Are payments under an equipment 'lease' taxable rentals, or nontaxable payments under a security agreement (financing)?

Plain-English summary

Eastman Kodak Company asked how New York sales tax applies to a lease-financing structure. A company (Corporation A) buys equipment, takes title and possession, then finances it through a finance company (Corporation C): Corporation A conveys its beneficial interest but keeps legal title, and continues to bear its obligations. Kodak asked (1) whether Corporation A's payments to Corporation C are taxable rentals or nontaxable payments under a security agreement, and (2) whether the answer changes if Corporation A uses the equipment in an exempt activity.

The Department held the arrangement is a security agreement, so the payments are not taxable.

• The test is true lease vs. security device. The pivotal question is whether Corporation C acts as a financing agency or a vendor, judged by the parties' intent and the facts at the time (UCC § 1-201(37); Sherwood Diversified Services).
• The factors pointed to financing. Corporation A had the option to become owner (for adjusted acquisition cost or fair market value); it bore all risk of loss and received surplus insurance or resale proceeds; Corporation C would file a UCC financing statement; Corporation A selected, installed, and maintained the equipment at its own expense; and the initial term ran to no more than 75% of the equipment's useful life.
• Result: not a taxable lease. The combined effect is that Corporation C acts as a financing agency, not a vendor, so Corporation A's payments are payments under a security agreement and are not subject to New York State or local sales or use tax.
• Second issue moot. Because the payments aren't taxable at all, whether the equipment is used in an exempt activity need not be decided.

What this means for you

A document labeled "lease" may be a financing in disguise

New York doesn't take the label at face value. If the arrangement functions as financing — the "lessee" can become owner, carries all the risk, and keeps any upside — it's a security agreement, and the payments are not taxable rentals. Conversely, a genuine rental (lessor keeps the risk and residual, definite term without a buyout) is a taxable lease.

Watch the classic security-interest factors

The Department weighed the familiar UCC signals: a purchase option at a set or fair-market price, the lessee bearing risk of loss and keeping surplus proceeds, a UCC financing statement, the lessee selecting and maintaining the equipment, and a term tied to useful life. The more of these you have, the more likely the deal is financing.

Nominal-buyout leases in particular are outright sales

This ruling reflects the broader New York rule that a "lease" letting the user become owner for nominal or set consideration is treated as a sale/security agreement up front, not a stream of taxable rentals — a distinction that recurs in later opinions on equipment finance.

Common questions

Q: Our equipment "lease" is really a financing — do we charge sales tax on the payments?
A: If it's a security agreement (purchase option, lessee bears all risk, UCC filing, lessee maintains, term tied to useful life), the payments aren't taxable rentals.

Q: What makes it a true lease instead?
A: The lessor keeping the risk of loss and the residual value, a definite term, and no buyout that turns the lessee into the owner for nominal or set consideration.

Q: Does it matter if the equipment is used in an exempt activity?
A: Here it didn't — once the payments were found nontaxable as financing, the exempt-use question was moot.

Citations and references

Statutes and regulations:

• Uniform Commercial Code § 1-201(37) — when a lease is intended as security (purchase option for nominal/no consideration)
• Tax Law § 1105(a) — tax on retail sales, including leases/rentals of tangible personal property

Cited authority:

• Sherwood Diversified Services, Inc., Debtor, 382 F. Supp. 1359 (S.D.N.Y. 1974) — analyzing intent to distinguish a true lease from a security agreement

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1990.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a90_8s.pdf

Original ruling text

New York State Department of Taxation and Finance
TSB-A-90(8)S
Sales Tax
March 12, 1990

