When a financial institution only holds a security interest in equipment (never taking title or possession), are its 'financing lease' interest charges subject to Texas sales tax?

Plain-English summary

A financial institution finances the purchase of tangible personal property for its business customers, documenting the arrangement as a "financing lease." But under the actual facts: title to the property transfers directly from the manufacturer or dealer to the customer (never to the financial institution); the customer then gives the financial institution a security interest in the property under the financing lease; and the customer retains all indicia of ownership — possession, maintenance responsibility, property taxes, insurance, and risk of loss. The financial institution asked the Comptroller to confirm this is a loan transaction, not a "sale" under Tax Code § 151.005, and that no sales tax applies to the finance charges.

The Comptroller agreed, reasoning through the rental/lease definition rather than the "sale" definition directly: Rule 3.294(a)(2) defines a lease or rental as a transaction where possession (even without title) of tangible personal property is transferred for consideration. Because the financial institution here never takes possession OR title — only a security interest — it isn't leasing or renting tangible personal property at all. That means Rule 3.294(d)(7)'s financing-lease interest rule controls: interest charges by a lessor to a lessee under a financing lease are taxable unless the interest rate or actual interest charged is separately stated on a contract, invoice, billing, or sales slip to the customer. Since the financial institution here separately states its interest/finance charges, no tax is due on them. The sales tax itself is owed elsewhere: the business customer must pay or accrue tax on its purchase of the equipment from the manufacturer or dealer.

What this means for you

Financial institutions and equipment finance companies

If you finance equipment purchases through a security-interest-only "financing lease" structure — never taking title or possession, with the customer retaining all ownership indicia — you're not treated as leasing tangible personal property, and your finance/interest charges escape sales tax as long as you separately state the interest rate or amount on the customer's paperwork. Bundle the interest into an undifferentiated payment, and it becomes taxable instead.

Business customers financing equipment purchases

Don't assume your financing arrangement's tax treatment removes your own sales tax obligation — you still owe sales or use tax on your purchase of the equipment itself from the manufacturer or dealer, separate from whatever your lender charges in interest.

Common questions

Q: Is interest on a financing-lease arrangement taxable?
A: Not if the financial institution never takes title or possession of the property (holding only a security interest) and separately states the interest rate or charge on the customer's paperwork.

Q: Who pays sales tax on the underlying equipment in this kind of arrangement?
A: The business customer, on its purchase from the manufacturer or dealer — not the financing institution.

Q: Can another financial institution rely on this exact letter?
A: No. This is a Texas STAR letter ruling binding on the Comptroller only for the taxpayer it addresses (34 Tex. Admin. Code Rules 3.1, 3.10); confirm your own facts with a tax professional.

Citations and references

Statutes and rules:

• Tax Code § 151.005 (definition of sale or purchase)
• 34 Tex. Admin. Code § 3.294(a)(2) (lease/rental requires transfer of possession)
• 34 Tex. Admin. Code § 3.294(d)(7) (financing-lease interest charges, taxable unless separately stated)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9709720L

Original ruling text

September 10, 1997

Dear **:

This is in response to your letter to Tom Soto requesting a ruling on the
taxability of a lease transaction under the following facts.

The client is a financial institution that finances the purchase of tangible
personal property for its business customers and utilizes a financing lease for
its documentation. Title to the property will be transferred directly from the
manufacturer or dealer to the customer. The customer will then provide the
financial institution with a security interest in and to the property under a
financing lease. The customer will retain all indicia of ownership, including
possession, responsibility for maintenance, property taxes and insurance, and
risk of loss.

You are requesting that we confirm that under these facts, the transaction is a
loan transaction rather than a "sale" for sales tax purposes under Texas Tax
Code section 151.005, and that no sales tax will apply to the finance charges
under such a lease.

Response: Subsection (a)(2) of 3.294 - Rental and Lease of Tangible Personal
Property, defines a lease or rental as:

A transaction, by whatever named called, in which possession but not title to
tangible personal property is transferred for a consideration. In this rule,
the words lease and rental are used interchangeably.

Subsection (d)(7) of this section provides that:

Under a financing lease, charges for interest by the lessor to the lessee will
be taxable unless the rate of interest or the actual interest charged is
separately stated in a contract, invoice, billing, sales slip, or ticket to the
customer.

Emphasis added.

Therefore, if the financial institution only has a security interest in the
property, never takes legal title to the property, and separately states the
rate of interest or the actual interest charged to its business customers, tax
will not be due on the separately stated finance/interest charges. Sales tax
must be paid or accrued by the business customer on its purchase of the
equipment from the manufacturer or dealer.

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

I hope this information answers your questions. If you need additional
information, please
call me toll-free at 1-800-531-5441, extension 3-4502. The direct line is
512/463-4502. You may also write to Tax Policy Division, Comptroller of Public
Accounts. You may also e-mail our tax help section at:
[email protected]

Sincerely,

Gilbert Zamora
Tax Policy Division

cc: Tom Soto