If a Utah government transit agency leases rail cars under a long-term, non-cancelable lease with a nominal purchase option, are the rail cars exempt from Utah property tax?

Plain-English summary

A representative for a Utah government transit agency (referred to here as ORGANIZATION, which operated the "Trax" light rail system) asked the Utah State Tax Commission to rule that rail cars the agency was acquiring from a private rail car company (COMPANY) would be exempt from Utah property tax. Under the deal, ORGANIZATION would take possession, use, and control of the cars under a "sublease agreement" starting in early 2003, make a lump-sum payment (estimated in the millions of dollars), pay for all maintenance, improvements, and insurance, and hold the cars under a non-cancelable payment obligation until 2017 -- at which point it could take legal title by paying a nominal additional amount. Because ORGANIZATION is a political subdivision of Utah, government-owned property is exempt from property tax under Utah Const. Art. XIII, § 3(1)(d), so the requester argued that ORGANIZATION should be treated as the true owner for tax purposes even though formal legal title would stay with other entities (tied up in prior financing arrangements) until 2017.

The Commission did not give the binding ruling requested. It first flagged a threshold problem: the Tax Commission's statutory assessment authority under § 59-2-203(1) covers "railroads" and "rail car companies," and nothing suggested a government transit agency fit either term -- so the Commission assumed the county assessor, not the Tax Commission, would be the one to actually assess the rail cars and decide in the first instance whether they were exempt. Because of that, any guidance the Commission gave would not bind a county assessor or county board of equalization, though a party could later appeal a county assessment decision to the Tax Commission under § 59-2-1102.

With that caveat, the Commission described the general legal test it would apply if the issue came before it: under the Uniform Commercial Code test in Utah Code § 70A-1-201(37)(b), as applied by the Utah Supreme Court in Salt Lake County v. First Security Leasing Co., 881 P.2d 877 (Utah 1994), a lease is treated as a "security interest" -- meaning the lessee, not the titleholder, is the property-tax owner -- when the lessee's payment obligation for the lease term is non-cancelable and the lessee has an option to become the owner for no or nominal additional consideration. If the lessee under such a lease is a tax-exempt government entity, the leased property is exempt from property tax.

The Commission said the lease terms as described "appear to comply" with that test, but stopped well short of a binding conclusion: it had not reviewed the actual lease document, and it reiterated that the letter was a general response, not an answer to the specific facts of this transaction, and was not binding given the county's apparent primary assessment authority.

What this means for you

Government entities leasing equipment from private companies

If your government agency is leasing personal property (vehicles, rail cars, equipment) under a long-term lease with a fixed, non-cancelable payment obligation and a nominal purchase option, Utah's UCC-based ownership test may let you be treated as the property-tax "owner" even without formal legal title -- meaning the property could be exempt if you're a tax-exempt government entity. But don't assume it: this letter shows the Commission will not commit to that conclusion without reviewing the actual lease, and the initial call may belong to a county assessor rather than the Tax Commission.

Rail and transportation companies leasing equipment to government agencies

If you're the private party (lessor) in a similar deal, be aware that structuring a transaction as a long-term, non-cancelable lease with a nominal buyout can shift property-tax ownership -- and the exemption question -- onto the government lessee under Utah's substance-over-form UCC test. That can matter for how the deal is priced and who is expected to bear any property tax risk.

Accountants and tax professionals advising on sale-leaseback or long-term equipment leases with government lessees

This letter is a useful illustration that Utah applies a substantive UCC test (not bare legal title) to decide who owns leased personal property for property tax purposes, per First Security Leasing. But it's equally useful as a caution: the Tax Commission may not be the right (or only) forum to get a binding answer -- assessment of specific personal property can fall to the county assessor, with appeal rights to the Tax Commission only after a county decision. Don't rely on general guidance like this in place of an actual assessment appeal or a ruling grounded in the real lease terms.

Common questions

Q: Did the Tax Commission rule that the rail cars were tax-exempt?
A: No. The Commission explicitly declined to issue a binding ruling on these facts. It gave general guidance on the legal test and said the described lease terms "appear to comply," but said this letter is not a binding answer to the specific transaction.

Q: Why wouldn't the Tax Commission just decide the question?
A: Because it wasn't confident it was even the right body to assess these rail cars. Its assessment authority under § 59-2-203(1) covers "railroads" and "rail car companies," and the Commission saw no basis for treating a government transit agency as either -- so it assumed the county assessor would make the initial call, with any appeal going to the Tax Commission afterward.

