Were lease-to-own security-system contracts true leases, and when was Florida sales or use tax due?

Plain-English summary

Florida treated the security-system “leases” as financed sales rather than true rentals. The customers bore the risk of loss, the payments amortized an original purchase price with interest, customers could prepay the remaining balance and take title, and each could buy the system for $1 at the end. Retained title and contract language calling the equipment personal property did not control the tax result.

The next question was what the particular installed system principally represented:

• If it was a sale of tangible personal property, sales tax was due on the entire purchase price when the agreement began. The installer did not tax the later monthly payments and could claim a credit for an uncollected price after default and repossession.
• If it was an improvement to real property, the installer did not collect tax from the customer but paid tax on the materials used in the job.

Florida said that classification had to be made contract by contract. Direct-wired, location-specific systems with screwed-in components were generally real-property work, while access cards, computers, software, and modems could point toward tangible personal property.

What this means for you

Installers should look past a contract's “lease” label. Risk of loss, amortization, bargain purchase options, attachment, structural wiring, and the relative importance of movable equipment can determine both the transaction's character and when tax is due.

Common questions

Q: Did retaining title make these true leases?
A: No. Florida treated that as protection for a retained security interest.

Q: Was tax collected on each monthly payment?
A: No for a system classified as tangible personal property. Tax was due on the full sales price at commencement.

Q: Were all installed security systems real property?
A: No automatic rule applied. Florida required a contract-by-contract classification.

Citations and references

• Fla. Stat. § 212.05 — taxable retail sales
• Fla. Stat. § 212.06 — sales and use tax administration
• Fla. Admin. Code r. 12A-1.051 — real-property contractor classification
• Fla. Admin. Code r. 12A-1.071(1)(f) — conditional and installment sales
• Hialeah, Inc. v. Dade County, 490 So. 2d 998 (Fla. 3d DCA 1986) — cited for substance-over-label treatment
• Fla. Stat. § 213.22 — Technical Assistance Advisements

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 03A-024

Original ruling text

SUMMARY

QUESTION: What are the tax consequences of leasing security
systems rather than selling them?

ANSWER - Based on Facts Below: Taxpayer's lease agreements
are essentially financing arrangements for sales. When the
predominate nature of the agreement is for the sale of
tangible personal property, Taxpayer must remit the tax due
on the entire sales amount at the commencement of the
lease. When the predominate nature of the agreement is for
the improvement to real property, Taxpayer should not
collect tax from its customer, but it owes tax on its
purchase of the materials used in the jobs.

May 06, 2003

Re: Technical Assistance Advisement 03A-024
Sales and Use Tax - Security System Leases
Sections: 212.031, 212.05, 212.06, F.S.
Rules: 12A-1.051, 12A-1.071, F.A.C.
Petitioner: XXX (herein "Taxpayer")
FEI: XX

Dear :

This letter is a response to your undated petition received by
this office on November 4, 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 1211, 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

Your petition sets forth the following facts:

Taxpayer is a Florida corporation whose business is the
furnishing and installation in real property of various
security systems, including automatic doors, access control
systems, fire and alarm systems, closed circuit video
systems, gates and fencing, parking control equipment,
telephone entry systems and other similar equipment
(referred throughout as the "System"). All of the
contracts entered into by the taxpayer are for lump sum,
cost plus, fixed fee or guaranteed price.

When contracts are entered into, taxpayer acquires all of
the tangible personal property needed for the Systems and
installs the Systems on the premises of the customer.
Except for access cards and door-opening transmitters, all
parts of the Systems are permanently affixed to the
customer's real property and [have] no practical use,
function or purpose independent of the System.

The taxpayer has begun to lease the System instead of
selling it to their customers. The Lease Contract...
states that upon the expiration or termination of the
lease, unless the Lessee exercises its option to purchase
the Equipment, the Lessor retains title and possession of
the System.

Taxpayer provided three sample lease agreements with its
request. The first lease (Lease 1) is dated in March 2000. It
is for a ten year term. It provides that upon expiration or
termination, the lessee shall return the property to Taxpayer.
Section 9 provides that lessee "assumes and shall bear the
entire risk of loss and damage to the Equipment from any and
every cause whatsoever". Lessee is required to continue to pay
rent even if the equipment is lost or damaged. Lessee is also
required to insure the equipment. Insurance proceeds will either
go to replacing the equipment or paying off the lessee's
remaining obligations under the lease. Section 20 of the
agreement provides that the equipment shall remain personal
property notwithstanding its attachment to real property.

Section 25 provides that the lessee has an option to purchase

the equipment at any time during the lease term. The purchase
price will be the "unamortized amount of the original schedule
set forth in Exhibit `A.'" At the end of the lease term, the
option price will be $1.00. Lessor provides maintenance
services at no charge for the first year. After that, the
lessee can elect to keep the maintenance services at set monthly
fees. If Taxpayer decides to terminate the maintenance
services, the lessee is required to exercise the purchase
option. Exhibit A shows the dates that payments are due under
the lease. In addition to the maintenance fees after the first
year, the Exhibit has columns labeled "Loan Payment" and
"Balance". The monthly Loan Payment is $2,329, and the balance
is a decreasing amount. It appears that the Loan Payments and
Balance are based on amortizing approximately $151,750 at 14%
over the 10-year payment period.