Taxpayer Services Division
Technical Services Bureau
STATE OF NEW YORK

COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S891031C

On October 31, 1989, a Petition for Advisory Opinion was received from Eastman Kodak
Company, 343 State Street, Rochester, New York 14650.
The issues raised by Petitioner, Eastman Kodak Company, are:
1.
Whether payments made by Corporation A to Corporation C under a lease
agreement, a copy of which was submitted as part of the Petition for Advisory Opinion, are
subject to sales tax as receipts from a lease of tangible personal property or constitute non
taxable payments under a security agreement?
2.
Whether the sales taxability of such payments differ if the tangible personal
property is used by Corporation A in an activity which is exempt from sales tax?
Corporation A purchases tangible personal property from Corporation B. Corporation A takes
possession of the property and obtains legal title to the property. Subsequently, Corporation A
finances the tangible personal property through Corporation C pursuant to a lease financing program.
Under the terms of a transfer of rights agreement, Corporation A (the lessee) will sell, assign, transfer
and convey to Corporation C (the lessor) all of Corporation A's right and beneficial interest, but not
legal title, in the property. Corporation A's conveyance pursuant to the transfer of rights and retention
of legal title to the property will not in any way alter its obligations under the lease.
In determining whether the "lease" agreement between Corporation A and Corporation C is
a true lease or constitutes a security agreement, the pivotal issue is to ascertain whether Corporation
C is acting as a financing agency or as a vendor. The proper method for analyzing the transaction in
question is to examine the intent of Corporation A and Corporation C and the facts and
circumstances existing at the time of the agreement. Sherwood Diversified Services, Inc., Debtor,
382 F. Supp. 1359 (S.D.N.Y. 1974).
In making this determination, the following factors and applicable sections of the lease
agreement between Corporation A and Corporation C are pertinent:
1.
Purchase Option - Where a lease is intended as a security device, the lessee
usually becomes or has the option to become the owner of the leased equipment.
Section 1-201 (37) of the Uniform Commercial Code provides that "... the
inclusion of an option to purchase does not of itself make the lease one
intended for security..." However, it also states that "... an agreement that

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upon compliance with the terms of the lease, the lessee shall become or has
the option to become the owner of the property, for no consideration or for
a nominal consideration does make the lease one intended for security."
Pursuant to Section 13 of the lease agreement between Corporation A and Corporation C,
Corporation A as lessee, has the right, upon ninety (90) days notice to Corporation C, as lessor, to
purchase the lessor's ownership interest in any unit of equipment for an amount equal to its adjusted
acquisition cost or its fair market value. Under Section 1 of the lease, adjusted acquisition cost is
defined as acquisition cost less the aggregate amount of all monthly rent components paid as portions
of basic rent for such unit of equipment prior to the time of determination.
2.
Risk of Loss or Damage - If a lease is intended to be a security device, the
lessee often bears the risk of loss or damage to the property. In such a case the lessee
would be required to make payments under the lease regardless of loss or damage to
the property. The lessee would, however, receive the proceeds of any insurance
payment resulting from such loss or damage. If the transaction is a true lease, then
the lessor would be expected to receive any insurance proceeds. Similarly, if the
property is sold to a third party, the lessee may be entitled to any surplus if the
transaction is a sale with retained security interest while the lessor would be so
entitled if the transaction is a true lease.
Pursuant to Section 15 of the lease agreement between Corporation A and Corporation C,
Corporation A, as lessee, assumes all risk of loss of or damage to equipment, however caused. No
loss of or damage to any equipment shall impair any obligation of Corporation A under the lease,
which shall continue in full force and effect with respect to any lost or damaged equipment. Section
10 and Section 15 of the lease agreement also provide that Corporation C, as lessor, will receive any
insurance proceeds which result from equipment damage, loss, theft, destruction, seizure,
confiscation or the equipment being rendered unfit for use or damaged beyond repair, such proceeds
to be applied against amounts owed to Corporation C by Corporation A with any proceeds received
by Corporation C in excess of the amounts owed by Corporation A to be paid by Corporation C to
Corporation A. Similarly, Section 12 of the lease provides that if Corporation A elects to terminate
the lease of any unit of equipment, upon proper notification to Corporation C, Corporation A may
arrange, at its own cost and expense, for the sale of such equipment in an arms length transaction,
the receipts from such sale to be delivered to Corporation C. Upon application of such receipts to
any amounts due Corporation C from Corporation A, any excess receipts from such sale shall be paid
to Corporation A by Corporation C.
3.
Recorded Security Interest - The filing of a security instrument by the "lessor"
pursuant to the provisions of Article 9 of the Uniform Commercial Code in an attempt to
perfect the security interest tends to indicate that the intention of the parties was other than
to create a leasehold interest since a true lease creates no interest which could be subject to
an Article 9 security interest. However, a lessor may record his interest, even though a true
lease is intended, as a means of protecting his claim in the event a court characterizes the

