If I transfer my manufacturing equipment to a new LLC to reduce personal liability and lease it back to my business, do the lease payments qualify for Utah's manufacturing sales tax exemption?

Plain-English summary

A sole proprietor, facing a product-liability lawsuit threat, formed a family-owned LLC on legal advice and transferred ownership of manufacturing equipment into it to reduce personal ownership exposure — planning to lease the equipment back to keep running the same manufacturing operation. The equipment had originally been purchased tax-free under Utah's "new or expanding manufacturing operations" exemption. The taxpayer asked whether the new lease payments to the LLC would also be exempt.

The Commission explained Utah's manufacturing exemption framework in detail and then applied it:

The manufacturing exemption (new/expanding operations): Sales or leases of machinery/equipment by a manufacturer (SIC codes 2000-3999) for use in a new or expanding manufacturing operation at a Utah facility are exempt — but only tangible personal property, not equipment with a useful life under three years, and not equipment used for non-manufacturing activities like shipping the finished product.

Replacement equipment: Equipment bought as a normal operating replacement for existing equipment (same purpose, old equipment retired within 12 months before/after) is currently taxable, though the legislature had just passed a phase-in of a replacement-equipment exemption: 30% for tax years beginning July 1, 1996; 60% beginning July 1, 1997; and 100% beginning July 1, 1998. Replacements bought before July 1, 1996 stay fully taxable.

Sale-leaseback exemption: Since July 1, 1995, § 59-12-102(13)(c) exempts lease payments under a sale-leaseback arrangement, but only if (1) the lessee paid sales tax on its original purchase and then transferred title to a lessor, (2) the leaseback is intended as a financing arrangement, and (3) the lessee capitalizes the property for financial reporting and accounts for lease payments as financing payments.

Applying these rules, the Commission found the taxpayer's arrangement failed both routes: the manufacturing exemption doesn't apply because the LLC's leaseback wasn't for a new or expanding operation — it's the same equipment doing the same job it always did. And the sale-leaseback exemption doesn't apply because the transaction wasn't structured as financing (and the original equipment was purchased tax-exempt, not taxed, failing condition 1). The LLC's own purchase of the equipment is tax-exempt as a purchase for resale (i.e., for leasing), but the lease payments the taxpayer pays back to the LLC are a separate, taxable transaction.

What this means for you

Business owners restructuring for liability protection

Moving equipment into an LLC or other entity to limit personal liability is a legal-structuring decision with its own sales-tax consequences. If the leaseback isn't a genuine financing arrangement — and simply continuing the same operations doesn't count as "new or expanding" — the lease payments will be taxable even though the underlying equipment was originally exempt.

Manufacturers considering a sale-leaseback for financing purposes

If your goal really is financing (not liability restructuring), structure the deal to satisfy all three conditions in § 59-12-102(13)(c): you must have paid sales tax on the original purchase, intend the leaseback as financing, and capitalize the equipment and account for lease payments as financing payments in your books. Missing any one of these breaks the exemption.

Accountants and tax professionals

Note the replacement-equipment exemption phase-in schedule this ruling documents (30%/60%/100% for tax years beginning July 1 of 1996/1997/1998) — useful for dating older Utah manufacturing exemption questions, since the percentage available depends on exactly when the tax year begins.

Common questions

Q: We're restructuring equipment ownership into a new entity purely to limit liability — will our lease payments be exempt?
A: Not under either exemption discussed here, unless the leaseback is a genuine financing arrangement meeting all three conditions of § 59-12-102(13)(c), or the equipment is being put into new or expanding manufacturing use (not just continuing the same operations).

Q: Does the manufacturing exemption apply to replacement equipment?
A: Not fully as of this 1996 ruling. Replacement equipment was taxable, with a phase-in exemption of 30% starting July 1, 1996, 60% starting July 1, 1997, and 100% starting July 1, 1998. Replacements bought before July 1, 1996 were fully taxable.

Q: If our LLC buys equipment specifically to lease it back to us, is that purchase taxable?
A: The Commission said the LLC's purchase for the purpose of leasing it back is exempt as a purchase for resale — but the lease itself is then a separate, taxable transaction (unless the sale-leaseback exemption's three conditions are independently met).

Citations and references

Statutes and administrative sources:

• Utah Code Ann. § 59-12-102(13)(c) (sale-leaseback lease payment exemption, effective July 1, 1995)
• 1987 Standard Industrial Classification Manual, SIC codes 2000-3999 (defines qualifying "manufacturer")

Source

• Landing page: https://tax.utah.gov/commission/rulings/
• Original page: https://files.tax.utah.gov/tax/commission/ruling/96-062.htm

Original ruling text

96-062

Response
April 9, 1996

Request

Attn:
XXXXX

Ref: Request for Advisory Opinion regarding XXXXX

Dear
Commissioner(s),

I
need a clarification pertaining to sales taxation on lease payments for
manufacturing equipment.