The second lease (Lease 2) is dated March 2002 and is similar to
Lease 1. Section 3 states that rent shall be as set forth in
Exhibit "A", but that Exhibit is a list of equipment. Section 9
provides for return of the equipment to lessor at the end of the
lease term. The assumption of risk and insurance provisions are
substantially the same as in Lease 1. Like Lease 1, Section 20
provides the equipment shall remain tangible personal property
throughout the lease term. Section 25 provides for a purchase
option at any time during the lease term for the "unamortized
amount of the original price" as shown on Exhibit "C" and at the
end of the lease term for $1.00. There was no Exhibit "C"
attached to Lease 2, but it appears that Lease 2 also involves
payments ties to an original purchase price of the equipment
amortized at some interest rate.

The third lease (Lease 3) was entered on July 1, 2001. The term
of Lease 3 was three years and it provided for an initial
payment of $1,525 and monthly payments of $353.82. The risk of
loss provision is similar to those in Leases 1 and 2. There is
a purchase option that can be exercised at any time during the
term of the lease for "the un-amortized amount of the balance
due" and at the end of the lease term for $1.00. No
amortization schedule was provided.

According to the petition, Taxpayer ordinarily sells Systems,

rather than leasing them, and it treats all of its contracts as
improvements to real property.

REQUESTED ADVISEMENT

Advice is requested on the tax consequences of leasing the
system rather than selling the system to its customers.

LAW AND DISCUSSION

Contracts that involve furnishing and installing security and
alarm systems that are designed for a customer's location,
involve structural wiring, and have direct-wired components that
are screwed in place are generally classified as real property
contracts. Taxpayer does also provide tangible personal
property, such as access cards, computer equipment, computer
software, and computer modems, as part of its systems. If a
particular contract were determined to be predominantly a
contract for tangible personal property rather than personal
property, it would be taxed differently. The real property
versus tangible personal property determination must be made on
a contract-by-contract basis, and Taxpayer should review the
provisions of Rule 12A-1.051, Florida Administrative Code, for
guidance on making that determination.

The focus of Taxpayer's request, however, is not whether it has
properly classified contracts as real property contracts but how
the use of its lease agreements affects sales and use taxation
of Taxpayer's transactions. The first step in answering that
question is to properly characterize the lease agreements
themselves. These agreements transfer the entire risk of loss
to Taxpayer's customers. The payments appear to be based on
setting a purchase price and interest rate and amortizing the
price over the term of the lease. The lessees have an option to
prepay the remaining unamortized principal owed on the purchase
price at any time and take title to the system. If they do not
exercise the option to prepay, at the end of the lease term they
can take title and keep the equipment for $1. Since the
alternative is to pay to have the equipment packaged and
delivered to Taxpayer, it is virtually certain that lessees will
pay the $1 if they have not already exercised the prepayment

option. While the agreements do provide that Taxpayer will
retain title and that the equipment will remain tangible
personal property during the lease term, those provisions are
typical means by which sellers or lenders protect a retained
security interest, and they do not control classification of the
agreements for sales and use tax purposes. Based on the terms
of the agreements provided, the contracts between Taxpayer and
the customers are in reality sales with a deferred payment plan
rather than leases. See Hialeah, Inc. v. Dade County, 490 So.2d
998 (Fla. 3DCA 1986).

If any system provided by Taxpayer would be taxed as a sale of
tangible personal property under the guidance provided in Rule
12A-1.051, Florida Administrative Code, sales tax would be due
on the purchase price to the Department of Revenue at the
commencement of the lease. See Rule 12A-1.071(1)(f), Florida
Administrative Code. No tax would be due on the monthly payments
as received. If a lessee defaulted and the lease terminated,
Taxpayer would be entitled to a credit for tax paid on the
uncollected price upon repossession of the system. Taxpayer
should not pay tax on its purchase of materials that are being
resold as part of these contracts.

In cases where the systems would be treated as improvements to
real property, Taxpayer will treat the lease the same as it has
treated its sales of improvements to real property in the past.
No tax is charged to the customer, but Taxpayer should pay tax
on its purchase of materials used in the contracts. See Rule
12A-1.051(3)(e), Florida Administrative Code.

CONCLUSION

Taxpayer's lease agreements are essentially financing
arrangements for sales. When the predominate nature of the
agreement is for the sale of tangible personal property,
Taxpayer must remit the tax due on the entire sales amount at
the commencement of the lease. When the predominate nature of
the agreement is for the improvement to real property, Taxpayer
should not collect tax from its customer, but it owes tax on its
purchase of the materials used in the jobs.

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 #52717