Were payments under a lease-form real-property financing structure taxable as Florida commercial rent?

Plain-English summary

Florida treated the so-called lease as mortgage financing, so the lessee's payments were not taxable commercial rent. The documents said the structure was a financing arrangement for all purposes except accounting and expressly granted the owner trustee a lien and mortgage.

The economics also resembled debt: the owner trustee was a single-purpose financing entity, basic rent equaled interest, supplemental rent covered principal and financing costs, and the lessee bore operating costs, termination value, condemnation exposure, and all risk of loss.

What this means for you

Florida looked beyond the document title to the parties' intent and the transaction's substance. Lease-form accounting did not control when the agreements and economics showed a secured loan.

Common questions

Q: Did calling the agreement a lease make rent taxable? No. The ruling examined all documents together.

Q: Which facts pointed to a mortgage? Express financing and mortgage language, interest-based payments, a single-purpose title holder, and the lessee's assumption of costs and risks.

Q: Did the ruling decide documentary stamp or intangible tax? No. It expressly limited the advisement to sales tax on the payments.

Citations and references

• Fla. Stat. § 212.031(1)(a) — commercial real-property rent
• Fla. Stat. § 697.01(1) — instruments securing payment treated as mortgages
• 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 99A-035

Original ruling text

SUMMARY

QUESTION: Does a set of agreements entered into in
connection with the acquisition or improvement of real
property constitute a lease of the property or a mortgage
financing arrangement?

ANSWER - Based on Facts Below: The set of agreements, even
though one agreement is designated a "lease," constitutes a
mortgage financing arrangement when all agreements are
considered together. Some of the relevant factors
considered were that the "lessor" was a single purpose
financing entity, the parties structured the transaction as
a lease in order to secure "off-balance sheet" financing,
the lessee bore all risk of loss, and the rent charged was
not a fair market rent, but rather, equaled the rate of
interest charged on funds borrowed by the lessor.

Aug 05, 1999

Re: Technical Assistance Advisement 99A-035
Sales & Use Tax - Financing Lease Agreement
Sections 212.031(1)(a); 697.01(1), F.S.
XXX ("Lessee")
F.E.I. #XX
XXX, National Association, not individually, but Solely as
Owner-Trustee under the XXX ("Owner Trustee")
XXX ("Bank")

Dear :

This is in response to your letter 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.

Advisement Requested

You have requested our advisement that the Lease Agreement
entered into by Lessee and Owner Trustee, when considered with
other relevant agreements pertaining to the same transaction,
constitutes a financing arrangement, rather than a lease or
rental arrangement, and accordingly, payments made pursuant to
the Lease Agreement are not subject to sales tax under section
212.031, F.S.

Discussion of Facts

The facts set forth in your letter may be summarized as the
following. Lessee is a corporation with a need to finance the
acquisition or improvement of real property for its business
purposes. Owner Trustee, a large national bank, is trustee of a
trust whose sole purpose is to acquire and hold title to the
real property of the Lessee for the benefit of a consortium of
banks and financial institutions. Owner Trustee is not a
business trust and is prohibited by the terms of the trust from
transacting business of any kind with respect to the trust
assets.

Lessee and Owner Trustee together entered into a transaction
that is covered by a number of agreements, all dated as of
December 31, 1998. Those agreements include: 1) Amended and
Restated Trust Agreement, 2) Participation Agreement, 3) Credit
Agreement, 4) Security Agreement, 5) Agency Agreement, 6) Lease
Agreement, and 7) Ground Lease.

Lessee, as landlord, and Owner Trustee, as tenant, entered into
a 99-year ground lease of certain real property. (Multiple
properties may be purchased or leased under the above
agreements, and the same terms and conditions will apply to
each). Bank, Owner Trustee, and Lessee entered into certain
agreements permitting Bank, under a bridge loan, to fund soft
costs and initial site construction. When a permanent loan (the
"Loan"), which is to provide funding for construction and
development of the premises, of approximately $30,000,000

closes, the bridge loan transaction will be terminated. The Loan
includes the execution by Owner Trustee, Bank, and Lessee of a
Participation Agreement and Credit Agreement, which provides for
loan advances and contains basic loan terms. These obligations
are secured by, among other things, an Open-End Leasehold
Mortgage, Assignment of Lease, Security Agreement, and Financing
Statement attaching to Owner Trustee's interest in the premises
and improvements and Lessee's sublease interest.