Q: What's the legal test for whether a lessee (rather than the titleholder) owns leased property for Utah property tax purposes?
A: Under Utah Code § 70A-1-201(37)(b) and Salt Lake County v. First Security Leasing Co., 881 P.2d 877 (Utah 1994), a lease is treated as a purchase (making the lessee the owner) if the lessee's payment obligation runs for the full lease term and can't be terminated, and the lessee has an option to become the owner for no or nominal additional consideration.

Q: Can I rely on this letter for my own lease of equipment to or from a government entity?
A: Not as binding precedent. A Utah private letter ruling binds the Commission only for the taxpayer and facts it was issued to -- and this particular letter goes further and says it isn't even a binding answer to the requester's own facts, since the actual lease wasn't reviewed and a county assessor may have the primary say. Treat it only as a general indication of how the Commission reasons about lessee ownership.

Q: Who actually decides if my leased equipment is property-tax exempt in Utah?
A: For locally assessed property, it is typically the county assessor in the first instance, with a right to appeal that county decision to the Tax Commission under § 59-2-1102.

Citations and references

Constitution and statutes (Utah Code Ann.):

• Utah Const. Art. XIII, § 3(1)(d) (effective January 1, 2003) -- exempts government-owned property from Utah property tax
• § 17A-2-1055 -- cited by the requester regarding the transit agency's status as a political subdivision
• § 59-2-203(1) -- Tax Commission's authority to assess "railroads" and "rail car companies"
• § 59-2-1102 -- right to appeal a county assessment decision to the Tax Commission
• § 70A-1-201(37)(b) (UCC) -- test for whether a lease is a "security interest" (i.e., a purchase), based on a non-terminable payment obligation plus a nominal purchase option

Case law cited: Salt Lake County v. First Security Leasing Co., 881 P.2d 877 (Utah 1994) (substantive UCC test controls property-tax ownership of leased personal property, not bare legal title); Interwest Aviation v. Salt Lake County Bd. of Equalization, 734 P.2d 1222 (Utah 1987) (incidents-of-ownership test for real property); Gunnison County v. Board of Assessment Appeals, 693 P.2d 400 (Colo. Ct. App. 1984) (cited with approval); University of Utah v. Salt Lake County, 547 P.2d 207 (Utah 1976); Springville v. Johnson, 37 P. 577 (Utah 1894)

Related Commission decisions cited by the requester: First Security Leasing v. Salt Lake County, case no. 91-1255 (UT Tax Comm'n 1993); Tax Comm'n Appeal No. 92-1896 (1993); Private Letter Ruling 96-125 (1996); ITT Commercial Financial Corp. v. Property Tax Division, case no. 88-1576 (UT Tax Comm'n 1990) (superseded approach, overruled by the 1993 First Security Commission decision)

Source

• Landing page: https://tax.utah.gov/commission/rulings/
• Original page: https://files.tax.utah.gov/tax/commission/ruling/02-036.html

Original ruling text

REQUEST LETTER

Response 1/27/03

02-036

NAME

ADDRESS

Re: Private Letter Ruling Request � Government Property Tax Exemption for COMPANY Rail Cars

Dear TP REP,

On behalf of ORGANIZATION, we hereby request a private letter ruling affirming our belief that rail cars to be acquired by ORGANIZATION from COMPANY will be exempt from Utah property tax.

COMPANY currently has possession of certain rail cars that will be transferred to ORGANIZATION and used as part of the ORGANIZATION light rail system in the early part of 2003. Under the terms of the acquisition agreement between ORGANIZATION and COMPANY, termed a "sublease agreement," ORGANIZATION will have possession, use and control of the rail cars, and will retain such under the terms of the agreement until 2017. In 2017, ORGANIZATION will take legal title to the rail cars through exercising a purchase option by paying an additional and nominal sum and, of course, continue to have full possession, use and control of the cars.

ORGANIZATION and COMPANY would prefer ORGANIZATION to take legal title to the rail cars now, but the rail cars are encumbered by the provisions of prior and still existing financing transactions wherein nominal legal title is in other entities until 2017. In 2017, when the terms of these prior transactions are complete, ORGANIZATION will exercise its nominal purchase option and obtain legal title to go along with all the other incidents of ownership its acquiring with the lump sum payment in 2003 as described below.

In exchange for possession, use and control of the rail cars between 2003 and 2017, ORGANIZATION will pay COMPANY a lump sum payment that is currently estimated to be $$$$$ million in 2003. ORGANIZATION will also pay for all maintenance, improvements and insurance while in possession of the rail cars. ORGANIZATION will also be required to pay any and all Utah state and local taxes imposed as a result of acquiring and using the cars in the Trax System. By January 1, 2004, ORGANIZATION has budgeted $$$$$ worth of capital improvements to the cars to be expended at its sole direction and expense. By DATE, ORGANIZATION has budgeted for a $$$$$ "half-life overhaul" of the rail cars, again to be expended at its sole direction and expense.