In
1995, XXXXX (a proprietorship by XXXXX) was threatened with a law suit relating
to product liability. Under advice from
legal counsel, I formed a XXXXX company (XXXXX) with the intent of transferring
the mfg. equipment ownership into the LLC to reduce my ownership fraction (each
member of my family owns a part). I
assumed that because the equipment originally fell under �new/expanding mfg.
operations,� the lease payments would not be subject to sales taxation. After researching this with one of your
auditors (XXXXX) it was suggested I seek a clarification.

If
these payments are taxable, I have only a couple of choices:

Reduce
the payments to some very low value (which may negate the validity of the
lease/ownership in a law suit).

or,
restructure XXXXX to be the LLC

Thank
you for your time in clarifying this matter.

Sincerely,

XXXXX

XXXXX

Re: Manufacturing sales tax exemption

Dear
XXXXX

We
have received your request for an advisory opinion as to whether your lease
payments are eligible for exemption as purchases of manufacturing equipment in
a new or expanding business.

Although
you have indicated that the equipment involved qualifies for a manufacturing
exemption, we cannot verify that from the information provided in your
request. Therefore, we start by
outlining the requirements for the manufacturing exemption so you can be sure
that your initial purchase was eligible for exemption.

Machinery
Purchased for New or Expanding Operations

Sales
or leases of machinery and equipment by a manufacturer for use in a new or
expanding operations related to the manufacturing process in a Utah
manufacturing facility are exempt from sales tax. To be eligible, the manufacturing operation must fit within the
classifications of manufacturer described in SIC codes 2000 - 3999 of the 1987
Standard Industrial Classification Manual.
The exemption is further limited or qualified as follows:

1. The exemption applies only to tangible
   personal property, not real property or tangible property that is purchased and
   becomes an improvement to real property.

2. Machinery or equipment with a useful
   economic or accounting life of less than three years is not eligible for the
   exemption.

3. Machinery or equipment used for an activity
   that is not part of the manufacturing process, such as equipment used to
   transport or ship the final product, does not qualify for the exemption.

Replacement
Equipment

Manufacturing
machinery or equipment which is purchased as a normal operating replacement is
currently subject to sales tax.
Replacement equipment is defined as equipment which serves the same
purpose as existing equipment. If the
existing equipment is retired from service within 12 months before or after the
purchase of new equipment, the new equipment is considered replacement
equipment.

The
state legislature recently passed a bill which phases in an exemption for
manufacturing replacement equipment over the next few years. The exemption rates which will apply to
replacement equipment are set out below.

1. For tax years beginning July 1, 1996, 30% of
   the exemption is allowed.

2. For tax years beginning July 1, 1997, 60% of
   the exemption is allowed.

3. For tax years beginning July 1, 1998, 100%
   of the exemption is allowed.

Normal
operating replacements purchased before July 1, 1996 are fully taxable.

Transfer
and Leaseback Arrangement

Assuming
that your equipment qualified for the manufacturing exemption, we turn to your
question regarding the sale and leaseback arrangement. Utah law imposes sales and use tax on retail
sales and leases of personal tangible property unless a statutory exemption
applies. However, section 59-12-102
(13) (c) of the Utah Code now provides that as of July 1, 1995, lease payments
made under a sale-leaseback agreement are exempt from sales tax if:

1. the lessee pays sales tax on its initial
   purchase and then enters into a sale-leaseback transaction which transfers
   title to the property to the lessor,

2. the transaction is intended as a form of
   financing for the property to the purchaser-lessee, and

3. the purchaser-lessee capitalizes the subject
   property for financial reporting purposes, and accounts for the lease payments
   as payment made under a financing arrangement.

If
your company purchased manufacturing equipment tax-free by claiming the
manufacturing exemption and the leaseback arrangement is entered for some
purpose other than financing, the sale-leaseback provision cited cannot apply
because it fails to meet conditions 1 and 2 above.

If
the LLC purchases the equipment for the purpose of leasing it back to you, the
LLC�s purchase is tax exempt as a purchase for resale. However, your lease from the LLC constitutes
a separate taxable transaction.
Unfortunately, the manufacturing exemption is of no use to you here
because you did not enter the lease to expand your manufacturing operations. You are using the same equipment to perform
the same functions that it has performed since it was put into service.

Unfortunately,
the sales tax laws seem to present an obstacle for you so long as the
transaction is structured as you�ve described it in your letter. As you consider other alternatives, please
feel free to call upon us for information or advice.

For the Commission,

Alice Shearer,

Commissioner