Concurrent with the execution of the loan documents among the
parties, Owner Trustee and Lessee entered into the Agency
Agreement, under which Lessee acts as the agent for Owner
Trustee to administer borrower's obligations under the Loan, to
administer the construction contracts and to supervise other
construction activities. Owner Trustee, as Lessor, and Lessee
entered into the Lease Agreement, under which Owner Trustee
leases to Lessee the property to be occupied by Lessee. The
term of the Lease Agreement is coterminous with the term of the
Loan. The Lease Agreement and the Loan contain cross default
provisions.

In summary, Lessee has leased to Owner Trustee certain real
property under a 99-year ground lease. Owner Trustee has
borrowed approximately $30,000,000 from Bank with which to
develop the property. Lessee is acting as the agent of Owner
Trustee to administer Owner Trustee's obligations under the
Loan, to administer the construction contracts for development
of the property, and to supervise other construction activities.
Owner Trustee is then leasing the property back to Lessee under
the Lease Agreement, and Lessee will occupy the property upon
completion of the construction.

The relevant provisions of the Lease Agreement are summarized as
follows:

1. The Lease term commences December 31, 1998, and terminates on
   December 31, 2001. The Lease may be renewed for two successive
   one-year terms, terminating finally on December 31, 2003.

2. Lessee is obligated to pay "Basic Rent" to Owner Trustee.
   Basic Rent is equal to the interest due on the funds borrowed by

Owner Trustee for acquisition of the property. In addition,
Lessee is obligated to pay "Supplemental Rent", which is defined
to mean all amounts, liabilities, and obligations other than
Basic Rent that Lessee has agreed to assume or pay under any of
the Agreements entered into by Lessee, including any amounts due
upon termination of the Lease Agreement.

3. Upon termination of the Lease, whether because of early
   termination, default, the purchase option described below, or
   the sale provision described below, Lessee must pay Owner
   Trustee the "Termination Value". The Termination Value is
   basically the sum of all amounts borrowed or invested by Owner
   Trustee, less prepayments and repayments, all accrued but unpaid
   interest, all rent and other amounts then due and payable, plus
   all expenses of sale if the property is sold pursuant to the
   sale provision.

4. Lessee is obligated to pay all costs for the use, occupancy,
   or operation of the property, including utility charges and
   property taxes.

5. Lessee's obligations under the Lease Agreement are absolute
   and unconditional, and the Lease constitutes a net lease.

6. The Lease Agreement evidences the intentions of the parties
   that it be treated as an operating lease for financial
   accounting purposes. For all other purposes, including federal,
   state, and local tax purposes, bankruptcy, commercial law, and
   real estate purposes, the Lease Agreement states that the
   intentions of the parties are that the Lease be treated as a
   financing arrangement, that Lessee be treated as owner of the
   property, and that Lessee be entitled to all tax benefits
   ordinarily available to owners of similar properties.

7. Lessee acquires the property in "as-is, where-is" condition.

8. Lessee maintains, at its own expense, insurance coverage with
   respect to the property.

9. Lessee must maintain the property in good condition, repair,
   and working order.

10. Lessee is entitled to retain any amounts recovered in the
event of a casualty loss or a condemnation of the property, but
in such a case, the Lease terminates, and Lessee must pay the
Termination Value.

11. If the Lessee defaults under the Lease, Owner Trustee is
    entitled to recover liquidated damages equal to the Termination
    Value. Owner Trustee is then required, at Lessee's expense, to
    assign its interest in the property to Lessee.

12. At the end of the lease term, unless Lessee elects to have
    the property sold to a third party, Lessee must purchase the
    property for its Termination Value. If Lessee elects to have
    the property sold to a third party, Lessee must pay Owner
    Trustee the Termination Value out of the proceeds of sale.

