Is a transaction called a lease but structured as a financing arrangement taxed as a lease, or as a sale, under Kansas sales tax?

Plain-English summary

A taxpayer asked how Kansas sales tax applies to transactions called "leases" that are, in substance, financing arrangements. Kansas taxes "the gross receipts from the service of renting or leasing tangible personal property" under K.S.A. 79-3603(h). The question was whether these financing "leases" fall under that lease tax.

The Department's framework:

• Financing "leases" reported as a sale for federal income tax. The tax on leasing under 79-3603(h) does not apply to any transaction that must be reported as a sale and purchase by the lessor and lessee (respectively) for federal income tax purposes. But if the subject is tangible personal property, the transaction is instead treated as a sale of that property, taxable under K.S.A. 79-3603(a).

• Nominal-buyout "lease" = a sale. A "lease" with a nominal purchase price at the end is actually a sale. Report the tax on the gross receipts, measured as:

  1. Accrual basis — the sales price as determined for federal income tax purposes; or
  2. Cash basis — the amount of each lease payment, minus interest or other charges, as determined for federal income tax purposes.

• Fair-market-value buyout = a true lease. If the "lease" has a buy-out clause at fair market value, it is a true lease. Kansas sales tax is due on each lease payment, and also on the buy-out amount if the option is exercised.

In every case, Kansas sales tax is imposed on the total amount of each lease payment the lessee is obligated under contract to pay the lessor.

What this means for you

Lessors and finance companies

The buyout terms decide the tax treatment. A $1 / nominal end-of-term purchase option means the deal is a sale up front — collect/report tax on the sales price (or, on a cash basis, on each payment net of interest and finance charges). A fair-market-value purchase option means it's a true lease — collect tax on each periodic payment (and on the buyout if the customer exercises it).

Lessees / business customers

Whether you see tax on the whole financed price or on each monthly payment depends on how the contract is structured. Nominal-buyout financing looks like a purchase for tax; a true operating lease is taxed as you pay.

Match the federal income-tax characterization

Kansas keys off how the deal is reported for federal income tax. If it must be reported as a sale/purchase, don't treat it as a taxable lease service — treat the tangible-property transfer as a sale.

Common questions

Q: Our "lease" ends with a $1 buyout. How is it taxed?
A: As a sale. Tax the sales price on an accrual basis, or each payment minus interest and other charges on a cash basis, as determined for federal income tax purposes.

Q: Our lease has a fair-market-value purchase option. How is it taxed?
A: As a true lease — Kansas sales tax on each lease payment, plus the buyout amount if the option is exercised.

Q: The deal is called a lease but we report it as a sale for federal income tax. Does the lease tax under 79-3603(h) apply?
A: No. That transaction isn't taxed as a lease; if it involves tangible personal property, it's taxed as a sale under 79-3603(a).

Q: What is the tax base on a true lease?
A: The total amount of each lease payment the lessee is contractually obligated to pay the lessor.

Q: Does this ruling apply to my business?
A: A Kansas private letter ruling addresses only the requesting taxpayer's facts and cannot be relied on as precedent by others, though it illustrates how the Department distinguishes financing sales from true leases.

Citations and references

• K.S.A. 79-3603(h) — imposes sales tax on the gross receipts from renting or leasing tangible personal property; does not apply to a transaction required to be reported as a sale/purchase for federal income tax.
• K.S.A. 79-3603(a) — imposes sales tax on retail sales of tangible personal property; a financing "lease" of tangible property is taxed here as a sale.
• Nominal-buyout test — a lease with a nominal end-of-term purchase price is treated as a sale; a fair-market-value buyout makes it a true lease.
• K.A.R. 92-19-59 — the regulation authorizing Kansas private letter rulings.

Source

• Landing page: Kansas Department of Revenue Policy Information Library
• Original document: P-2003-012

Original ruling text

Private Letter Ruling

Body:

Office of Policy & Research

February 26, 2003

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Dear Ms. TTTTTT:

We wish to acknowledge receipt of your letter dated October 7, 2002, regarding the application of Kansas Retailers' Sales tax.

K.S.A. 79-3603(h) imposes a sales tax upon: "the gross receipts from the service of renting or leasing tangible personal property. . ."

In your letter you have raised the question as to whether certain transactions referred to as "leases" but in fact are in the nature of financing transactions, should be subject to the tax imposed by K.S.A. 79-3603(h).

On this regard, the Department of Revenue has ruled that K.S.A. 79-3603(h) does not apply to any transaction which is required to be reported as a sale and purchase by the lessor and lessee respectively for federal income tax purposes. However, if the subject of such transaction is tangible personal property, the transaction would be considered a sale of such property, subject to the tax imposed by K.S.A. 79-3603(a).

In the case of a transaction which is referred to as a "lease" but which constitutes a "sale" for sales tax purposes, the gross receipts upon which any Kansas sales or use tax may be due must equal to whichever of the following situations is applicable:

1) When reporting sales or use tax on an accrual basis, gross receipts are defined as the sales price, as determined for federal income tax purposes.

2) When reporting sales or use tax on a cash basis, gross receipts are the amount of each lease payment, minus interest or other charges, as determined for federal income tax purposes.

The department has determined that the lease with a nominal purchase price at the end of the lease would actually be a sale and the above reporting requirements should be followed. If the lease has a buy-out clause at a fair market value, then it would be considered a true lease, and sales tax would be due on each lease payment, as well as the buy-out clause, if it is exercised.

Kansas sales tax shall be imposed on the total amount of each lease payment which the lessee is obligated under contract to pay the lessor.

This is a private letter ruling pursuant to K.A.R. 92-19-59. It is based solely on the facts provided in your request. If it is determined that undisclosed facts were material or necessary to an accurate determination by the department, this ruling is null and void. This ruling will be revoked in the future by the operation of law without further department action if there is a change in the statutes, administrative regulations, or case law, or published revenue ruling, that materially effects this private letter ruling. If I may be of further assistance, please contact me at your earliest convenience at (785) 296-7776.

Sincerely yours,

Thomas P. Browne, Jr.
Tax Specialist

TPB

Date Composed: 03/12/2003 Date Modified: 03/12/2003

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