If a compression-services company restructures into separate lease and service entities, are the compressor leases and the compression services taxable in Utah, and is transferring the compressor fleet into the new entities a taxable sale?
Apply this to your situation
This page answers the general question as of 2007. Ezel answers yours, under current Utah tax law, with citations.
Plain-English summary
A company that assembles natural-gas compressors ("Company 1") was reorganizing its compression-services business into three new related entities: a "Lease Company" that would lease compressors to a related entity through bare-rental agreements, a "Service Company" that would lease the compressors from Lease Company and provide compression services to third-party customers, and "Lease Company 2" that would lease part of the fleet back to Company 1 itself. Under the new customer contracts (a "Master Services Agreement"), the customer would pay for compression services rather than a bare equipment rental, with risk of loss, insurance, and ad valorem taxes shifted to the service provider and no specific compressor identified in the contract. Company 1 asked whether the Commission would treat these new service contracts as nontaxable services rather than taxable equipment rentals, and whether transferring its existing compressor fleet into the new subsidiaries would trigger sales or use tax.
The compression-services contracts are still taxable leases, not services. Utah taxes both retail sales and leases/rentals of tangible personal property used in the state (§ 59-12-103(1)(a), (k), (l)), and the statutory definition of "sale" specifically includes a lease/contract transaction under which the right to possession, operation, or use of tangible personal property is granted (§ 59-12-102(82)(b)(v)). The Commission found the restructured Master Services Agreement was, in substance, still a lease of the compressors: the customer provides the site and pays a mobilization fee, and Service Company installs and maintains a compressor to meet the contract's specifications -- ensuring specific equipment performs the customer's task, functionally the same as a rental. That no particular compressor model is named in the contract, or that the provider will repair/replace a malfunctioning unit, doesn't change that conclusion. Both Service Company's and Company 1's compression services to third parties remain subject to Utah sales and use tax as leases or rentals.
But the intercompany leases and formation transfers are exempt as sales for resale. Because Service Company (and Company 1, via Lease Company 2) will be re-leasing the compressors to their own customers in taxable transactions, the underlying leases from Lease Company to Service Company, and from Lease Company 2 to Company 1, qualify as exempt "sales for resale" under § 59-12-104(25). The same logic exempts the initial transfer of the compressor fleet from Company 1 into the new subsidiaries: although that transfer is a taxable "sale" (an exchange for an ownership interest, which counts as consideration) and doesn't qualify as an exempt isolated-or-occasional sale (inventory transfers are never isolated or occasional, and Company 1 is regularly engaged in the rental business), it still qualifies for the resale exemption because the subsidiaries will re-lease the compressors in taxable transactions of their own.
The Commission also flagged, in a footnote, that Utah law on "disregarded entities" is undeveloped -- the new entities are disregarded only for federal income tax purposes and remain separate entities for Utah sales tax purposes, so intercompany sales between a parent and wholly owned subsidiary are ordinarily subject to normal sales and use tax rules (citing Institutional Laundry, Inc. v. State Tax Commission, 706 P.2d 1066 (Utah 1985)) -- though it didn't need to resolve that issue here because the transfers were exempt regardless.
What this means for you
Natural-gas services companies restructuring into lease/service entity structures
Relabeling a compressor rental as a "compression service" does not avoid Utah sales tax if the customer is still, in substance, obtaining the use of dedicated equipment for a fee. The Commission looked past the contract's service-agreement framing to the underlying economic substance -- site provision, mobilization fees, and equipment dedicated to performing the customer's task all pointed to a taxable lease.
Equipment lessors using tiered lease/sub-lease structures
Intercompany leases in a chain that ends in a taxable re-lease to the ultimate customer can qualify for the resale exemption at each intermediate step, so restructuring into separate holding/service entities doesn't multiply your tax exposure -- but the ultimate lease to the end customer stays taxable.
Accountants and tax professionals structuring formation transfers
A contribution of business equipment into a new subsidiary in exchange for an ownership interest is a taxable "sale" for Utah sales tax purposes (consideration = the value of the ownership interest) and does NOT qualify as an isolated-or-occasional sale if the transferor regularly deals in that type of property or the property is inventory -- but it can still be exempt under the resale exemption if the subsidiary will resell or re-lease the property in taxable transactions.
Common questions
Q: Can a compression-services contract avoid sales tax by calling itself a "service" instead of a "lease"?
A: Not automatically. The Commission looks at economic substance -- if the customer is effectively getting the use of dedicated equipment (site provided by customer, mobilization fee, equipment maintained to spec), it's taxed as a lease even if the contract is labeled a service agreement.
Q: Are intercompany equipment leases in a corporate restructuring taxable?
A: They can be exempt as "sales for resale" if the lessee will itself re-lease or resell the property in a taxable transaction to an outside party.
