Was a nine-year machinery sale-leaseback with a 10%-of-cost purchase option a financing lease for Texas tax?

Plain-English summary

An American company planned to buy papermaking machinery, sell it to a German company, and lease it back for nine years. At the end, the American company could buy the machinery for the lesser of fair market value or 10% of its original price.

Expected fair market value after nine years was 60% of original price, so the option price would be one-sixth of fair market value. The Comptroller treated that amount as nominal under Rule 3.294(a)(1)(A)(ii). The transaction was therefore a financing lease, taxed as a sale rather than a lease.

If the American company paid or accrued tax on its initial purchase, the later sale-leaseback was a financing arrangement with no further tax due. If it used a resale certificate for the initial purchase, that purchase was for resale and the later sale-leaseback was taxable as a financing lease.

All parties had to keep records documenting the transactions.

What this means for you

The purchase option's relationship to expected fair market value—not merely its percentage of original cost—drove the lease classification in this letter.

Common questions

Was this an operating lease? No.

Why was the purchase price nominal? The 10%-of-original-cost option was only one-sixth of the machinery's estimated fair market value at the option date.

What if tax was paid on the first purchase? No further tax was due on the described financing arrangement.

What if the first buyer issued a resale certificate? The later sale-leaseback was subject to tax as a financing lease.

Citations and references

• 34 Tex. Admin. Code Rule 3.294(a)(1)(A)(ii) and (b)(2) (financing leases)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9011L1059E01

Original ruling text

COMPTROLLER OF PUBLIC ACCOUNTS
STATE OF TEXAS
AUSTIN, TEXAS 78774

BOB BULLOCK
Comptroller November 16, 1990

Dear **:

Tom Soto has asked me to respond to your FAX of November 8, 1990,
regarding tax treatment of the following sale and leaseback trans-
action.

As I understand it, an American company will purchase certain paper
making machinery, sell the machinery to a German company, and then
lease the machinery back for a term of nine years. The contract
provides that at the end of that time, the American company may pur-
chase the machinery for the lesser amount of: (a) the fair market
value of the equipment at the time the option is to be exercised,
or (b)10% of the original purchase price.

You estimate that the fair market value of the equipment at the end
of the lease term will be 60% of the original purchase price. Thus,
the lessee will have the option to purchase the equipment for 10%
of the original purchase price (that is, one-sixth of the fair mar-
ket value at the end of the lease term). This fraction is small
enough to constitute a nominal price under current Rule 3.294 (a)(1)
(A)(ii). Therefore, the transaction you describe is, as you suggest,
a financing lease under that Rule.

A financing lease is taxed as a sale, and not as a lease. Rule 3.294
(b)(2).

If the American company paid or accrued tax on the initial purchase
of the equipment, the subsequent sale and leaseback will be treated
as a financing arrangement with no further tax due. If the American
company issued a resale certificate in lieu of tax on the initial
purchase, then we will treat the initial purchase as a sale for re-
sale, with the subsequent sale and leaseback transaction subject to
tax as a financing lease.

Of course, all parties must maintain sufficient records to document
these transactions.

This opinion is based on the facts presented. Different facts, though
similar, might lead to different answers. If you have further ques-
tions, feel free to write or call me at 1-800-531-5441, ext. 3-3889.

Sincerely,
John Christian
Taxability Section
Legal Services Division