How did Texas calculate tax on an equipment financing lease and its early-settlement payment?

Plain-English summary

The contract was a financing lease because the lessee had to acquire title after paying all rent and other required sums. Under the letter's stated assumptions, the lessor should have charged tax at the lease's inception on the contract value, including all lease payments and the required purchase option, rather than only on the equipment's apparent cost.

Interest or finance charges could be excluded only when the contract separately stated the interest rate or actual interest charge. This contract did neither. The 5% early-termination penalty was taxable, while the early-payment rebate reduced the taxable settlement amount.

Because the original figures were redacted and the answer depended on assumptions about invoicing and prior tax remittance, the preserved letter supplies a method rather than a usable dollar calculation. It also used a historical 5 1/8% tax rate and mentioned a then-pending rule revision, neither of which should be treated as current law.

Common questions

Why was the arrangement a financing lease? Title had to transfer to the lessee after full performance and payment.

Was tax limited to the equipment's original cost? No.

Was the early-termination penalty taxable? Yes.

Did the rebate reduce the taxable amount? Yes, under the letter's assumptions.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/8907L0950C06

Original ruling text

July 21, 1989

Dear ***:

Thank you for your inquiry regarding the taxability of a lease settlement
payment.

The information that you submitted and your letter indicated that you leased
various equipment from ***. You also indicated that you received
differing opinions from our personnel regarding the taxability of the lease
settlement.

In my phone conversation of July 19, 1989, with ** of
**, the lessor, she indicated that the lease settlement included
the following:

Original lease balance - $**
Less: Payments made - ($**)
Remaining lease balance - $**
Less: Rebate - ($**)
5% Penalty - $**
Amount to settle - $**

Since I don't have all the information regarding the lease invoices, tax
remitted, etc., I have answered your inquiry based on the following
assumptions:

1. The sales tax noted in the lease agreement represents tax charged by
   ** to you. That is, ** didn't pay tax to the vendor
   on the equipment.

2. *** remitted the tax to the state at the appropriate time as
   required by Rule 3.294(f)(3))4(B).

3. The "rebate" at settlement represents a reduction of the lease based on
   early payment.

4. Interest or carrying charges weren't billed separately on the invoices
   (billings) to you.

First, the lease that you submitted is a financing lease for sales tax purposes
because title to the property is transferred to the lessee at the end of the
lease term. That is, the lease qualifies as a financing lease under subsection
(a)(l)(A)(i) of the enclosed Comptroller's Rule 3.294 (Rental and Lease of
Taxable Items). In particular, the purchase agreement in the lease states that
"lessee, upon payment in full of all rents and all other sums and performance
of all obligations under the Lease, shall purchase from Lessor the equipment
for the sum of ($***), plus all applicable sales taxes, on an "as
is where is" basis".

Second, ** should have charged tax on $** at the
inception of the lease (60 lease payment at $** plus purchase
option of $** less $** sales tax). The lessor only
charged tax on $** (which was apparently the equipment cost).
Although interest or finance charges under a financing lease aren't taxable if
the rate of interest or the actual interest charged is separately stated in the
contract, the lease contract doesn't specify either a rate of interest or
interest charge. In addition, the lessor should have charged tax on the
purchase option that was required under the lease terms because this is a part
of the lease contract.

Third, the lessor must charge tax on any penalties for early termination of the
lease (Rule 3.294(e)(4)). Therefore, the 5% penalty of $***
assessed for lease termination is taxable.

Fourth, the taxable amount is reduced by the "rebate" of $***.

The lessor should, accordingly, charge tax upon settlement on the following:

Taxable at lease inception (see above) - $**
Less: Taxable amount charged by lessor - ($**)
Plus: Early termination penalty - $**
Less: Rebate - ($**)
Taxable amount at settlement - $***

You should note that penalties are assessed on the tax due based on the
additional taxable amount at the inception of the lease. That is,
$** less $** times the 5 1/8% tax rate. Furthermore,
penalties may also be assessed if tax wasn't remitted as required under Rule
3.294.

In any case, the taxable amounts may vary if the facts differ from the
assumptions that I stated above.

Finally, you should note that subsections (e)(2) and (e)(3) of Rule 3.294 are
being revised to reflect a statutory change which imposes tax on all
installation and charges made by a lessor to a lessee.

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

If you have any questions, please contact Tax Correspondence. You may call toll
free 1-800-252-5555, or our regular number is 512/463-4600. My extension is
3-4662.

Sincerely,

Bob Jeffcoat
Tax Correspondence