Would amended building leases become mortgage financing when the lessee acquired the lessor but retained title and leases to preserve bond debt?

Subject

Real Property Transaction Creates a Lease or a Mortgage

Plain-English summary

The proposed amended leases were mortgage financing rather than taxable commercial leases. The taxpayer would buy the ownership interest in the entity owning the lessor, while title remained with the lessor only to preserve and secure existing note-and-bond financing.

Payments were tied almost exactly to debt service and directed to the trustee. The amendments imposed ownership costs and risk on the taxpayer, were noncancelable, granted mortgage and foreclosure remedies, and required title transfer or a payoff purchase when the notes were satisfied.

What this means for you

Calling the documents leases did not control. The integrated acquisition, financing purpose, payment economics, title function, remedies, and ownership burdens made the arrangement a mortgage.

Common questions

Q: Were payments under the amended leases taxable rent? No.

Q: Why did the lessor retain title? To secure and preserve the existing financing until the notes were paid.

Q: Who bore the property's ownership risks? The taxpayer-lessee.

Citations and references

• Fla. Stat. § 212.031(1)(a) and (c) — commercial real-property rental tax
• Fla. Stat. § 697.01(1) — instruments intended as security
• Bridgestone/Firestone, Inc. v. Department of Revenue, DOAH Case No. 92-2483, 15 FALR 4874 (1993)
• Fla. Stat. § 213.22 — Technical Assistance Advisements

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 01A-022

Original ruling text

SUMMARY

QUESTION: Does the subject Lease Agreement between Taxpayer
and Lessor, when considered with all other relevant
documents to the same transaction, constitute a financing
arrangement, rather than a lease or rental of commercial
real property?

ANSWER - Based on Facts Below: Yes. Crucial factors
contained in the documentation of the transaction indicate
that the transaction is in the nature of a mortgage rather
than an operating lease and as such, payments made by
Taxpayer, pursuant to the Amended Lease Agreement, will not
be subject to sales tax imposed pursuant to section
212.031, F.S.

Apr 30, 2001

Re: Technical Assistance Advisement 01A-022
Sales and Use Tax - Whether the Subject Real Property
Transaction Creates a Lease or a Mortgage
Sections: 212.031(1)(a), (c), 697.01(1), F.S.

Dear :

This is in response to your request, dated XX, received XX, for
the Department's issuance of a Technical Assistance Advisement
("TAA") concerning the above referenced parties and matter. Your
letter has been carefully examined and the Department finds it
to be in compliance with the requisite criteria set forth in
Chapter 12-11, F.A.C. This response to your request constitutes
a TAA and is issued to you under the authority of section
213.22, F.S.

Documents provided by Taxpayer

You have provided several documents that are relevant to the
transaction. These include the following:

Agreement of Purchase and Sale Lease Agreements and
amendments thereto Guaranties (Buildings XXX) (Building
XXX) Proposed Amendments to Leases entitled, "Second
Amendment of Lease (Buildings XXX)" and "Third Amendment of
Lease (Building XXX)".

Facts

The facts as provided in your letter may be summarized as
follows.

The Taxpayer is a corporation engaged in the business of XXX.
Taxpayer's headquarters are located in XXX.

On XX, Taxpayer entered into Lease Agreements with Lessor for
the lease of XXX Buildings ("the Buildings" or "the properties")
located in XXX. The Lease Agreements continue to be in effect
and Taxpayer continues to lease the Buildings from the Lessor.
At the time of the execution of the Lease Agreements, Guarantor
entered into agreements (Guaranties) to guaranty Taxpayer's
obligations under the Lease Agreements.

At a point contemporaneous with the execution of the Lease
Agreements and Guaranties, the Sole Limited Partner of Lessor
established a Trust. Bonds were issued by the Trust to finance
the development of the Buildings. The proceeds of the bond
issuance were paid by the Trust to the Lender in exchange for
the assignment by the Lender to the Trust of two promissory
notes (Notes) executed by the Lessor in favor of the Lender. The
Notes are secured by mortgages on the Buildings executed by the
Lessor. The Lender assigned the mortgages to the Trust. The
Lessor has made payments to the Trust on the Notes from the date
they were assigned through the present and the Trust has,
accordingly, made payments to the purchasers of the bonds.