Q: Is contributing equipment to a new subsidiary a taxable sale?
A: Yes -- receiving an ownership interest in the subsidiary counts as consideration, making it a "sale." It won't qualify as an exempt isolated-or-occasional sale if the transferor regularly deals in that property, but it may still be exempt under the resale exemption if the subsidiary will lease or resell the property in taxable transactions.
Q: Does this ruling apply to my company's restructuring?
A: No. It binds the Commission only for the requesting taxpayer and the facts described, and can't be relied on by another taxpayer, though it shows how the Commission reasons about similar lease-versus-service and resale-exemption questions.
Citations and references
Statutes:
- § 59-12-103(1)(a), (k), (l) (tax on retail sales and leases/rentals)
- § 59-12-102(80) (definition of "retail sale")
- § 59-12-102(82)(a), (b)(v) (definition of "sale")
- § 59-12-102(43) (definition of "lease" or "rental")
- § 59-12-104(13) (isolated or occasional sale exemption)
- § 59-12-104(23) (property stored for resale)
- § 59-12-104(25) (property purchased for resale)
Source
- Landing page: https://tax.utah.gov/commission/rulings/
- Original PDF: https://files.tax.utah.gov/tax/commission/ruling/06-023.pdf
Original ruling text
This private letter ruling was inadvertently not posted in 2007.
FINAL PRIVATE LETTER RULING
REQUEST LETTER
06-023
October 10, 2006
Utah State Tax Commission
ATTN: TRU
210 North 1950 West
Salt Lake City UT 84134
Re: Letter Ruling Request – Compression Services
Dear Sir or Madam:
Our Client, COMPANY 1 (“COMPANY 1”), would like clarification regarding the application
of the Utah Sales and Use Tax statues to its activities in Utah.
COMPANY 1 assembles compressors (in STATE 1) that are used in connection with natural gas
exploration, production, processing and transportation. Historically, the assembled compressors
are either sold to third party customers or COMPANY 1 retains ownership and the compressors
are used by COMPANY 1 at customer locations to provide compression for a fee. Most of
COMPANY 1’s current contractual agreements with their customers are structured such that they
would be considered a “rental” or “lease” for Utah sales and use tax purposes.
COMPANY 1 is in the process of reorganizing its business. As a result of the reorganization,
COMPANY 1 will have four primary entities involved in the compression business in your
jurisdiction. Three of these entities will be new entities. One entity will lease compressors,
COMPANY 2 (“Lease Company”), to a related entity through agreements that should be
considered bare rentals. One of the purposes of Lease Company will be to streamline sales tax
compliance procedures by eliminating inefficiencies in the sales/use tax self-assessment process.
This is accomplished as a result of the bare rentals changing the nature of the tax form from a use
tax to a sales tax in most jurisdictions.
The lessee of the compressors from Lease Company, COMPANY 3 (“Service Company”), will
provide compression services to third parties. COMPANY 1 will contribute a portion of its
current fleet of compressors, subject to certain liabilities, to Lease Company in a transaction that
will be tax-free for federal income tax purposes. The remaining compressors will be contributed
to a new entity owned by COMPANY 1, COMPANY 4. “LEASE COMPANY 2”) that will lease
the compressors to COMPANY 1 for use in its compression business. This contribution will also
be tax-free for federal income tax purposes. Lease Company and LEASE COMPANY 2 will be
disregarded entities for federal tax purposes.
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As part of the reorganization, COMPANY 1 is also changing its contracts with certain
customers. The revised contracts will be used by both Service Company and COMPANY 1.
After these changes, the following contractual provisions indicate that the new service contract is
properly treated as a service agreement for federal income tax purposes, rather than a lease:
● risk of loss, control, and certain other characteristics will be the responsibility of
Service Company/ COMPANY 1 rather than the customer.
● the new contract does not specify a particular compressor or model of compressor
that will be used to perform the service, rather the contract stipulates only that the
compression services will be provided based on certain agreed upon parameters.
Thus, as the contract acknowledges, the compressors are tools used by the Service
Company / COMPANY 1 to perform services.
● ad valoem taxes will be the responsibility of Service company / COMPANY 1,
● Service Company / COMPANY 1 will be responsible for insurance for the
compressors,
● the fee charged for compression services is substantially higher than the cost of
bare rental of a compressor.
● the contracts are typically for approximately three years, or less than 15 percent of
a compressor’s economic life,
● Service Company / COMPANY 1 bears the risk of performance of its contractual
obligation to provide compression services. Thus, to the extent that Service
Company / COMPANY 1 is unable to provide compression services to its
customers, the Service Company/ COMPANY 1 will suffer a reduction in the fee
for compression services that it charges the customer and
● Service Company / COMPANY 1 does not own the gas at any point in the
process, but Service Company / COMPANY 1 compresses the natural gas for its
customers that typically sell the natural gas to third parties.
