When a company buys equipment under a resale certificate and leases it to a customer, is sales tax owed on the rental payments or on the outstanding balance when the equipment is returned to the vendor?

Plain-English summary

A company that buys equipment from a vendor using a resale certificate and then leases it to a customer (lessee) asked the Comptroller three questions about how Texas sales tax applies, given that the equipment goes back to the vendor at the end of the lease term.

First, the Comptroller held that tax is owed on the rental stream — either accrued on the rental payments as they come due or remitted on each payment as it's received — not on any outstanding balance still owed to the vendor once the equipment is returned. That's because when the lessor returns the equipment to the vendor, the vendor is repurchasing it for resale, and Texas's sales tax law has no provision requiring the lessee to pay tax on any balance still owed on the property.

Second, the Comptroller confirmed this arrangement is an operating lease or rental, not a capital lease, for sales tax purposes. Texas sales tax law generally does not distinguish between "leases" and "rentals" (motor vehicles are the one exception), though it does distinguish between operating leases and financing leases. Because the lessee here never takes title to the equipment, the arrangement is an operating lease/rental. Third, the Comptroller confirmed that Texas's sales tax treatment doesn't differ depending on whether a transaction is labeled a capital lease or a rental — the same rules apply either way.

What this means for you

Equipment lessors buying under a resale certificate

If you purchase equipment tax-free under a resale certificate and lease it out, you owe sales tax on the rental payments themselves (accrued or remitted per payment) — not on any residual or outstanding balance you may owe the original vendor when you return the equipment at the end of the lease. Returning equipment to the vendor for resale does not create a separate taxable event.

Accountants and tax professionals structuring lease agreements

For Texas sales tax purposes, whether an arrangement is labeled a "lease," "rental," or "capital lease" generally does not change the tax treatment (motor vehicles are the exception). What matters for the operating-lease-versus-financing-lease distinction is whether title to the property passes to the lessee — if it doesn't, the arrangement is treated as an operating lease or rental.

Common questions

Q: Do I owe sales tax on the balance still owed to the vendor when I return leased equipment at the end of a lease?
A: No. The Comptroller found no provision requiring tax on any outstanding balance owed the vendor when equipment purchased under a resale certificate is returned for resale — tax is owed only on the rental payments themselves.

Q: Does it matter whether my agreement is called a "capital lease" or a "rental"?
A: No. The letter confirms Texas sales tax law does not vary between capital leases and rentals; the same rules apply either way (with motor vehicles as the one general exception to the lease/rental distinction).

Q: How does the Comptroller decide whether something is an operating lease or a financing lease?
A: Based on this letter, an arrangement is an operating lease (rather than a financing/capital lease) when the lessee does not take title to the property during or at the end of the lease term.

Citations and references

No statutes or administrative rules were cited by number in the original letter.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9405676L

Original ruling text

May 4, 1994

Dear **:

Recently, you wrote requesting information about tax on the rental of equipment
in Texas. As I understand the facts, your company will purchase the equipment
from a vendor and lease it to a lessee. At the end of the lease, the equipment
will go back to the vendor.

You asked three questions:

1. Would the sales tax on this equipment need to (be) paid on the outstanding
   balance or should we pay the sales tax on the rental stream?

Answer: The equipment may be purchased under a resale certificate and tax
either accrued on the rental payments or remitted on each payment as received.
When the property is returned to the vendor, no further tax is owed as the
vendor is repurchasing the property for resale. We do not have a provision in
our act that would require the lessee to pay tax on any outstanding balance
owed the vendor.

2. Would this be looked at as a capital lease or a rental?

Answer: Our sales tax law makes no distinction between leases and rentals
(except for motor vehicles). We do make a distinction between operating leases
and financing leases. This is an operating lease or rental because the lessee
does not take title to the property.

3. Are the laws for your state different for a capital lease or a rental?

Answer: No.

I hope this satisfactorily answers your questions. Please feel free to write
me at 111 E. 17th Street, Austin, Texas 78774, or call me at 1-800-531-5441
should you have further questions.

Sincerely,

Wade Anderson
Assistant Director of Tax Administration

cc: Glen Hunt, Director, Tax Administration
Charles Johnstone, Manager, Tax Administration