For the new manufacturing-equipment lease exemption starting October 1, 1995, what makes an operating lease qualify, and can an existing lease be renegotiated to qualify?

Plain-English summary

The Texas Comptroller's Tax Policy Division responded to a taxpayer asking about the exemption available for manufacturers on leased equipment — an extension of the existing manufacturing exemption to equipment that is leased rather than purchased.

To qualify as exempt, the letter says a lease must meet three conditions: (1) it must originate or renew on or after October 1, 1995; (2) it must be a single operating lease contract with a lease term of one year or more; and (3) it must be a lease of equipment that already qualifies for the manufacturing exemption — meaning it is leased by the manufacturer as tangible personal property, and it is machinery, equipment, replacement parts, or accessories used in actual manufacturing, processing, fabrication, or repair of tangible personal property to be sold (and necessary and essential to that operation), or necessary and essential to a pollution control process resulting from that manufacturing or repair operation.

The letter is explicit about what does not qualify: leases for equipment not used in the exempt manner; leases whose term began before October 1, 1995 but ends after that date; and leases with a term shorter than one year. It also addresses automatically-renewed leases — since each lease term is treated as its own separate transaction, a series of automatically renewed shorter terms is really a string of transactions, not one single lease, so it doesn't satisfy the one-year-minimum, single-contract requirement.

Finally, the letter explains that an existing lease can be renegotiated to qualify. Renegotiation can be simple (extending an existing lease) or more involved (terminating an existing lease and rewriting a new one). Either way, qualifying requires a written contract to lease qualifying equipment for a lease term that begins October 1, 1995 or later and extends for a minimum of 365 days, including the initial date of the lease term — for example, a lease beginning October 1, 1995 must continue at least through September 30, 1996.

What this means for you

Manufacturers who lease equipment

If you lease machinery, equipment, replacement parts, or accessories that would otherwise qualify for Texas's manufacturing exemption if purchased, you can also get that exemption on a lease — but only if the lease is a single operating lease contract of at least one year, starting on or after October 1, 1995. Short-term or month-to-month arrangements, even if renewed repeatedly, don't meet the requirement because each renewal counts as its own separate transaction.

Businesses with leases that straddle October 1, 1995

If your lease term started before October 1, 1995, it does not qualify for the exemption even if it continues past that date. To get the exemption going forward, the letter explains you would need to renegotiate: either extend the existing lease or terminate it and write a new one, so that a qualifying written contract exists with a term beginning October 1, 1995 or later and running at least 365 days from that start date.

Accountants and tax professionals structuring lease agreements

When advising manufacturing clients on lease structuring around this exemption, confirm three things: the lease is a single contract (not a series of shorter renewed terms), the term is at least 365 days measured from a start date of October 1, 1995 or later, and the underlying equipment independently meets the manufacturing-exemption use tests (actual manufacturing/processing/fabrication/repair, or qualifying pollution control).

Common questions

Q: Can a lease that started before October 1, 1995 qualify for the exemption if it continues after that date?
A: No. The letter states that leases whose lease term began before but ends after October 1 do not qualify.

Q: Does a lease with automatic renewals count as one lease meeting the one-year minimum?
A: No. The letter explains that each lease term is a separate transaction from the previous or subsequent term, so automatically renewed operating leases are really a series of lease transactions strung together, not one lease — meaning the minimum one-year requirement is not met on a single transaction.

Q: How can an existing lease be renegotiated to qualify for the exemption?
A: The letter says renegotiation can be as simple as extending an existing lease or as complex as terminating an existing lease and rewriting another. Either way, it requires a written contract to lease qualifying equipment for a lease term beginning October 1, 1995 or after that extends for a minimum of 365 days, including the initial date of the lease term.

Q: What kind of equipment can be leased under this exemption?
A: Equipment that already qualifies for the manufacturing exemption — leased by the manufacturer as tangible personal property, and either used in and necessary/essential to actual manufacturing, processing, fabrication, or repair of tangible personal property to be sold, or necessary/essential to a pollution control process resulting from that manufacturing or repair operation.

Q: Can I rely on this letter for my own leases?
A: This opinion is based on the facts presented to the Comptroller's office; the letter notes that if there are additional or different facts, the opinion may change. Consult the Comptroller's Tax Policy Division or a tax professional about your specific facts.

Citations and references

No specific statutes or administrative rule citations appear in this letter's text.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9509602L

Original ruling text

September 28, 1995

Dear **:

Thank you for your letter clarifying the exemption available for manufacturers
on leased equipment. This exemption is intended as an extension of the existing
manufacturing exemption for equipment. In order for the lease to qualify as
exempt, it must:

• be a lease originating or renewing on or after October 1, 1995;

• be a single operating lease contract with a lease term of one year or more;
  and

• be a lease of equipment qualifying for the manufacturing exemption. That is
  it must be: 1. leased by the manufacturer as tangible personal property; 2. be
  a lease of machinery, equipment, replacement parts for machinery or equipment,
  or accessories to machinery or equipment used (a) in the actual manufacturing,
  processing, fabrication, or repair of tangible personal property to be sold,
  and (b) the use of the item must be necessary and essential to the
  manufacturing, processing, fabrication, or repair operation; or 3. be a lease
  of machinery, equipment, replacement parts for machinery or equipment, or
  accessories to machinery or equipment necessary and essential to a pollution
  control process resulting from said manufacturing or repair operation.

Leases for equipment not used in the exempt manner, leases whose lease term
began before but ends after October 1, and leases whose term is less than one
year do not qualify for this exemption. The term of an operating lease may be
one hour, one day, one month, etc. Each lease term is a separate transaction
from the previous or subsequent lease term. Operating leases that are
automatically renewed are actually a series of lease transactions strung
together rather than one lease; therefore, the minimum requirement is not met
on a single transaction.

For sales tax purposes, renegotiation can be as simple as extending an existing
lease for a period of time or it can be as complex as terminating an existing
lease and completely rewriting another. Renegotiating a lease to qualify for
this exemption will require a written contract to lease qualifying equipment
for a lease term beginning October 1, 1995, or after, that extends for a
minimum of 365 days including the initial date of the lease term. For example,
a lease that begins on October 1, 1995, must continue at least through
September 30, 1996.

This opinion is based upon the facts presented. If there are additional or
different facts, this opinion may change. You may also write to Tax Policy
Division, Comptroller of Public Accounts.

Sincerely,

Tax Policy Division