When a Texas equipment lease is renewed or extended, does the seller charge sales tax at the old rate from the original lease or the new rate in effect at renewal?

Subject

Operating Lease — Renewals Or Extensions Considered New Leases — Tax Rate In Effect At Time Renewal Is Executed

Plain-English summary

A Texas equipment lessor asked the Comptroller how to tax two of its fixed-term lease products, called "B" leases and "C" leases, in light of a 1991 Hearings Decision. B leases run three to five years at a fixed rate set when the lease is signed, and the customer can renew one or more times up to a maximum of eleven years total; at each renewal the rent is reset based on the equipment's projected fair market value at that time, and at the end the customer can buy the equipment at fair market value. C leases work the same way but also bundle in maintenance service. The lessor's own practice was to treat every renewal or extension as a new lease that incorporates the old one, and it wanted the Comptroller to confirm the tax-rate consequences of that.

The Comptroller ruled that the lessor must collect and remit Texas sales tax during the initial term of both B and C leases at the tax rate in effect when that initial lease was executed. Then, because a renewal or extension is legally treated as a brand-new lease — not a mere continuation of the original one — any renewal or extension term is taxed at the rate in effect on the date the renewal or extension itself is signed. In other words, the tax rate "resets" every time the lease is renewed, following whatever the current rate happens to be at that moment.

What this means for you

Equipment lessors and leasing companies

If your lease agreements allow renewals or extensions (rather than being a single fixed term with no further options), don't assume the tax rate from the original lease carries forward automatically. Each renewal or extension is its own taxable event, and you need to apply the sales tax rate that is in effect on the date the renewal/extension is executed, not the rate from years earlier when the original lease began.

Accountants and tax professionals advising lessors

When state or local sales tax rates change between a lease's original term and a later renewal, build a process to re-check the current rate at each renewal date. This ruling shows the Comptroller's general approach: a lease renewal or extension is a new transaction for sales tax purposes, so rate changes enacted after the original lease was signed still apply to renewal terms.

Lessees negotiating renewal terms

Expect that if your area's sales tax rate has changed since your lease started, your renewal or extension pricing may reflect the new rate rather than the rate you originally locked in.

Common questions

Q: Does the sales tax rate from my original lease term carry over when I renew?
A: No. According to this ruling, a renewal or extension is treated as a new lease, so the tax rate in effect on the date the renewal or extension is executed applies, not the rate from the original signing.

Q: What tax rate applies during the initial term of the lease?
A: The rate in effect at the time the initial lease (the "B" or "C" lease) was executed.

Q: Does it matter whether the lease includes maintenance services (a "C" lease) versus a bare equipment lease (a "B" lease)?
A: No. The Comptroller applied the same rule to both lease types in this ruling — tax at the rate in effect when each term (initial or renewal) is executed.

Q: Can I rely on this letter for my own lease agreements?
A: Only the taxpayer who received this letter can rely on it as a defense in an audit. It shows how the Comptroller reasoned about a specific renewal-based leasing structure, but your facts may differ. See the disclaimer below.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9208L1186F04

Original ruling text

August 18, 1992

Dear ***:

Thank you for your recent letter regarding the applicable tax on fixed term
leases to be charged by your client, *****.

As result of Hearings Decision No. 27,336 issued September 10, 1991, you are
requesting rulings and guidance on the applicable tax rate for the lease term
for "B" and "C" Leases as defined in your letter.

B Leases are generally for a term of three to five years at a fixed lease rate
set by the parties prior to the execution of the B lease. A customer may renew
a B lease one or more times, but not beyond six years from the end of the
initial term. Thus the maximum lease term for a B lease is 11 years. Upon
renewal, the rent is determined by ** using the projected fair market
value of the leased equipment as of the commencement of the renewal term. Upon
expiration of the lease, the customer has an option to purchase the leased
equipment at the fair market value price. The customer is liable, directly or
indirectly, for taxes, charges and fees imposed by any governmental body or
agency. The execution of each renewal or extension of a lease is considered to
be a new lease by **, although it incorporates the previously executed
lease.

The C lease has the same terms as the B lease, but also includes maintenance
services for the leased equipment.

QUESTIONS AND RULINGS

1. Rate of tax during the initial term of B lease?

RESPONSE: ***** must collect, report, and remit Texas sales tax during
the initial term of the B leases, based on the tax rate in effect at the time
the B leases are executed.

2. Rate of tax during the initial term of C lease?

RESPONSE: ***** must collect, report, and remit Texas sales tax during
the initial term of the C leases, based on the tax rate in effect at the time
the C leases are executed.

3. In addition to the ruling requested above, ***** requests guidance on
   the proper rate of Texas sales tax that should be used to compute the tax
   liability during the renewal or extension terms of the B and C Leases.

RESPONSE: A renewal or extension is considered a new lease. ***** must
collect, report, and remit Texas sales tax at the rate in effect at the time
the renewal or extension is executed.

This opinion is based on the facts presented. Other facts though similar may
provide a different result.

If you have other questions or need more information, you may call me at
1-800-252-5555, extension 3-4502. The regular number is 512/463-4600. You may
also write to Tax Administration Division at the above address.

Sincerely,

Gilbert Zamora
Tax Administration Division