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transaction as a sale governed by the provisions of Article 9.
Pursuant to Section 1 of the lease between Corporation A and Corporation C, "lien" is
defined as any security interest ... (including, without limitation, any... title retention agreement, any
financing lease having the same economic effect as any of the foregoing, and the filing of any
financing statement under the Uniform Commercial Code or comparable law of any jurisdiction in
respect of any of the foregoing).
4.
Selection, Maintenance and Use of Property - A requirement, under the terms
of the lease, that the lessee has full responsibility to select, order, take delivery, set up,
operate and maintain the property is an indication that the transaction is a sale rather than a
lease. The presence of only a single factor (i.e., responsibility for maintenance) is
considerable less persuasive.
Maintenance of the property by the lessor or establishment of maintenance standards by the
lessor to be followed by the lessee tends to indicate a lease rather than a sale unless there exists a
separate maintenance charge or contract. Similarly, restrictions on the lessee's use of the property
or the right to sublease or assign tend to indicate a true lease.
Section 5 of the lease between Corporation A and Corporation C provides that Corporation
A, as lessee, shall select the equipment on the basis of its own judgment and shall ensure that the
installation or erection of any equipment is in accordance with the specifications and requirements
of the vendor thereof.
Section 9 of the lease provides that the lessee shall pay all costs, expenses, fees and charges
incurred in connection with the ownership, use and operation of any unit of equipment and that the
lessee shall at all times, at its own expense, and subject to reasonable wear and tear, keep equipment
in good operating order, repair, condition and appearance.
5.
Duration of Lease - A true lease is ordinarily of a definite duration. If the
terms of the lease do not provide for the expiration or termination of lessee's payments, other
than by purchase of the leased equipment, this tends to indicate that the lease was intended
to be a security device.
Pursuant to Section 6 of the lease, the initial term of the lease for each unit of equipment shall
not exceed 75% of its economic useful life. Section 13 of the lease grants Corporation A the right
to purchase Corporation C's ownership interest in any unit of equipment on the last basic rent
payment date of the initial term or on any basic rent payment date during any month of an extended
term for an amount equal to the greater of its adjusted acquisition cost or its fair market value; or,
on the last basic rent payment date of an extended term or on any basic rent payment date during any
month of a renewal term, for an amount equal to its fair market value.

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Based on the above factors and the pertinent sections of the lease agreement between
Corporation A and Corporation C, it is determined that the lease between Corporation A and
Corporation C provides or infers that:
1.

Corporation A (lessee) has the option to become the owner of the leased
equipment;

2.

Corporation A assumes all risk of loss or damage to the equipment, however
caused, and will receive any surplus insurance proceeds resulting from
equipment damage, loss, theft, destruction, seizure, confiscation, or being
rendered unfit for use or damaged beyond repair;

3.

Corporation C will file a financing statement under the Uniform Commercial
Code;

4.

Corporation A will have the responsibility to select and insure that the
installation or erection of any equipment is in accordance with the
specifications and requirements of the vendor thereof and that as lessee shall
at all times, at its own expense, keep equipment in good operating order,
repair, condition and appearance;

5.

Corporation A has the option to purchase Corporation C's ownership interest
in any unit of equipment.

The combined effect of these factors supports the conclusion that the equipment lease
transactions between Corporation A and Corporation C will be security agreements and that
Corporation C will act as a financing agency and not a vendor.
Accordingly, payments made by Corporation A to Corporation C under such lease agreement
will constitute payments under a security agreement and will not be subject to New York State or
Local Sales or Use Tax.
Since the agreement between Corporation A and Corporation C has been determined to be
a security agreement, issue "2" is moot, and need not be addressed in this opinion.

DATED: March 12, 1990

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.