Were payments under a real-property lease agreement taxable as commercial rent when the overall transaction functioned as financing?

Plain-English summary

The described development transaction was a financing arrangement, not a taxable commercial real-property lease. The taxpayer leased Florida land to a special-purpose financing entity, developed the property as that entity's agent, and leased it back. But the documents showed that the lessor held title mainly as security for the lenders.

The payment amount reflected financing costs rather than fair-market rent. Payments went toward the lenders, the taxpayer could purchase the property for the outstanding loan amount, and the taxpayer carried the property's costs, maintenance duties, risk of loss, taxes, environmental responsibilities, and other owner-like burdens. The default remedies also resembled lien enforcement and foreclosure.

What this means for you

Florida looked at the full transaction and the parties' actual economic rights, not merely the word “lease.” A document can be an operating lease for financial reporting yet function as a mortgage for this tax analysis.

Common questions

Q: Were the lease-agreement payments subject to sales tax on commercial rent? No, under the facts reviewed.

Q: What was especially important? The single-purpose lessor, debt-based payments, loan-balance purchase option, security and foreclosure rights, and the taxpayer's owner-like risks and costs.

Q: Does every synthetic lease receive this result? No. The ruling is expressly tied to the complete document set and specific economics described.

Citations and references

• Fla. Stat. § 212.031(1)(a), (c) — tax on commercial real-property rent
• Fla. Stat. § 697.01(1) — instruments intended to secure payment treated as mortgages
• Fla. Stat. § 213.22 — Technical Assistance Advisements

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 02A-029

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 the 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 Lease Agreement, will not be
subject to sales tax imposed pursuant to section 212.031,
F.S.

Jun 28, 2002

Re: Technical Assistance Advisement 02A-029
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.
XXX (herein Taxpayer, Lessee or Agent), FEI No: XX
XXX (herein Lessor or Owner)
XXX (herein Lenders)
XXX (herein Lender and Agent for Lenders)
XXX (herein Guarantor), FEI No: XX

Dear :

This is in response to your request, dated 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 for Lease dated September 9, 1999, among Owner, as
Owner, and Taxpayer, as Agent (Agreement for Lease)

Lease Agreement dated September 9, 1999, among Owner, as Lessor,
and Taxpayer as Lessee (Lease Agreement)

Corporate Guaranty dated September 9, 1999 (Corporate Guaranty
Agreement)

Ground Lease Agreement dated November 27, 2001, among Taxpayer,
as Lessor and XXX, as Lessee (Ground Lease)

Leasehold Mortgage, Assignment and Security Agreement dated XX,
among XXX, as Mortgagor, and Lender

Memorandum of Lease Agreement dated XX

Facts

You have provided the following facts in your letter:

Taxpayer owns unimproved real property located in Florida.
Taxpayer intends to XXX on the Property. Taxpayer is financing
the Property's development with a group of lenders through a
financing lease transaction.

In accordance with the above documents, Taxpayer will lease the
Property to Owner, a special purpose financing entity, pursuant
to the Ground Lease and act as Owner's agent in the development
of the Property pursuant to the Agreement for Lease.

Upon substantial completion of the improvements, the Property
and improvements (collectively "the Property") are leased by
Owner back to Taxpayer pursuant to the Lease Agreement.
Taxpayer/Lessee will then make rent payments to Owner/Lessor.

The rent payments are not based upon fair market rental value,
but are instead reflective of Owner's financing costs. Taxpayer
has the option to purchase the Property from Owner for the
amounts due to the Lenders. The Loan is secured by the
Leasehold Mortgage of Owner's interest in the Property.
Pursuant to the Corporate Guaranty Agreement, all of Taxpayer's
payment and performance obligations are guaranteed. Should
Owner's interest under the Ground Lease expire or terminate, the
Lease Agreement will also terminate and Taxpayer will be
obligated to purchase Owner's interest in the Property for the
outstanding Loan amount.

Requested Advisement

You have requested an advisement that the payments made in
accordance with the Ground Lease and Lease Agreement, when
considered with all other relevant documents to the same
transaction, constitutes a financing arrangement, rather than a
lease or rental arrangement. Therefore, payments made in
accordance with the agreements 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). Additionally, the Hearing Officer
stated: "Initially, it is noted that a taxpayer can treat an
item one way for financial recording purposes and another way
for tax purposes...." (Paragraph 24)

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 Taxpayer's principal aim of entering into this complex
transaction is to secure financing for the improvement and
acquisition of the Property that will be treated as an operating
lease for accounting purposes but for all other purposes will be
treated as a borrowing of money secured by a mortgage. The
Lessor is created solely to serve 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 is created to serve as
an integral part of the entire financing arrangement. The
Lessor is not a landlord but serves more in the capacity of an
administrator of the transactions. The following language from
the Agreement for Lease and Lease Agreement clarifies the
purpose of the transaction:

It is the intent of Agent and Owner that: (i) this Lease
constitutes an operating lease between Owner, as lessor,
and Agent, as lessee, for purposes of Agent's financial
reporting, (ii) notwithstanding any of the provisions of
this Agreement, the Lease or the other Transaction
Documents to the contrary, Agent is and will be the owner
of the Unit Premises, Unit Improvements,... for federal and
state income tax purposes, and (iii) the Lease grants to
Owner a Lien on all of Agent's right, title and interest in
and to the Unit Premises, Unit Improvements,.... Agent and
Owner agree that Owner shall be deemed to have a valid and
binding security interest in and Lien on the Unit Premises,
Unit Improvements,..., free and clear of all Liens, other
than Permitted Liens, as security for the obligations of
Agent under the Lease and this Agreement (it being
understood and agreed that in order to secure the payment
and performance of the obligations of Agent under this
Agreement and the Lease, Agent does hereby grant a Lien on,
and convey, transfer, assign, mortgage and warrant to
Owner... for the benefit of Owner... and as collateral
security, the Unit Premises, Unit Improvements, Unit FF&E
and Units and any proceeds or products thereof....