The multimillion payment ORGANIZATION will make for the right to possession, use and control of the rail cars is an obligation for the term of the agreement (until DATE) not subject to termination by ORGANIZATION. It is our belief that due to the rights and substantially all the incidents of ownership ORGANIZATION is acquiring, the cars are exempt from Utah property tax under Utah law, and we hereby request a private letter ruling from the Commission affirming our belief.

Because ORGANIZATION is a political subdivision of the state of Utah, the rail cars will be exempt from property tax in Utah if they are owned by ORGANIZATION for property tax purposes. See Utah Const. Art. XIII, � 3(1)(d) (effective January 1, 2003) and Utah Code �17A-2-1055.

Based on Utah law, we believe
ORGANIZATION will own the rail cars for Utah property tax purposes, making the
rail cars tax exempt, even though ORGANIZATION will not have formal legal title
until 2017. In Salt Lake County v.
First Security Leasing Co., 881 P.2d 1222 (Utah 1994) and Interwest
Aviation v Salt Lake County Bd. Of Equalization, 734 P.2d 1222 (Utah 1987),
the Utah Supreme court indicated that substantive Uniform Commercial Code
("UCC") and "incidents of ownership" tests, along with
sound tax policy, dictate who owns property for property tax purposes, not
formal, nominal legal title.

In Interwest, 734 P.2d
at 1222, the Utah Supreme Court held that vendors at the Salt Lake airport had
ownership of improvements at the facilities for property tax purposes because
the vendors had more improvements at the facilities for property tax purposes
because the vendors had more "significant incidents of ownership"
than the airport authority. The Court
stated that "the status of formal legal title, while relevant, is not
controlling" in determining property tax ownership. Id at 1226 (emphasis added). The Court continued by stating "[t]he
approach we adopt allows the taxation of property which is used exclusively by
a private person even though legal title is clearly in a governmental agency,
as long as the most significant incidents of ownership to the property are in
the private user." Id.
(emphasis added). The court also cited
with approval a case where the Colorado Court of Appeals held this same
principle to be true (a principle on all fours with the case at hand) where the
roles of the parties were reversed. As
stated by the Utah Supreme Court, the Colorado court ruled "in favor of
tax exemption for property leased by a country from a private party
because the county held the most significant incidents of ownership in the
improvements." Id. (citing
Gunnison County v. Board of Assessment Appeals, 693 P.2d 400, 404 (Colo.
Ct. App. 1984)).

The Utah Supreme Court made
similar statements in First Security, 881 P.2d at 877. In that case, the court held property tax
ownership to be in lessees of First Security Leasing Company, even though First
Security held formal legal title. The
court stated property tax ownership should be determined by looking "to
the essence of the transaction [under the UCC], irrespective of the legal form
to which the parties to a transaction cast it." *Id. * At 879 (emphasis added).

The Utah State Tax Commission
has also applied the substantive UCC test for the past several years to
determine who has property tax ownership.
See First Security Leasing v. Salt Lake County, case no. 91-1255
(UT Tax Comm'n 1993); Tax Comm'n Appeal No. 92-1896 (1993); Tax Comm'm Private
Letter Ruling 96-125 (1996). In 1990,
the commission ruled that formal legal title controlled in determining property
tax ownership. See ITT Commercial
Financial Corp. v. Property Tax Division, case no. 88-1576 (UT Tax Comm'n
1990). In the 1993 First Security decision,
however, the Commission specifically overruled the ITT decision and has applied
a substance-based UCC test ever since in property tax cases.1

1 There are cases where
the Utah Supreme Court has appeared to look solely to bare legal title to
determine who has ownership for property tax purposes. See University of Utah v Salt Lake
County, 547 P.2d 207 (Utah 1976) (holding property taxable because it was
owned by Picker X-ray, even though it was leased to and used by the University
of Utah); Springville v Johnson, 37 P. 577 (Utah 1894) (holding property
exempt because it was owned by Springville Cit, even though it was used by a
private, taxable person for grazing of livestock). While these cases may appear to be in conflict with Interwest
and First Security, the court resolved this apparent conflict in First
Security by pointing out that the University/Picker X-ray transaction at
issue in the University of Utah case did not satisfy the
substantive UCC test. First Security, 881 P.2d at 879. In other words, the court, like the Tax
Commission, feels a substantive test should be applied in every case to
determine property tax ownership.

