Is a sale-leaseback transaction, structured as a financing arrangement even though it's booked as a sale for financial-accounting purposes, subject to New York sales or use tax on the 'sale' and 'lease' payments?

Subject

Whether the transaction described, which is a financing transaction for Federal income tax purposes but is structured as a sale leaseback for financial accounting purposes, constitutes a security or financing agreement which is not subject to New York State sales or compensating use tax.

What this means for you

A finance company's customer owns furniture, leasehold improvements, and fixtures in New York and wants to refinance the related debt so both the debt and the assets come off its balance sheet for accounting purposes -- while remaining the owner for federal income tax purposes. The mechanics: the customer sells the property to the finance company via a bare Bill of Sale (transferring only enough legal title to satisfy accounting rules), then "leases" it back with payments structured as principal-and-interest amortization, with a purchase option at the end (at a fixed, not-quite-bargain price) or a third-party sale where the customer gets any upside and guarantees part of the downside.

New York asks whether a transaction like this is a TRUE lease (a taxable sale/rental) or really a SECURITY AGREEMENT (a financing arrangement, not taxable) by weighing several traditional factors: who bears the risk of loss (here, the customer, from the moment of shipment); who receives insurance proceeds and controls their use (here, largely the finance company, but tied to repair/replace or debt obligations); whether a security interest was filed (yes, a UCC Article 9 filing was made here); who's responsible for selecting, delivering, and maintaining the equipment (here, the customer handles all of that, shipped directly from the original supplier); and whether the arrangement has a definite end (here, it does, with purchase/return/resale options). Weighing all these factors together, the opinion concludes the customer functions as the real owner throughout, and the finance company is acting as a secured lender, not a vendor -- so the whole sale-and-leaseback is a financing/security arrangement, not a taxable sale, and escapes New York sales and use tax.

Q&A

Q: We're restructuring an on-balance-sheet asset into an off-balance-sheet sale-leaseback purely for accounting purposes, while keeping ownership for tax purposes -- does the "sale" trigger New York sales tax?
A: Per this opinion, not necessarily -- if the traditional lease-vs-security-agreement factors (risk of loss, insurance proceeds, UCC filing, maintenance/delivery responsibility, definite lease term) show the customer functions as the real owner throughout and the finance company as a secured lender, the transaction is treated as a financing/security agreement rather than a taxable sale.

Q: We filed a UCC Article 9 financing statement on the leased equipment -- doesn't that alone prove it's a sale with a retained security interest?
A: Not necessarily, per this opinion -- filing can indicate a security interest, but a lessor may also file defensively (to protect its claim in case a court later recharacterizes a true lease as a sale), so it's just one factor weighed among several, not dispositive on its own.

Q: Does it matter that our customer has a purchase option at the end of the lease term?
A: This opinion notes an option to purchase doesn't, by itself, make a lease a security device under UCC § 1-201(37) -- but an option to become owner for NO additional consideration would. Here, the option required a real payment, so this factor alone didn't decide the outcome; it was the combination of all factors that did.

Citations

• UCC § 1-201(37) -- provides that including a purchase option doesn't by itself make a lease a security device, but an option to become owner for no consideration does.
• Sherwood Diversified Services, Inc., Debtor, 382 F. Supp. 1359 (S.D.N.Y. 1974) -- cited for the proper method of analyzing lease-vs-security-agreement intent based on the parties' facts and circumstances at the time of the agreement.

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1994.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a94_14s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-94 (14)S
Sales Tax
April 4, 1994