Agreement for Lease, section 1.3; Lease Agreement, section 4

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
merely designed to recompense Lessor for the loan amount. See
Lease Agreement, sections 1 and 7. Furthermore, rent is not
paid to the Lessor but is instead paid to the Agent for Lenders
for subsequent disbursement to the Lenders in satisfaction of
the debt owed. See Lease Agreement, section 21 (b); Leasehold
Mortgage, Assignment and Security Agreement.

Finally, the transaction provides default remedies atypical of a
Landlord-Tenant relationship. Lessee has granted Lessor a
security interest in and lien on the Property. See Agreement
for Lease, section 1.3; Lease Agreement section 4. In the event
of Lessee's default, Lessor is authorized to enforce its lien
via power of sale or by any other appropriate legal means. See
Agreement for Lease, section 11.2 (c) and (e); Lease Agreement,
section 19 (c) and (e). Lessor has express foreclosure rights.
See Memorandum of Lease. In the event of Lessee's default,
Lessee is obligated to purchase the Property for the outstanding
Acquisition Cost. See Lease Agreement, section 14 (a).

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

As part of the total financing arrangement, Guarantor will
guaranty the Lessee's rental/payment obligations under the Lease
Agreement. Such a pledge is not typically provided on behalf of
a Tenant in a lease agreement. See Corporate Guaranty Agreement.

Additionally, Lessee accepts the Property in "as is" condition,
with no warranties of title or suitability. Lessee assumes all
risk and waives any defenses, set-offs, deductions,
counterclaims, or other rights as to Lessee's obligation to pay
rent (or any other amounts pursuant to the agreements), relating

to "the safety, title, condition, quality, quantity, fitness for
use, merchantability,... or any other quality or characteristic
of any property...." See Lease Agreement, section 5 (d).

Lessee also controls the granting of all easements on the
Property, a privilege typically retained and controlled by the
Lessor. See Lease Agreement, section 16 (c).

As noted earlier, as rent, the Lessee pays monies the sum of
which is directly related to the loan amount rather than a sum
that is representative of fair market rent.

Additionally, after January 9, 2002, Lessee has the option to
purchase the property on any basic rent payment date for the
Adjusted Acquisition Cost, which is an amount equal to the
outstanding loan. See Lease Agreement, section 12 (a).

Typical obligations of ownership, risk and maintenance are with
Lessee, rather than with the Lessor. This is illustrated in the
following sections of the Lease Agreement:

Section 9 of the Lease Agreement provides:

(b) The Lessee shall pay all costs, expenses, fees and
charges... incurred in connection with the ownership, use
or occupancy of any Parcel of Property.... ...[A]nd as
between the Lessor and the Lessee all risks of damage to
Property or Equipment are assumed by the Lessee....
Notwithstanding any other provisions of this Lease to the
contrary, neither the Lessor nor any Assignee shall have
any duty to maintain or repair any Property or Equipment,
or... to make any payments whatsoever in connection with
any maintenance, alteration or repair of any Property or
Equipment....

(c) With respect to any Parcel of Property, the Lessee
shall pay: (i) all taxes, assessments, levies, fees, water
and sewer rents and charges, and all other governmental
charges, general and special, ordinary and extraordinary,
foreseen and unforeseen, which are, at any time, imposed or
levied upon or assessed against (A) the Parcel,....

Section 15 of the Lease Agreement provides:

The Lessee hereby assumes all risk of loss of or damage to
Property..., however caused.... [N]o loss of or damage to
any Property or Equipment shall impair any obligation of
the Lessee under this Lease,....

Furthermore, Lessee's payment obligations under the Lease
Agreement are "absolute and unconditional." Section 5 (d) of
the Lease Agreement provides:

This is a net Lease. The obligations of Lessee to pay all
amounts payable pursuant to this lease... shall be absolute
and unconditional under any and all circumstances of any
character, and such amounts shall be paid without notice,
demand, defense, setoff, deduction or counterclaim and
without abatement, suspension, deferment, diminution or
reduction of any kind whatsoever...." See also Agreement
for Lease, section 18.4.

In regard to environmental covenants, Lessee is responsible for
all environmental monitoring, reporting, compliance and clean
up. See Lease Agreement, section 2 (r), (v).

Finally, condemnation and casualty proceeds are payable to the
Lessee rather than to the Lessor in the event of a taking or
insured loss. See Lease agreement, section 10 (e), (f), 15 (c),
16; Agreement for Lease, section 11.3 (j).

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 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 # 49444