Based on Interwest, First
Security, and this Tax Commission precedent, property tax ownership in the
instant case is not controlled by the fact that another entity currently and
temporarily has formal legal title to the rail cars. Rather, substantive tests dictate who has property tax ownership,
and we believe under the many cases cited above that the essence of the
ORGANIZATION/COMPANY transaction, as explained below, places property tax
ownership in ORGANIZATION.

In First Security, the
court declared that the substantive test for determining who has property tax
ownership of personal property, such as the rail cars, is found in the UCC at
Utah Code � 70A-1-201(37)9b). First
Security, 881 p.2D AT 878-879. If a
transaction constitutes a "security interest" under the UCC, then the
relevant property has been "purchased" and the purchaser is the owner
for property tax purposes. In the case
at hand, the ORGANIZATION/COMPANY transaction indeed creates a security
interest, meaning ORGANIZATION will have property tax ownership.

The UCC test provides as follows:

�a transaction creates a security interest if the consideration the lessee is to pay the lessor for the right to possession and use of the goods is an obligation for the term of the lease not subject to termination by the lessee, and:

(i) The original term of the lease is equal to or greater than the remaining economic life of the goods;

(ii) The lessee is bound to renew the lease for the remaining economic life of the goods or is bound to become the owner of the goods;

(iii) The lessee has an option to renew the lease for the remaining economic life of the goods for no additional consideration or nominal additional consideration upon compliance with the lease agreement; or

(iv) The lessee has an option to become the owner of the goods for no additional consideration or nominal additional consideration upon compliance with the lease agreement.

Utah Code � 70A-1-201(37)(b).

The ORGANIZATION/COMPANY
transaction is a security interest under this test because a) the several
million-dollar acquisition price ORGANIZATION is to pay COMPANY for the right
to possession and use of the rail cars is an obligation for the term of the
lease (through 2017) not subject to termination by ORGANIZATION, and b) ORGANIZATION will have the option to
purchase the rail cars for nominal consideration in 2017 upon compliance with
the terms of the lease agreement.
Because the ORGANIZATION/COMPANY transaction creates a security
interest, ORGANIZATION will be "purchasing" the rail cars rather than
leasing them under the UCC analysis deemed to be the relevant analysis by the
Utah Supreme Court and the Utah State Tax Commission. ORGANIZATION will thus be the owner of the rail cars, meaning the
rail cars will be exempt from property tax.2

While the substantive UCC
test indicates the rail cars will be tax exempt, so does sound tax policy. In First Security, the Utah Supreme
Court said Interwest stands for the proposition that property tax
ownership "should be decided on the purpose of the tax exemption, not
on the meaning of the term "owner". . " Id. (emphasis added). This stands to reason because the Interwest
Court stated "[f]or one unit of government. . to have levy a tax so that
is can pay taxes to another overlapping unit . . .makes little economic sense
and is bad tax policy." Id
at 1225. In the case at hand, tax
policy favors a property tax exemption for the rail cars. It makes little economic sense for ORGANIZATION
to raise sales taxes a quarter cent to pay for property taxes to Salt Lake
County. It is simply bad tax policy.3

2 The Interwest
case involved real property which is not subject to the UCC, so the court crafted
an "incidents of ownership" test to determine who held property tax
ownership. See Interwest, 734
P.2d at 1226, First Security, 881 P.2d at 879. This test analyzed who possessed, used, enjoyed, depreciated and
profited from the property, who funded maintenance and improvements, and who
paid taxes and insurance. Interwest,
734 P.2d at 1226-1227. While the rail
cars are personal property and thus subject to the UCC, it is interesting to
note that ORGANIZATION would likely own the rail cars under the "incidents
of ownership" test as well.

COMPANY and ORGANIZATION will treat ORGANIZATIONas the property tax owner regardless of the Utah Tax Commission's determination by requiring ORGANIZATION to pay property taxes, if any are ever determined to be due.

In addition to the technical
points of a substantive UCC analysis, the substance of the transaction from a
practical perspective supports the conclusion of ORGANIZATION ownership of
these rail cars. For all practical
purposes, ORGANIZATION has all the rights and obligations of the owner of the
cars. IT has the right to refurbish and
overhaul the cars in any way it sees fit.4 In fact, the substantial overhaul contemplated in 2006 will
cost more than the initial acquisition cost.
It will also have the insurance and maintenance obligation associated
with the possession and use of the cars.

The cars will be painted and outfitted and for all practical purposes will look like the other cars in use in the Trax system that are owned by ORGANIZATION and are exempt fro property tax.