COMPANY 1 would specifically like guidance on how the changes described above affect the
Utah sales and use tax treatment of Service Company’s / COMPANY 1’s business transaction in
the state.
1. Will the Utah State Tax Commission treat the attached agreement (“Master
Services Agreement”) as a service agreement rather than a rental for Utah sales
and use tax purposes?
2. Will there by any Utah sales or use taxes due as the result of transferring the
existing compressors from COMPANY 1 to LEASE COMPANY 2 and Lease
Company? Will the resale exemption apply to the transfer?
If you have any questions or need additional information related to this ruling request, please call
me at PHONE NUMBER.
Best regards,
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NAME 1
TITLE 1
COMPANY 5
CITY 1, STATE 1
RESPONSE LETTER
November 30, 2007
NAME 1
TITLE 1
COMPANY 5
ADDRESS 1
ADDRESS 2
CITY 1, STATE 1 ZIP CODE 1
RE: Private Letter Ruling Request – 06-023
Dear NAME 1,
We have received your letter regarding the application of the Utah Sales and Use Tax
statutes to COMPANY 1 activities in Utah.
It should be noted that the ruling in this letter is not intended to be a statement of broad
Tax Commission Policy. It is an interpretation of the tax law as it relates to the facts presented in
your request letter and the assumptions stated in this ruling. If the facts or assumptions are not
correctly described in this ruling, please let us know so we can assure a more accurate response
to your circumstances.
FACTS
COMPANY 1 (COMPANY 1) assembles compressors at their facility in STATE 1.
These compressors are either sold to third parties or used in COMPANY 1’s compression service
business. COMPANY 1 is reorganizing its business structure to create the following three new
entities that will be subsidiaries of COMPANY 1:
1) COMPANY 2 (Lease Company), which will lease compressors to a related entity through
“bare rental” agreements.
2) COMPANY 3(Service Company), which will lease the compressors from Lease
Company and will provide compression services to third parties.
3) COMPANY 1 COMPANY 4. (LEASE COMPANY 2) will lease compressor to
COMPANY 1 for use in its compression business.
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Both Lease Company and LEASE COMPANY 2 will be disregarded entities for federal income
tax purposes.
COMPANY 1 plans to transfer a portion of its current fleet of compressors to Lease
Company, and to transfer the remainder to LEASE COMPANY 2. LEASE COMPANY 2 will
then lease the compressors to COMPANY 1 for use in its compression business. NAME 2 is
understanding of these transactions is that they will be tax free for federal income tax purposes.
The entities plan to treat the new contracts as services agreements for federal tax purposes, rather
than leases. You have provided a copy of the Master Services Agreement.
APPLICABLE LAW
Utah Code Section 59-12-103(1) imposes the tax on “(a) retail sales of tangible personal
property within the state.”
Subsection (k) of that same section imposes tax on “amounts paid or charged for leases or
rentals of tangible personal property if within this state the tangible personal property is: (i)
stored; (ii) used; or (iii) otherwise consumed;”
Subsection (l) imposes tax on, “amounts paid or charged for tangible personal property if
within the state the tangible personal property is: (i) stored; (ii) used; or (iii) otherwise
consumed.”
Utah Code Section 59-12-102 (80) defines a "retail sale" or "sale at retail" as a sale, lease,
or rental for a purpose other than:
(a) resale;
(b) sublease; or
(c) subrent.
Utah Code Section 59-12-102 (82) (a) defines “sale” as “any transfer of title, exchange,
or barter, conditional or otherwise, in any manner, of tangible personal property or any other
taxable transaction under Subsection 59-12-103(1).”
Utah Code Section 59-12-102 (82) (b)(v) states that “sale” includes “any transaction
under which right to possession, operation, or use of any article of tangible personal property is
granted under a lease or contract and the transfer of possession would be taxable if an outright
sale were made.”
Utah Code Section 59-12-102(43) states, “(a) ’lease’ or ‘rental’ means a transfer of
possession or control of tangible personal property for: (i) (A) a fixed term; or (B) an
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indeterminate term; and (ii) consideration…” Subsection (c) of this same section specifically
excludes from the definition of a lease a transaction “providing tangible personal property along
with an operator for a fixed period of time or an indeterminate period of time if the operator is
necessary for the equipment to perform as designed.”
Utah Code Section 59-12-104(13) provides the following exemption: “(a)…the sale of
tangible personal property by a person: (i) regardless of the number of transactions involving the
sale of that tangible personal property by that person; and (ii) not regularly engaged in the
business of selling that type of tangible personal property.”
Utah Code Section 59-12-104(23) provides an exemption from sales tax for “property
stored in the state for resale.”
