Were natural-gas compressor agreements taxable leases, and were compressor transfers in a business reorganization exempt?

Subject

Master Services Agreement; Transfer of property through a reorganization

Plain-English summary

Virginia treated the proposed compressor-services agreement as a taxable lease of equipment, not an exempt service. The company would transport, install, start, insure, maintain, and later remove the compressor, but the compressor itself was critical to providing natural-gas compression. Under the true-object test, those services facilitated the customer's use of tangible property.

The full gross proceeds from a Virginia compressor lease were therefore taxable. The company and leasing partnerships could buy compressors used exclusively for leasing under a resale certificate.

The transfers of compressors from the company to two newly created partnerships were exempt as an occasional sale because they occurred through a business reorganization. Compressors transferred to the partnership for continued taxable leasing also qualified for the exemption for property acquired for future taxable lease, including a leaseback.

The partnerships had to register to collect Virginia tax on lease proceeds when leasing equipment in Virginia. The third partnership would also have to register if it engaged in Virginia lease activity.

What this means for you

• Calling a contract a services agreement does not control when equipment is the transaction's true object.
• Transportation, installation, start-up, insurance, and maintenance can remain part of a taxable equipment lease.
• A qualifying whole-business reorganization may receive occasional-sale treatment.
• Leasing entities still must register and collect tax on later Virginia lease receipts.

Common questions

Were the asset transfers themselves taxable? No, under the proposed reorganization they qualified as exempt occasional sales.

Were the later compressor charges exempt services? No. Virginia treated them as taxable lease proceeds.

Citations and references

• Va. Code §§ 58.1-603, 58.1-602, 58.1-612(B), and 58.1-609.10(2)-(3).
• 23 VAC 10-210-4040(A), (D) and 23 VAC 10-210-840.
• P.D. 01-16 and P.D. 04-194.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-35

Original ruling text

April 10, 2008

Re: Request for Ruling: Retail Sales and Use Tax

Dear *:

This will reply to your letter and recent conversation with a member of the Appeals and Rulings staff, in which you request a ruling on behalf of your client * (the "Taxpayer"), on the application of the retail sales and use tax to the transfer of property through a reorganization of the Taxpayer's business. In addition, you request a ruling on the application of the retail sales and use tax to the Taxpayer's "Master Services Agreement". I apologize for the delay in responding to your letter.

FACTS

The Taxpayer, an out-of-state corporation, is engaged in the business of engineering and assembly of natural gas compressors for sale and for use in providing compression of natural gas to its customers. The Taxpayer is registered with the Department for the collection of the tax on lease contracts in Virginia.

The Taxpayer is in the process of reorganizing its business in a tax-free reorganization for federal income tax purposes. The Taxpayer will form three new limited liability partnerships that will be disregarded entities under Treasury Regulation § 301.7701-3 b. The newly formed partnerships will be located in another state.

Under the reorganization, the Taxpayer will contribute a portion of its compressors for investment in a newly formed limited liability partnership (Partnership A). Partnership A will lease the compressors back to the Taxpayer for use in providing compression of natural gas to its customers. The taxpayer will contribute the remaining compressors for a consideration to a second newly formed partnership (Partnership B). Partnership B will lease the compressors to another newly formed partnership (Partnership C) for use in providing compression of natural gas to third parties.

Compressors currently under lease/rental agreements in Virginia will remain in force subsequent to the transfer of ownership to the partnerships under the reorganization. The Taxpayer questions whether the transfer of the compressors to Partnerships A and B is subject to Virginia sales and use tax or will the resale exemption apply.

The Taxpayer also plans to restructure its current contract for the lease of compressors to a contract for the provision of compressor services. The Taxpayer questions whether the Department will treat the revised Master Services Agreement as the provision of a nontaxable service or the lease/rental of tangible personal property for purposes of the Virginia sales and use tax.

RULING

Master Services Agreement

According to the Master Services Agreement (the "Agreement"), the Taxpayer and the customer enter into a contract in which the Taxpayer provides compression of the customer's natural gas for a fee. The Taxpayer will provide mobilization and transportation of employees, tools, equipment and property to the customer's site. In addition, the Taxpayer will provide installation, connection supervision and start-up of such equipment. Upon termination of the lease/rental, the Taxpayer will provide disconnection supervision, if required, and demobilization and transportation of the equipment from the customer's site. The Taxpayer maintains ownership of and is responsible for the insurance on the equipment as well as the maintenance, including inspections and repairs.

