Were payments taxable under an equipment transaction in which the user retained legal title and possession but transferred ownership rights to a financier and leased those rights back?

Plain-English summary

Company A bought equipment and paid Texas sales tax or accrued use tax. To finance it, A transferred rights and interests in the equipment to Company C for the original purchase price, while retaining legal title and possession, and then made payments under a lease-form agreement.

The Comptroller treated C as a secured creditor and the arrangement as financing rather than a taxable lease. A retained title and possession, bore repair, loss, insurance, and maintenance responsibilities, and held options to reacquire C's ownership rights. Payments from A to C were therefore not taxable.

Common questions

Were the financing payments taxable? No.

What facts supported financing treatment? A retained legal title and possession and bore the equipment's operating risks and costs.

Had tax been paid on the equipment purchase? Yes. A either paid sales tax to the original seller or accrued and remitted use tax.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9004L1028E01

Original ruling text

COMPTROLLER OF PUBLIC ACCOUNTS
STATE OF TEXAS
AUSTIN, 78774

April 18, 1990

Dear ***:

Your letter and accompanying documents concerning a purchase, transfer
of rights and subsequent lease of equipment has been forwarded to our
section by Bob Jeffcoat of the Comptroller's Tax Correspondence Section.

Your correspondence indicates that Company A purchased equipment from
Company B. Along with the purchase price, Company A either paid applica-
ble Texas sales tax to B or accrued Texas use tax.

To finance the equipment, A will sell the "rights and interests in the
equipment" to Company C. Title is not to be transferred to C. The price
of this sale of rights equals the price that A agreed to pay B.

C, as lessor, and A, as lessee, then enter into a lease agreement. Be-
cause A has retained the legal title to the equipment, the rights and
interests are being leased by C to A.

Some of the equipment may be used by A prior to the sale of rights to C.

The leases of the equipment have an initial term (usually one year) and
extended terms. The initial term plus the extended terms equals a time
period that approximates the asset's useful life. The monthly payments
by A to C are the total of: (a) the straight-line amortization of the
asset (b) the cost of commercial paper and (c) fees due to C as lessor.

A assumes all responsibility for damages to the assets, insurance and
maintenance.

Any of the equipment leases can be terminated by A at the end of the
initial term or at any time during the extended term. However, if A
exercises this right, the equipment must be sold and A must transfer
title to the purchaser. If the sales price is more than C's original
cost of the rights and interests less lease payments made by A, A gets
to keep the excess. Generally, C will receive its original cost less
lease payments made by A. If a lease is terminated by A in this manner,
the equipment may not be purchased by A or any of its affiliates.

C can terminate the lease if financing cannot be arranged. A can then
purchase the equipment for an amount equal to C's acquisition cost less
payments received from A.

A can purchase C's ownership interest in the assets at the greater of
the fair market value of the assets at the end of the initial lease
term or at any date in the extended term.

At the end of the extended term, A can renew the lease again at the
fair market rental value for an additional term as specified in the
lease.

A will be considered to be in default on the lease if any of these
events occur: (a) A fails to pay amounts due (b) A fails to maintain
adequate insurance (c) A incurs an adverse court decree (d) A becomes
insolvent or declares bankruptcy (e) A defaults on any debt of over $50
million (f) A provides an inaccurate or false representation or warran-
ty (g) A different group or person acquires control of A (h) there is
a change of 50% or more of A's board of directors.

If A is in default, C has these options: (1) terminate the lease
(2) take immediate possession of the assets whether or not the lease is
terminated (3) sell the assets. A will owe for any amount less than C's
adjusted purchase price. A will receive any excess over C's adjusted
purchase price. (4) use the equipment in its own operations (5)initiate
legal action to enforce the lease or recover damages.

At the and of the lease, including extended terms, if the equipment isn't
sold to A or another purchaser, A must surrender the equipment to C.

This contract between A and C contains rights and options that are nor-
mally not found in "sale and lease-back" agreements. However, I am of
the opinion that the contract does establish corporation C as a secured
creditor. Corporation A does retain legal title and possession, bears
responsibility for repairs, losses and insurance, and does have options
to reacquire C's "rights of ownership" at the lease's termination.

The agreement between A and C is a financing arrangement and the pay-
ments made by A to C are not taxable. A has taken care of the tax con-
sequences of these transactions by either paying sales tax to B or
accruing and remitting tax at the time of the purchase of the equipment
from B.

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

Please write or call if you have any questions. You can call toll-free
at 800-531-5441. Our regular number is 512-463-3830 and our FAX number
is 512-475-0900.

Sincerely,
Larry Koenig
Taxability Section
Legal Services Division