The cars are under the total
control of ORGANIZATION to be deployed in the Trax system as they see fit.5
The cars will be controlled, possessed and used before and after legal
title is obtained in 2017 in an indistinguishable manner.

Based on the foregoing analysis, we believe property tax ownership will lie with ORGANIZATION. Substantively and practically, the rail cars are owned by ORGANIZATION for property tax purposes and therefore the cars should be exempt from property tax in Utah.

We know of the Commission's busy schedule, made even more so with the legislature in session in mid-January, but inasmuch as the answer to this questions affects the budget of ORGANIZATION and the economics of this potential acquisition. UTA would appreciate a private letter ruling as soon as possible. A reply by February 1, 2003 would allow ORGANIZATION to more appropriately structure the deal terms as it attempts to acquire these needed cars. If you need more information, please contact me. Thank you for responding to our request.

4 The only restriction ORGANIZATION has with respect to the cars is that they must be used with ORGANIZATION Trax System and cannot be taken out of service and put into private, non-governmental use.

Sincerely,

NAME

Cc: NAME

NAME

NAME

NAME

RESPONSE LETTER

January 24, 2003

NAME

ADDRESS

RE: Private Letter Ruling Request � Government Property Tax Exemption for Leased Property

Dear NAME,

We have received your request for a private letter ruling concerning the �sublease agreement� for rail cars between the ORGANIZATION and the COMPANY Transportation. You have asked the Commission to confirm your belief that ORGANIZATION would be considered the owner of these rail cars for property tax purposes and, because of ORGANIZATION'S exempt status, that the rail cars would not be subject to Utah property taxes.

Before addressing your specific question, we need to clarify an underlying issue. The Tax Commission is responsible to assess �railroads� and �rail car companies.� Utah Code Ann. �59-2-203(1). However, these terms are not defined in Title 59 of the Utah Code and there is no authority presented to suggest that a governmental entity (ORGANIZATION) should be considered a �railroad� or �rail car company� for assessment purposes. For these reasons, we assume that the county assessor, not the Tax Commission, would assess any rail cars brought into Utah by ORGANIZATION; i.e., the county assessor would initially determine if the rail cars were exempt from taxation.

As a result, any guidance the Tax Commission might offer you in a private letter ruling would not be binding on a county assessor or board of equalization in their determination of whether locally assessed property is exempt from taxation. In addition, a party subject to local assessment has the right to appeal a county decision to the Tax Commission under Utah Code Ann. �59-2-1102. Should either of the parties you describe appeal a county assessment, we would address their specific circumstances through that process.

Furthermore, we note that we have not seen an actual lease or any of its specific items. Accordingly, we offer a general response to your request, so that this letter should not be considered an answer to the specific circumstances of the entities you describe.

The issue we address here, then, is whether personal property leased by a Utah government entity is exempt from taxation when: 1) the lessor retains legal title to the property; 2) the consideration paid by the lessee for the right to possession and use of the leased property is an obligation for the term of the lease not subject to termination by the lessee; and 3) the lessee has an option to become the owner of the leased property for no additional consideration or nominal additional consideration upon compliance of the lease agreement.

Ordinarily,
the property tax on personal property is assessed to and responsibility of that
property�s owner of title, even when that property is leased to another entity. Under certain circumstances, however, the
Utah Supreme Court has held that a lessee is considered the owner of leased
personal property for property tax purposes.
See Salt Lake County v. First Security Leasing Co., 881 P.2d 877
(Utah 1994). These criteria are
specified in the Uniform Commercial Code (�UCC�), as codified in Section
�70A-1-201(37)(b) of the Utah Code.
Such a distinction is critical when the lessee is a tax-exempt
government entity and the lessor is an entity subject to taxation. In such circumstances, the property is
exempt from taxation if the tax-exempt lessee, not the owner of title, is
considered the owner of the leased property for property tax purposes.

In
accordance with First Security, the Tax Commission considers a lessee to
be the owner of personal property for property tax purposes to the extent that
the terms of the lease meet the Section 70A-1-201(37)(b) UCC guidelines. With such a lease in place, the leased
property would be exempt from taxation if the lessee were a Utah governmental
entity.

While the terms of the lease that you describe appear to comply with the criteria listed above, we reiterate that, without analyzing the actual lease, and more importantly, because of the county�s apparent right to assess the rail cars, this letter is not a binding ruling that addresses the specific parties and circumstances set forth in your request. Please contact us if you have any other questions.

For the Commission,

Marc B. Johnson

Commissioner

Cc: NAME

NAME

02-036