The Taxpayer now endeavors to purchase the Buildings; however,
in order to maintain favorable financing afforded by the terms
of the Notes, it is necessary to maintain the existing ownership
structure for the Buildings until the terms of the Notes are
satisfied. Furthermore, it is also necessary to maintain the

subject Lease Agreements and Guaranties to serve as additional
security for the Notes.

Taxpayer intends to enter into an Agreement of Purchase and Sale
whereby Taxpayer will purchase the interest in the entity that
owns the Lessor. Although this would in effect result in the
Taxpayer's ownership of the Buildings, the Lessor will retain
title to the property. Using this method, the Taxpayer will
also indirectly assume liability under the Notes.

Upon consummation of the above purchase, the Taxpayer intends to
enter into amendments to the Lease Agreements. The amendments
are intended to convert the subject Lease Agreements into
capital leases or, in effect, mortgages. Payments made under
the proposed Amended Leases will provide the Lessor the revenues
necessary to fulfill the debt service requirements on the Notes.
The Taxpayer will occupy the Buildings under the Amended Leases
until the Notes are satisfied. Upon satisfaction of the Notes,
Taxpayer will take title to the properties either under the
terms of the Amended Leases or through some other mechanism such
as merger with the Lessor. Specifically, the Lease Amendments
include the following:

Intent statements by the parties that the Amended Leases will
serve as additional security for the Notes and will operate as
mortgages.

Substantive provisions stating that the transactions are to be
treated as a loan and financing arrangement.

Transfer of title to Taxpayer/Lessee upon satisfaction of the
Notes.

Placement of all obligations and risks concerning property on
Taxpayer/Lessee.

Lease payments that equal debt service.

"Hell or high water" payment obligation.

An express grant of a mortgage and security interest with

foreclosure remedies.

Requested Advisement

You have requested an advisement that the proposed amendments to
the subject Lease Agreement between Taxpayer and Lessor, when
considered with all other relevant documents to the same
transaction, constitute a financing arrangement, rather than a
lease or rental arrangement. Therefore, payments made in
accordance with the Amended Lease Agreement would not be subject
to sales tax pursuant to section 212.031, F.S.

Law and Analysis

Section 212.031(1)(a), F.S., provides:

It is declared to be the legislative intent that every
person is exercising a taxable privilege who engages in the
business of renting, leasing, letting, or granting a
license for the use of any real property....

Section 212.031(1)(c), F.S., provides:

For the exercise of such privilege, a tax is levied in an
amount equal to 6 percent of and on the total rent or
license fee charged for such real property....

Section 697.01(1), F.S., provides:

All conveyances, obligations conditioned or defeasible,
bills of sale or other instruments of writing conveying or
selling property, either real or personal, for the purpose
or with the intention of securing the payment of money,
whether such instrument be from the debtor to the creditor
or from the debtor to some third person in trust for the
creditor, shall be deemed and held mortgages, and shall be
subject to the same rules of foreclosure and to the same
regulations, restraints and forms as are prescribed in
relation to mortgages.

Therefore, it must be determined when analyzing the transaction

as a whole, in light of the parties' intentions, whether the
Lessor is engaged in leasing real property to the
Taxpayer/Lessee, or whether the transaction is in substance a
mortgage arrangement under which bare legal title to the
property is held by the Lessor as security for repayment.

Under certain circumstances, for tax purposes, a document
structured as a lease may be treated as a mortgage.
Bridgestone/Firestone, Inc. v. Department of Revenue, DOAH Case
Number 92-2483, 15 FALR 4874 (1993). The Administrative Hearing
Officer in Bridgestone/Firestone stated, "Although a document
may be called a lease on its face, this in itself is not
dispositive of the issue. Rather, in order to properly
determine the true nature of the transaction, it is necessary to
examine the intention of the parties and the substance of the
agreement." (Paragraph 23).