13. All risk of loss with respect to the property is assumed by
    Lessee.

Law and Analysis

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

The question that we must answer in this case is whether, when
the transaction is analyzed as a whole in light of the parties'
intentions, the Owner Trustee is engaged in leasing real
property to the Lessee, or whether the transaction is in
substance a mortgage arrangement under which bare legal title to
the property is held by the Owner Trustee 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. Great emphasis in the case was placed upon the fact that
the transaction was structured specifically to have the
transaction treated as a lease for accounting purposes, yet
still have the overall economic substance of the transaction
treated as financing for federal tax purposes. In particular,
the taxpayer did not treat the sale-leaseback as a sale,
continued to depreciate the property, and reported payments as
principal and interest. Additionally, the rental payments were
based upon the value of the consideration (interest) for the
financing, not upon the fair market value of the property. The
obligations of the tenant continued even in the case of
condemnation, and the risk of loss stayed with the tenant.

Those factors are also present in the instant case. The sole
purpose of entering into this very complex transaction,
requiring seven agreements and hundreds of pages of
documentation, was to secure financing for the Lessee that would
be treated as a lease for accounting purposes but for all other
purposes would be treated as a borrowing of money secured by a
mortgage. The Lease Agreement clearly states in Article 7.1(a)
that the parties "intend that for federal and all state and
local income tax purposes, bankruptcy purposes, regulatory
purposes, commercial law and real estate purposes and all other
purposes (other than for accounting purposes)... this Lease will
be treated as a financing arrangement." These types of
arrangements are often used by corporations to secure "off
balance sheet financing."

The Lease Agreement further states that for all purposes other
than financial accounting purposes, the parties "intend this
Lease to constitute a finance lease and not a true lease". The
Lease Agreement goes on to grant in specific terms a lien and
mortgage to the Owner Trustee on all right, title, and interest
of the Lessee in the real property. The Agreement provides in
Article 7.1(b) that the acquisition of title by the Owner
Trustee constitutes a grant by Lessee of a "security interest,
lien and mortgage...."

As indicated, the Administrative Hearing Officer in
Bridgestone/Firestone also focused on other factors in reaching
his decision, such as whether the lessor is a single purpose
financing entity; whether the rent charged is a fair market rent
or some mix of interest and principal; and which party bears the
risk of loss and certain expenses.

It was found in Bridgestone/Firestone that the lessor was a
single purpose financing entity. In the present case, the Owner
Trustee is also a single purpose financing entity. The national
bank acting as Owner Trustee is prohibited from engaging in any
business in its capacity as trustee other than is necessary to
fulfill the purposes of the transaction as described above.

As in Bridgestone/Firestone, the payments being made under the
Lease Agreement, although described as rent for accounting
purposes, bear no relationship to what might be the fair rental
value of the real property. Instead, "Basic Rent" is precisely
equal to the interest due on the funds borrowed by the Owner
Trustee for acquisition of the property, and "Supplemental Rent"
is equal to the principal due on such funds plus all financing
costs.

The Administrative Hearing Officer in Bridgestone/Firestone also
focused on the fact that the lessee bore the risk and expense of
certain obligations. Here, the Lessee pays all costs for using
and operating the property, and upon termination of the Lease,
has the absolute obligation to pay to the Owner Trustee the
Termination Value, which is defined by the agreements
essentially as the balance due on the mortgage loan. Such
obligation survives condemnation. Additionally, all risks of

loss of the property, including damage or destruction by fire,
the elements, casualties, thefts, riots, wars, or otherwise, are
assumed by the Lessee.

Accordingly, under the terms and conditions of all of the
documents presented, as in Bridgestone/Firestone, it is our
conclusion that the Lease between Owner Trustee and Lessee more
closely resembles a mortgage loan than it does an arrangement
for the use of 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. (Emphasis added)

Section 697.01(1), F.S., thus provides that even though the
documentation of a transaction may not be denominated as a
"mortgage," it will be treated as such if entered into for the
purpose of securing the payment of money. Here, the transaction
is denominated as a lease for financial accounting purposes, but
is also denominated, for all other purposes, as a financing
arrangement, and the Lessee specifically grants a lien and
mortgage to the Owner Trustee. Payments made by Lessee under
the Lease Agreement are therefore not considered lease payments
and are not subject to sales tax under section 212.031, F.S.

Pursuant to your letter indicating that we only discuss the
application of sales and use tax to the payments made under the
Lease Agreement, this letter does not discuss any other tax
aspects of the overall transaction, such as the possible
application of the Florida intangible tax or documentary stamp
tax.

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 advise, 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., which 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 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,

Robert D. Heyde
Senior Attorney
Technical Assistance & Dispute Resolution
Control #37781