Were two off-balance-sheet property lease structures taxable leases or mortgage financing arrangements?

Plain-English summary

Florida treated both stated leases as mortgage financing rather than taxable rentals of real property. Looking across the full document sets, the Department found that the owner-trustee held title as security for repayment.

The trustee was a single-purpose financing entity. Basic rent equaled borrowing interest plus investor yield rather than fair-market rent, while the lessees paid operating costs, bore all risk of loss, owed the financing balance at termination, and granted liens, mortgages, and security interests.

One lessee would occupy property acquired through the other lessee's arrangement without paying rent to that lessee, the trustee, or anyone else. Florida found no rental tax on that use because no rent was paid.

What this means for you

Labels did not control. Florida examined economic substance, the complete agreement set, financing-based payment terms, ownership burdens, security rights, and whether any related-party occupancy charge existed.

Common questions

Q: Were the stated lease payments taxable? No.

Q: Why were the arrangements treated as mortgages? They secured repayment and placed ownership economics and risks on the lessees.

Q: Was rent-free related-party occupancy taxable? No, under the stated facts.

Citations and references

• Fla. Stat. § 212.031(1)(a) — tax on renting, leasing, or licensing real property
• Fla. Stat. § 697.01(1) — instruments intended to secure payment treated as mortgages
• Bridgestone/Firestone, Inc. v. Department of Revenue, DOAH Case No. 92-2483, 15 FALR 4874 (1993) — financing substance
• Department of Revenue v. Ryder Systems, Inc., 406 So. 2d 1299 (Fla. 1st DCA 1981) — no-rent related use
• Fla. Stat. § 213.22 — Technical Assistance Advisements

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 99A-072

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," constitute 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.

Dec 14, 1999

Re: Technical Assistance Advisement 99A-072
Sales & Use Tax - Financing Lease Agreement
Sections 212.031(1)(a); 697.01(1), F.S.
F.E.I. # XX
XXX ("Lessee One")
F.E.I. # XX
XXX ("Lessee Two")
F.E.I. # XX
XXX, not individually, but Solely as Owner-Trustee under
Trust dated XX ("Owner Trustee")

Dear :

This is in response to your letter dated XXX, 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.

Advisements Requested

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

You have also requested our advisement that, even though Lessee
One will occupy Lessee Two's property, the relationship between
the Lessees will not be one of landlord and tenant, and, because
no rent will be paid by Lessee One to Lessee Two, no sales tax
will be due on the occupancy by Lessee One of Lessee Two's
property.

Discussion of Facts

The facts set forth in your letter may be summarized as the
following. Lessees are both subsidiaries of a bank, and the
Lessees have a need to finance the acquisition or improvement of
real property for their business purposes. Owner Trustee, a
large national bank, is trustee of trusts whose sole purpose is
to acquire and hold title to the real property of the Lessees
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 Two and Owner Trustee entered into a transaction that is
covered by a number of agreements, all dated as of September 3,
1999. The agreements include: 1) Amended and Restated Trust
Agreement, 2) Participation Agreement, 3) Credit Agreement, 4)
Security Agreement, 5) Agency Agreement, and 6) Lease Agreement.
Lessee One and Owner Trustee entered into a substantially
identical transaction that is also covered by the same number of

agreements, all dated as of September 3, 1999. You have stated
that the agreements with respect to Lessee Two are substantially
identical to the agreements with respect to Lessee One, and
therefore, for convenience, the following discussion of facts
and law will refer simply to "Lessee," rather than to both
Lessee One and Lessee Two, except as to any discussion of the
relationship between the two Lessees.

Owner Trustee is acquiring, under a ground lease, property that
has been identified by Lessee. (Multiple properties may be
purchased or leased under the above agreements, and the same
terms and conditions will apply to each). Owner Trustee will
hold title to the property, or the leasehold interest, on behalf
of certain holders, who have provided funds to the Trust and
hold beneficial interests in the Trust, and subject to the
security interests of certain lenders, who have loaned funds to
the Trust. Lessee, as construction agent, will construct
improvements on the property on behalf of Owner Trustee.

Owner Trustee and Lessee entered into the Lease Agreement, under
which Owner Trustee leases to Lessee the property identified by
Lessee. The term of the Lease Agreement is coterminous with the
term of Owner Trustee's borrowings from lenders. The Lease
Agreement and the loan documents contain cross default
provisions.

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

1. The Lease is for a basic term of three years and is
   automatically renewed for one additional year if no default has
   occurred and Lessee does not exercise its purchase option or
   sale option, as described below.

2. Lessee is obligated to pay "Basic Rent" to Owner Trustee.
   Basic Rent is equal to the sum of the interest due on the funds
   borrowed by Owner Trustee for acquisition of the property and
   the yield promised to the holders of interests in the Trust. 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 option 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 accrued but unpaid yield to holders, and all rent
   and other amounts then due and payable, including 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. If Lessee defaults under the Lease, Owner Trustee, among
    other remedies, is entitled to recover final 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.

As indicated earlier in this letter, both Lessee One and Lessee
Two are acquiring properties under substantially identical
agreements, which are described above. The property acquired by
Lessee Two will be used and occupied by Lessee One. Lessee One
will not, however, pay any rent to Lessee Two, to the Owner
Trustee, or to any other party.

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 the Owner Trustee's
property interest is held merely 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 six 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, commercial law and real
estate purposes and all other 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 "lien on and security
interest, mortgage lien and deed of trust in all of Lessee's
right, title, and interest in and to the Property..."

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 sum of the interest due on the funds borrowed by
the Owner Trustee for acquisition of the property and the yield
promised to the holders of the beneficial interests in the
Trust.

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 the 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
it is also denominated, for all other purposes, as a financing
arrangement, and the Lessee specifically grants a lien, security
interest, mortgage and deed of trust 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.

As to the use of Lessee Two's property by Lessee One, no rent
will be paid, and accordingly, no tax will be due. See,
Department of Revenue v. Ryder Systems, Inc., 406 So.2d 1299
(Fla. 1st DCA 1981).

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 #39312