Was a utility's sale-leaseback of gas meters a financed purchase or a taxable operating lease?

Plain-English summary

Florida classified the gas-meter sale-leaseback as an operating lease, so each rental payment was taxable. The utility had sold previously owned meters to a financing company and leased them back under a master lease with early and end-of-term purchase options.

The arrangement did not meet the rule for a conditional-sale lease. The lessor took federal tax depreciation, and neither purchase option was nominal: the planned early option required 19.48% of acquisition cost plus other amounts, while the later option required fair market value.

Florida also warned that the utility's initial sale of the meters to the lessor could be taxable unless the lessor furnished a valid annual resale certificate. If a purchase option were later exercised, the cited rule taxed only the remaining option price not already subjected to lease tax.

What this means for you

Sale-leaseback classification depends on tax ownership, depreciation benefits, option pricing, and the transfer of ownership benefits and risks. Book treatment as financing did not control this ruling.

Common questions

Q: Was the planned early purchase price nominal?
A: No.

Q: Were all monthly payments taxable?
A: Yes, as operating-lease payments.

Q: Was the initial sale automatically exempt?
A: No. Florida required a valid resale certificate to support resale treatment.

Citations and references

• Fla. Stat. § 212.05 — sales and rental tax
• Fla. Admin. Code r. 12A-1.071 — operating and conditional-sale leases
• Fla. Stat. § 213.22 — Technical Assistance Advisements

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 03A-015

Original ruling text

SUMMARY

QUESTION: What is the taxability of the sale/leaseback
transaction involving gas meters entered into by Taxpayer?

ANSWER - Based on Facts Below: The Master Lease and the
Lease Schedule do not constitute a conditional-sale type
(capital) lease, because, among other things, the Lessor
takes depreciation of the equipment for Federal income tax
purposes; therefore, the transaction is classed as an
operating lease. Each rental payment is taxable as such.

Apr 04, 2003

Re: Technical Assistance Advisement 03A-015
Sales and Use Tax - Sale/Leaseback: Gas Meters
Section: 212.05, F.S.
Rule: 12A-1.071, F.A.C.
Petitioner: XXX (herein "Taxpayer")
FEI: XX

Dear :

This letter is a response to your petition dated November 11,
2002, for the Department's issuance of a Technical Assistance
Advisement ("TAA") concerning the above referenced party and
matter. Your petition 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 s. 213.22, F.S.

FACTS

The petition sets forth the following facts:

1. [Taxpayer] is a [non-Florida] corporation headquartered
   in [a state other than Florida]. [Taxpayer's] division,

[Utility], is a public utility providing natural gas
service to residents of... County, Florida.

2. [Taxpayer] recently entered into a sale-leaseback
   transaction with [Leasing Company/Lessor]. [Leasing
   Company] a [non-Florida] corporation, is a bank owned
   company engaged in the financing business.

3. The sale-leaseback involved gas meters owned by
   [Utility] prior to the transaction, which are installed and
   in[]use at various residential, commercial and industrial
   customer service locations. The meters were originally
   acquired and installed during the period of 1959 through
   early 2002, with appropriate sales or use tax paid at the
   time of purchase.

4. The lease is documented by a Master Equipment Lease
   Agreement, which provides the general terms of the lease, a
   Lease Schedule, which describes the equipment and location,
   acquisition cost, lease term and rental payment amount, a
   Stipulated Loss Value Schedule, which lists the percentage
   of acquisition cost used to calculate damages as of each
   rental payment, and various other supporting documents....

5. The following pertinent facts are summarized from the
   lease documents and supporting information prepared during
   negotiation of the transaction:

e. [Taxpayer] grants to [Lessor] a security interest in all
of [Taxpayer's] rights in and to the equipment subject to
the lease.

g. The sale-leaseback was chosen as an attractive method of
obtaining financing because the Lessor can use the
availability of tax depreciation to offer a lower interest
rate to [Taxpayer]. [See Paragraph 7 of the Master Lease
Agreement.]

h. [Taxpayer] guarantee's Lessor's tax depreciation benefit
by agreeing to reimburse Lessor for any Tax Loss.

i. If the equipment is not delivered, is not properly
installed, does not operate as warranted, becomes obsolete,
or is unsatisfactory for any reason whatsoever, [Taxpayer]
shall make no claims against Lessor and shall nevertheless
pay all rental payments.

j. [Taxpayer] is appointed Lessor's agent for purposes of
purchasing, arranging for shipment and delivery, and paying
for the equipment, and Lessor shall reimburse [Taxpayer]
for the Acquisition Cost of the equipment.

k. In event of default, [Taxpayer] may pay damages equal to
an amount shown on the Schedule of Stipulated Loss Value,
which lists a Percentage of Acquisition Cost for each
Rental Payment Number. (The percentages shown for rental
payments 117 and 118 are 20.14% and 19.23%, respectively.)

l. There are two purchase options available: 1) After 117
months (the option that [Taxpayer] intends to utilize), the
assets may be purchased by paying (in addition to any
outstanding rental payments, late charges, taxes, etc.) an
amount equal to 19.48% of the Acquisition Cost (roughly
equal to the Stipulated Loss Value amount). 2) At the end
of the lease term, a second purchase option is available
for the fair market value of the assets.

m. Title is transferred to [Taxpayer] upon execution of one
of the purchase options.