In Bridgestone/Firestone, a sale-leaseback transaction was
examined. In that case, it was determined that the transaction
taken as a whole was a mortgage loan transaction (affirmed by
the Department of Revenue in its final order), rather than a
lease, and that, as a result, payments made under the agreement
were not subject to sales tax.

In analyzing the instant transaction in its entirety, an
analogous determination is made. A Landlord/Tenant relationship
does not exist between Taxpayer and Lessor. Thus, there is no
"total rent or license fee" paid by the Taxpayer. The Lessor is
not the landlord, because the transaction represents a financing
arrangement rather than the execution of a lease. This
conclusion is based upon the following factors:

The sole purpose of this transaction is to finance the
acquisition of the subject properties while assuming the
existing financing arrangement, by purchasing the ownership
interest in the entity/partnership. The Lessor serves as a
single purpose financing entity. As a consequence, the Lessor
is not in the business of engaging in the conveyance of a lease
or the grant of a license to use real property. Rather, the
Lessor serves as an integral part of the financing arrangement.
The Lessor is not a landlord but serves more in a capacity of

the administrator of the transactions. The following language
from the Amended Leases clarifies the purpose of the
transaction:

Introductory paragraph XX, on page XX of the Amended Leases,
states:

WHEREAS, Tenant intends to acquire title to the Leased
Premises but, in order to maintain indebtedness owed
pursuant to the Mortgage Notes, it is necessary for Tenant,
instead, to acquire ownership and control of Landlord and
to maintain the Lease to serve as additional security for
the Mortgage Notes until such time as the indebtedness
evidenced by the Mortgage Notes is satisfied:...

Paragraph XX of the Amended Leases, entitled "Nature of
Transaction" (amending Lease section XX) provides:

Nature of Transaction. It is the intent of the parties
hereto that (i) the transaction contemplated hereby
constitutes a capital lease from Landlord to Tenant for
purposes of Tenant's financial reporting; (ii) the
transaction contemplated hereby constitutes a loan to
Tenant and a financing arrangement between the parties for
all other purposes, including, without limitation,
financial reporting, federal, state and local tax purposes,
bankruptcy, commercial law and real estate purposes; (iii)
Tenant, pursuant to the Lease, grants a security interest
or lien, as the case may be, in the Leased Premises; and
(iv) for purposes of federal and state income tax and
bankruptcy purposes, among others, the payment by Landlord
of rent and additional rent hereunder shall be treated as
payments of interest, and the payment by Tenant of the
Contingent Payment shall be treated as repayment of
principal.

Paragraph XX, of the Amended Leases, entitled "GRANT OF MORTGAGE
AND SECURITY INTEREST" (amending Lease section XX) provides:

Title to the Leased Premises shall remain in Landlord, as
security for the obligations of Tenant hereunder and under

each of the Security Documents to which it is a party,
until such time as Tenant shall have fulfilled all of its
obligations hereunder. Tenant hereby mortgages, conveys,
warrants, assigns, grants and pledges to Landlord for the
benefit of the Trustee and the Landlord a mortgage and
security interest in and lien against all of Tenant's
right, title and interest, whether now or hereafter
existing or acquired, in the Leased premises and proceeds
therefrom, to secure the payment and performance of all
obligations of Tenant now or hereafter existing under this
Lease or any other Security Documents.... Upon Tenant's
request, Landlord shall at such time as all of the
obligations of Tenant under this Lease or any other
Security Documents have been indefensibly paid or performed
in full, execute and deliver releases, termination
statements and other appropriate documentation reasonably
requested by Tenant, all at Tenant's expense to evidence
Landlord's release of its lien against the Leased Premises.
Tenant shall have the right to grant easements, make
subleases and grant other rights which may affect title;
all subject and subordinate, however, to the Security
Documents. (emphasis added)

There is no economic substance to the lease agreement beyond
insuring amortization of the debt. The Lessor does not receive a
rental or license fee in the ordinary sense of the economic
owner of property attempting to maximize income from an
investment by charging a rent or fee determined by the market
value of the improvements. Rather, the "rent" payments here are
almost exactly equal to the debt service requirements of the
Notes and in the event that such payments are not sufficient,
the proposed Lease Amendments require Taxpayer/Lessee to satisfy
any deficiency. The amendments also state that the Tenant is
authorized and directed by the Landlord to pay all such payments
of rent to the Trustee to be applied to the payments due and
owing on the Mortgage Notes. See paragraph XX of Lease
Amendments (amending Lease section XX).