Pursuant to Title 23 of the Virginia Administrative Code 10-210-4040 A, charges for services generally are exempt from the retail sales and use tax; however, services provided in connection with the sale of tangible personal property are taxable. When a transaction involves both the sale of tangible personal property and the provision of services, generally the transaction is either taxable or exempt on the full amount charged, regardless of whether the charges for the services or the property are separately stated. The true object test is used to determine the taxability of these transactions.

Title 23 VAC 10-210-4040 D sets out the guidelines used to determine the "true object" of a transaction that includes both the sale of tangible personal property and the provision of services:

If the object of the transaction is to secure a service and the tangible personal property which is transferred to the customer is not critical to the transaction, then the transaction may constitute an exempt service. However, if the object of the transaction is to secure the property which it produces, then the entire charge, including the charge for any services provided, is taxable.

In this case, the compressor is a critical element of the transaction. While the terms of the Agreement require the Taxpayer to provide certain start-up and maintenance services of the equipment, including transportation and installation, such items are provided as part of and facilitate the primary objective of the Agreement, the provision of tangible personal property. Based on my review, the true object of this Agreement is to furnish tangible personal property. The Department has addressed services versus sales in prior Department rulings. See Public Document (P.D.) 01-16 (3/9/01) and 04-194 (10/29/04).

Tax Treatment of Leases

Virginia Code § 58.1-603 imposes the sales tax on every person who sells or leases or rents tangible personal property in the Commonwealth. Virginia Code § 58.1-602 defines sale to mean "any transfer of title or possession, or both, exchange, barter, lease or rental, conditional or otherwise, in any manner or by any means whatsoever, of tangible personal property . . . ."

The tax imposed by Va. Code § 58.1-603 on the lease of tangible personal property is to be collected by the "dealer" and remitted to the Department on the gross proceeds derived from the lease or rental of tangible personal property. The term "dealer" is defined in Va. Code § 58.1-612 B to include every person who leases or rents tangible personal property for a consideration. "Gross proceeds" is defined in Va. Code § 58.1-602 as "the charges made or voluntary contributions received for the lease or rental of tangible personal property or for furnishing services, computed with the same deductions, where applicable, as for sales price . . . ." The Code defines "sales price" to mean "the total amount for which tangible personal property or services are sold, including any services that are a part of the sale... without any deduction therefrom on account of the cost of the property sold, the cost of materials used, labor or service costs, losses or any other expenses whatsoever".

When the Taxpayer or partnerships enter into an Agreement for the lease of a compressor in Virginia, the Agreement will be subject to the tax on the gross proceeds received from the lease of the equipment. Under Title 23 VAC 10-210-840, both the Taxpayer and partnerships may purchase compressors used exclusively for lease purposes exempt of the tax using a resale certificate of exemption, Form ST-10.

Transfer of Property Under Reorganization

The transfer of assets constitutes a "sale" as defined in Va. Code § 58.1-602. However, pursuant to Va. Code § 58.1-609.10 2, an occasional sale is not subject to taxation. Virginia Code § 58.1-602 defines an "occasional sale" to include:

the sale or exchange of all or substantially all the assets of any business and the reorganization or liquidation of any business, provided such sale or exchange is not one of a series of sales and exchanges sufficient in number, scope, and character to constitute an activity requiring the holding of a certificate of registration.

Based on the information provided in your correspondence, the transfer of the assets from the Taxpayer to Partnerships A and B is a reorganization of a business and, therefore, is an exempt occasional sale.

Furthermore, Virginia Code § 58.1-609.10 3 provides a sales tax exemption for "[t]angible personal property for future use by a person for taxable lease or rental as an established business or part of an established business, or incidental or germane to such business, including a simultaneous purchase and taxable leaseback." This exemption is shown as Item #2 on the Department's Resale Exemption Certificate, Form ST-10.

In this case, the compressors transferred to Partnership B under the reorganization are under a lease/rental contract and will qualify for the exemption in Va. Code § 58.1-609.10 3. As a dealer in the business of leasing tangible personal property in Virginia, Partnerships A and B will be required to register with the Department for the collection of the tax on the proceeds from the lease of compressors to third parties. If Partnership C should engage in lease activities in Virginia, it will be required to register with the Department for the collection of the tax on the gross proceeds received from the lease of equipment.

This ruling is based on the facts presented as summarized above. Any change in the facts or the introduction of new facts may lead to a different result.

The Code of Virginia sections, regulations and public documents cited, along with other reference documents, ,ire available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions about this response, you may contact *, in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-1055135686.T