The petition also asserts that the following statements are fact
as "summarized from the lease documents and supporting
information prepared during the negotiation of the transaction."
The information was not sufficient to verify the statements as
fact. These statements are as follows:

a. The stated Acquisition Cost of the equipment is equal to
the book value of the meters, including costs of
installation and related materials, on [Taxpayer's] books.

b. Rental payments represent the sum of a principal
component (Acquisition Cost divided by the number of months

in the term) and an interest component.

c. The equipment continues to be depreciated on
[Taxpayer's] (Lessee's) books.

d. On [Taxpayer's] books, the transaction is reflected as a
capital lease treated as a loan and rental payments are
recorded as the payment of principal and interest.

f. [Taxpayer's] payment obligations under the lease are
absolute and unconditional and the lease is a net lease.

The first purchase option (Early Purchase Option) price includes
all rental payments, taxes and 19.48000% of the Acquisition
Cost. The second purchase option price is set forth in the
Purchase Option Rider as the "Fair Market Value" of the
equipment. The fair market value is to be determined within 160
days prior to the end of the lease term by mutual agreement of
the parties subject to the limitations contained in the Rider or
by an appointed appraiser certified by the American Society of
Appraisers.

On March 13, 2003, the Taxpayer's Representative verified the
following with the Department. The subject sale-leaseback
transaction involves only meters that were previously owned by
Taxpayer and it does not involve the purchase of any new meters
or equipment. These previously owned meters were sold to the
Leasing Company and subsequently leased back to Taxpayer with
the option to purchase.

REQUESTED ADVISEMENT

Taxpayer requests advice of the taxability of the transaction.

LAW AND DISCUSSION

Rule 12A-1.071(1)(d), Florida Administrative Code, sets forth
the requirements for an agreement to be considered a capital
(conditional-sale type) lease, and it states as follows:

(d) Where a contract designated as a lease transfers

substantially all the benefits, including depreciation, and
risks inherent in the ownership of tangible personal
property to the lessee, and ownership of the property
transfers to the lessee at the end of the lease term, or
the contract contains a purchase option for a nominal
amount, the contract shall be regarded as a sale of
tangible personal property under a security agreement
(commonly referred to as a conditional-sale type lease)
from its inception. The purchase option shall be regarded
as a nominal amount if it does not exceed $100 or 1 percent
of the total contract price, whichever is the lesser
amount. (Emphasis Supplied)

Applying the above paragraph of the rule, the Master Lease and
Lease Schedule do not contain a purchase option for a nominal
amount (the lesser of $100 or 1 percent of the total contract
price), and they do not transfer substantially all of the
benefits inherent in ownership to Taxpayer (Lessor takes the
depreciation for tax purposes). Therefore, the Master Lease and
Lease Schedule do not satisfy the description of a conditionalsale type lease set out in Rule 12A-1.071(1)(d), Florida
Administrative Code. Accordingly, classification of the Master
Lease and Lease Schedule constitutes an "operating lease"
pursuant to Rule 12A-1.071(1)(a), Florida Administrative Code,
which specifies that "All leases of tangible personal property
other than conditional-sales type leases as described in
paragraph (1)(d) of this Rule, are operating leases."

As we have established under the applicable administrative law
that the Master Lease and the Lease Schedule constitute an
operating lease, we are, therefore, compelled to conclude that
each payment by the Taxpayer to the Lessor under the terms of
the Master Agreement and Lease Schedule is subject to sales tax
pursuant to the provisions of Rule 12A- 1.071(8), Florida
Administrative Code, which states:

Each operating lease payment due under a lease purchase or
similar agreement which also grants the lessee an option to
purchase the tangible personal property is taxable. When
the option is exercised and title to the property passes to
the lessee-purchaser, no tax is due on that part of the

purchase price upon which lease tax has been paid. Only the
balance of the purchase price required to be paid by the
purchaser upon the exercise of the option is taxable.

CONCLUSION

The Master Lease and the Lease Schedule do not constitute a
conditional-sale type (capital) lease; therefore, the
transaction is classed as an operating lease. Each rental
payment is taxable as such.

Please be advised that the sale of the equipment to Lessor may
also be taxable, unless Lessor can extend to Taxpayer a valid
Annual Resale Certificate.

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 s. 213.22, F.S. Confidential information must be
deleted before public disclosure. In an effort to protect
confidentiality, we request 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 which 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,

Sara D. Faulkenberry

Tax Law Specialist
Technical Assistance and Dispute Resolution
850/414-9838

Control #52783