Finally, the Amended Lease provides the Lessor with the default
remedy of foreclosure, a remedy that is typically not seen in a
lease agreement between Landlord and Tenant. Specifically,

paragraph XX of the Amended Lease provides:

The Landlord may exercise any of its rights and remedies
under the grant of mortgage and security interest set forth
in Section XX hereof, including foreclosure of such
mortgage and security interest on Tenant's right, title and
interest in the Leased Premises. (emphasis added)

Furthermore, the Taxpayer is not a tenant of the Lessor for the
following reasons:

As part of the total financing arrangement, Guarantor has
guaranteed the Lessee's rental/payment obligations under the
Lease Agreement. Although the Guarantor's obligations are
limited to the original lease agreement, the Guaranty
nevertheless serves as security for the subject financing
arrangement. See Guaranty and Amended Leases. Such a pledge is
not typically provided on behalf of a Tenant in a lease
agreement.

As rent, the Taxpayer/Lessee pays monies the sum of which is
directly tied to the debt service owed on the Notes rather than
a sum that is representative of fair market rent.

Typical obligations of ownership and risk are with the
Taxpayer/Lessee, rather than the Lessor. The Taxpayer/Lessee
will pay all costs for using and operating the property and will
"assume with respect to the Leased Premises every obligation
relating thereto which the ownership, use, possession, control
and operation thereof entails...." see paragraphs XX, Lease
Amendments (amending Lease sections XX).

The Leases will be "non-cancelable by the Tenant for any reason
whatsoever...." see paragraph XX, Lease Amendments (amending
Lease section XX).

Upon satisfaction of the Notes at lease termination, title to
the leased premises will be transferred to Taxpayer/Lessee;
also, Taxpayer/Lessee has the option of purchasing the leased
premises for an amount equal to that required to satisfy the
Notes. See paragraph XX, Lease Amendments (amending Lease

section XX).

The payment obligation under the Leases survives condemnation of
the properties. See paragraph XX, Lease Amendments (amending
Lease subsection XX).

All risk of loss for the properties, including damage or
destruction by fire, the elements, casualties, thefts, riots,
wars, or otherwise, will be assumed by Taxpayer/Lessee. See
paragraph XX, Lease Amendments (amending Lease section XX).

Response

Based on the facts, law, and analysis as presented, a
determination is made that the subject transaction is in the
nature of a mortgage rather than an operating lease and, as
such, payments made by Taxpayer, pursuant to the Amended Lease
Agreement, will not be subject to sales tax imposed pursuant to
section 212.031, F.S.

This response constitutes a Technical Assistance Advisement
under section 213.22, F.S., which is binding on the Department
only under the facts and circumstances described in the request
for this advice, as specified in section 213.22, F.S. Our
response is predicated upon those facts and the specific
situation summarized above. You are advised that subsequent
statutory or administrative rule changes or judicial
interpretations of the statutes or rules upon which this advice
is based may subject similar future transactions to a different
treatment from that which is expressed in this response.

You are further advised that this response, your request, and
related backup documents are public records under Chapter 119,
F.S., and are subject to disclosure to the public under the
conditions of section 213.22, F.S. Confidential information
must be deleted before public disclosure. In an effort to
protect confidentiality, we request that you provide the
undersigned with an edited copy of your request for Technical
Assistance Advisement, the backup material and this response,
deleting names, addresses, and any other details that might lead
to identification of the taxpayer. Your response should be

received by the Department within 15 days of the date of this
letter.

Sincerely,

Shehla A. Milliron
Senior Attorney

Control # 44564