Utah Code Section 59-12-104(25) provides an exemption from sales tax for “property
purchased for resale in this state, in the regular course of business, either in its original form or as
an ingredient or component part of a manufactured or compounded product.”
ANALYSIS
Transactions between Service Company and third parties. Under Utah Code Section
59-12-102 (82)(b)(v), and §59-12-103(1)(k), the agreement to provide compressor services to
third parties under the Master Services Agreement is, in substance, a taxable rental or lease of
compressors subject to Utah sales and use tax. The customer agrees to provide a site for the
compressor and to pay a mobilization fee for installing the compressor. Service Company agrees
to install a suitable compressor and to maintain it in the necessary operating condition to meet
the specifications of the contract. In other words, it ensures that the compressor it provides will
perform the necessary task. The agreements are in essence agreements to lease equipment
(compressors) to provide compression for a fee in connection with natural gas exploration,
production, processing and transportation. The fact that no specific piece of equipment is
identified is not dispositive; nor is the fact that Service Company will repair or replace the
compressor if it is not performing properly. For sales tax purposes, Service Company is leasing
equipment (compressors) to its customers.
For the same reasons, we believe any “compression services” performed by COMPANY
1 under the Master Service Agreement are also subject to sales tax as leases or rentals of tangible
personal property.
The lease of compressors from Lease Company to Service Company. As noted
above, a taxable “sale” for Utah sales tax purposes includes a lease. Because the Service
Companies will be “re-leasing” the compressors to their own customers, the lease of the
compressors to Service Company from Lease Company will be a “sale for resale.” Sales for
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resale are specifically exempted from tax under Section 59-12-102(25). Acccordingly, the lease
of compressors from Lease Company to Service Company is exempt from Utah sales tax.1
The lease of compressors by LEASE COMPANY 2 to COMPANY 1. The lease of
compressors by LEASE COMPANY 2 to COMPANY 1 is an exempt sale for the same reasons
that the lease of compressors by Lease Company to Service Company is exempt.
Tranfers of assets on formation of LEASE COMPANY 2 and Lease Company. The
transfer of the compressors from COMPANY 1 to LEASE COMPANY 2 and Lease Company
constitute sales of tangible personal property as defined in Utah Code §59-12-102(82). “Sale” is
defined as “any transfer of title, exchange, or barter, conditional or otherwise, in any manner, of
tangible personal property or any other taxable transaction under Subsection 59-12-103(1), for
consideration.” COMPANY 1 is transferring its compressors to LEASE COMPANY 2 and
Lease Company in exchange for an ownership interest in each subsidiary. This interest qualifies
as valuable consideration.
Although transfers of property pursuant to incorporations or formations of business
enterprises are typically exempt as “isolated or occasional sales, this exemption does not apply to
transfers of inventory. Under Utah law, a transfer of inventory is never “isolated or occasional.”
Therefore, these transfers do not qualify as isolated or occasional sales pursuant to Section 59-
12-104(13) because COMPANY 1 is regularly engaged in the business of renting compressors.
However, the transfer of compressors to LEASE COMPANY 2 and Lease Company
does qualify for an exemption from sales tax under the resale exemption in Section 59-12-
104(25). As noted above, both LEASE COMPANY 2 and Lease Company will be leasing the
compressors to their customers in taxable transactions. Accordingly, the transfer of compressors
from COMPANY 1 to its subsidiaries, pursuant to the formation of those subsidiaries, is exempt
from Utah sales tax.
CONCLUSION
The Master Services Agreement is not a service agreement for the purposes of Utah sales
and use tax. Accordingly, both COMPANY 1 and Services must collect sales and use tax on the
“services” performed for their customers under the Master Services Agreement. The lease of
compressors from Lease Company to Service Company, or from LEASE COMPANY 2 to
COMPANY 1, are exempt “sales for resale.” Transfers from COMPANY 1 to COMPANY 1
1
We note that the law on “disregarded entities” is not well-developed in Utah. As a general proposition,
we believe the entities in question are disregarded for federal income tax purposes only. They are still separate
entities for sales tax purposes. Sales between a parent and its wholly owned subsidiary are subject to the normal
sales and use tax laws. See Institutional Laundry, Inc. v. State Tax Commission, 706 P.2d 1066 (Utah 1985).
Because the sales are exempt in any event, it is not necessary to rule on this issue in this ruling.
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Lease Company and Lease Company on formation of those subsidiaries are also exempt under
the resale exemption.
Our conclusion is based on the facts you presented. Should the facts be different from
those represented in this letter, our opinion may change accordingly. Thank you for your inquiry
into this matter.
For the Commission,
Marc B. Johnson
Commissioner
MBJ/SR/RBJ
06-023
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