sells
such tangible personal property to its customers and to the general
public in cases where such property is returned prior to completion
of a "rent-to-own" contract.

Upon taking possession of the tangible personal property, customers
initially sign a contract (attached hereto as Exhibit 1) that states
the following:

1) The name of the customer;

2) A description of the property;

3) The weekly, or semi-monthly payment;

4) The number of payments necessary to obtain ownership;

5) The total cost to obtain ownership;

6) The payment period basis selected;

7) The expiration date of the contract.

The contract also contains the following provisions:

1) A renewal option wherein the customer can renew
the contract by sending Corporation X a weekly, semi-
weekly, semi-monthly or monthly payment before the
end of the payment period.

2) An ownership provision providing that the customer
will obtain ownership of the property, if payments are
made for the period specified in the contract.

3) A cash purchase option wherein the customer can buy
the property at any time for the current cash sales price.
The cash sales price decreases am the customer makes pay-
ments. At the end of the period of payments provided for
in the contract, the purchase option price is zero.

4) A statement that the customer is "not obligated in any
way to renew this agreement or to purchase the property."
If the customer does not desire to purchase the property or
renew the contract, then the lessee's only obligation is to
return the property to Corporation X.

Corporation X's business is primarily a "rental/purchase" or "rent-to-
own" business rather than "rent-to-rent." The intention of Corporation
X is to finance the sale of property to customers that are unable to
obtain credit elsewhere or that have not established a credit history.
The customers generally enter into the purchase agreement with the in-
tention of buying the product. A survey of customer intent has indi-
cated that a substantial majority of the customers entering into the
contracts intend to make all payments under the contract and take title
to the property after the last payment is made. Substantially all of
the items returned before title passes are returned because the customer
is unable to continue the payments, rather than unwilling to continue
the payments. A majority of all contracts entered into by Corporation X
result in the customer obtaining ownership of such property. The payment
period required for ownership approximates a typical finance payment
peri-
od for similar property and is clearly less than the property's useful
life.

A comparison between the cumulative cost of payments under the contract
for the property and the cost of purchasing the same item at a department
store (including finance charges and service policies) showed that the
cost of purchasing at certain department stores was lower than the total
cost of the contract payments to Corporation X for the period necessary
to obtain ownership. This difference is due to the service provided by
Corporation X to the property during the term of the contract, the addi-
tional finance costs associated with the higher risk in financing Corpo-
ration X's customer base, and to some extent is also due to sale
markdowns
by retail outlets. When prices arecompared with retail stores that sell
to poor credit risks, Corporation X's cost to obtain ownership is less than the
retail
stores' sales price.

A slight difference between Corporation X and typical retail stores is
in the area of repairs to property. Retail stores generally do not pro-
vide free property repairs and service on the items sold to their cus-
tomers, unless a separate service contract is purchased by the customer.
As a result, retail store customers' property is covered only by any
manufacturer's warranty. Conversely, Corporation provides free routine
service and normal repairs of the property during the contract period or
until the property is returned by the customer. The customer, however,
is liable if the property is damaged, destroyed, or stolen during the
contract period. Once the contract period has expired and the customer
takes full title to the property, Corporation X no longer provides free
repair service.

In July 1986, Corporation X requested the Internal Revenue Service
("IRS")
to rule on the issue of whether the contracts in question constituted
leases or contingent sales. The IRS ruled in Technical Advice Memorandum
8642009 that these contracts constituted "contingent sales" rather than
"true" leases. A copy of this Technical Advice Memorandum is attached to
this letter as Exhibit 2.

In summary, the contracts in this case are, in effect, the equivalent of
nonrecourse conditional sales. A purchaser under a nonrecourse condi-
tional sale agreement typically has no personal obligation to make any
payment beyond the initial payment. If the purchaser does make all the
scheduled payments, title is transferred to the purchaser. If the pur-
chaser defaults, the seller, who retains a security interest in the
property, merely repossesses the property and neither party has any fur-
ther obligation.Although Corporation X's contract bears some resemblance
to a "lease", the entire nature of the transaction is much more like a
sale, as evidenced by the intent of both the customers and Corporation X,
and by the nature of the contracts, which envision ultimate transfer of
the property to the customer. Although the Texas Tax Code only recog-
nizes two types of leases, "operating leases" and "financing leases" for
sales and use tax purposes, Corporation X's contract is essentially a
hybrid of these two. There is no obligation for a customer to continue
to make the monthly or weekly payments under the contract, yet there is
an anticipation of title transfer at the end of the contract. As a
result, we believe these contracts must be categorized as neither an
operating lease nor a financing lease but rather treated in the nature
of an installment sale with contingent terms.

Based on the foregoing facts and the IRS technical Advice Memorandum,
we respectfully request your office to rule that the contracts signed
between Corporation X and their customers are contingent sales for
Texas Sales and Use Tax purposes, and therefore that these contracts
qualify for the prior contract exemption under Section 6 of Art. 13,
H.B. 122, Laws 1984, 2nd Sp. Sess; Sec. 5A of Ch. 10, Laws 1986, 3rd
Called Sess.; Sec. 4 of Art. 1, Pt. 3, H.B.'s 61 and 176, Laws 1987,
2nd Called Sess; and 34 TAC Sec. 3.319.

We hereby certify the contracts referred to above are not presently be-
ing examined through any audit by the Texas Comptroller of Public
Accounts.

We appreciate your consideration of this request. Of course, should you
have any questions or need any additional information with respect to
this matter, please advise the undersigned at ***.

Very truly yours,