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S931213A

On December 13, 1993 a Petition for Advisory Opinion was received from General Electric
Capital Corporation, 260 Long Ridge Road, Stamford, CT 06927.
The issue raised by Petitioner, General Electric Capital Corporation, is whether the
transaction hereinafter described, which is a financing transaction for Federal income tax purposes
but is structured as a sale leaseback for financial accounting purposes constitutes a security or
financing agreement which is not subject to New York State sales or compensating use tax.
Petitioner's customer, hereafter referred to as "Customer", currently has furniture, leasehold
improvements and fixtures located in New York City. Customer is the owner of said furniture,
leasehold improvements and fixtures for financial reporting and Federal income tax purposes.
Customer currently claims depreciation on the furniture, leasehold improvements and fixtures for
financial reporting and Federal income tax purposes.
Customer proposes to enter into a transaction with Petitioner whereby Customer will
refinance the debt associated with the furniture, leasehold improvements and fixtures in such a
manner that both the debt and objects are removed from Customer's financial reporting balance
sheet. Customer will remain the owner of the furniture, leasehold improvements and fixtures for
Federal income tax purposes.
Customer will sell the furniture, leasehold improvements and fixtures to Petitioner pursuant
to a Bill of Sale. The Bill of Sale transfers bare legal title sufficient to satisfy financial reporting
requirements. For commercial law purposes Petitioner will not view itself as owner, but as a secured
party.
After the transfer, Petitioner will "lease" the furniture, leasehold improvements and fixtures
to Customer. However, the "lease" payments will correspond to a principal and interest amortization
schedule. At the end of the lease Customer can "purchase" the furniture, leasehold improvements and
fixtures for a fixed amount which is not a bargain, but may be below fair market value. If Customer
chooses not to "purchase" furniture, leasehold improvements and fixtures, a sale will be made to a
third party. Customer will receive all the upside over the fixed purchase amount. Further, Customer
will guarantee a portion of the downside residual for Petitioner.
In the event that there is an early termination event, Customer is only responsible for the
termination value payment plus all unpaid rentals, fees, taxes and other charges. Any amount
received in excess of said termination value and other unpaid amounts will be for the account of the
Customer.

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April 4, 1994
In determining whether the "lease" agreement between Petitioner and Customer is a true lease
or constitutes a security agreement, the pivotal issue is to ascertain whether Petitioner 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 Petitioner and Customer and 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 Petitioner and Customer are pertinent:
The first factor is that 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 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 does make the lease one
intended for security."
Pursuant to Section XVII of a sample master lease agreement submitted by Petitioner, for
income tax purposes, Petitioner will treat Customer as the owner of the Equipment. Petitioner will
not claim any tax benefits available to an owner of the Equipment. Lessee grants to Petitioner a first
priority security interest in the Equipment, together with all additions, attachments, accessions,
accessories and accessions thereto whether or not furnished by the Supplier of the Equipment and
any and all substitutions, replacements or exchanges therefor, and any and all insurance and/or other
proceeds of the property in and against which a security interest is granted hereunder.
Pursuant to Section XIX of the sample master lease agreement, Customer may exercise an
early purchase option to purchase all (but not less than all) of the Equipment listed and described in
this schedule on any Rent Payment Date following the First Termination Date as set forth in this
Schedule, and prior to the date which is the scheduled expiration of this Lease (the "Early Purchase
Date"), for a price equal to (i) the Termination Value (calculated as of the Early Purchase Date) for
the Equipment, and (ii) all rent and other sums due and unpaid as of the Purchase Date (the "Early
Option Price"), plus all applicable sales taxes on an as is basis, provided Customer gives Petitioner
at least 30 days but not more than 270 days prior written notice of Customer's irrevocable election
to exercise such option.
This section also provides that if Customer exercises its Early Purchase Option, Customer
shall pay Petitioner any rent and other sums due and unpaid and shall pay the Early Option Price,
plus all applicable sales taxes, on the Early Purchase Date.
Additionally, Section XX of the agreement provides Customer the option, upon the scheduled
expiration of the term of the Lease, to return or purchase all (but not less than all) of the Equipment
for the applicable Realized Value. If Customer elects to purchase the equipment, the applicable

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TSB-A-94 (14)S
Sales Tax
April 4, 1994
Realized Value of each unit will be its Estimated Residual Value. If Customer elects not to purchase
any unit(s) of Equipment, Petitioner will sell such units at each unit's determined fair market value.
Customer will not be allowed to bid directly or indirectly on the units. In the event the Realized
Value of the Equipment is less than the Estimated Residual Value Customer will pay Petitioner an
amount equal to the difference between the Realized Value and the Estimated Residual Value. In the
event the Realized Value exceeds the Estimated Residual Value, Petitioner shall pay Customer an
amount equal to 100% of such excess, but only to the extent Petitioner actually receives the Realized
Value in cash.
This section also defines certain terms as follows:
(i)

"Equipment" means all but not less than all units of the Equipment described
on the Schedule.

(ii)

"Estimated Residual Value" means 20% of Petitioner's Cost of the Equipment
as set forth on the Schedule.

(iii)

"Realized Value" means the net proceeds realized by Petitioner from sale of
the Equipment after deduction of expenses of such sale, if any, and all sums
due under the Lease as of Schedule Expiration.

(iv)

Schedule Expiration" means the last day of the scheduled term of the Lease
as to the Equipment.

The second factor is that 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.
Section VIII of the sample master lease agreement provides that Customer assumes and will
bear the entire risk of any loss, theft, damage to, or destruction of, any unit of Equipment from any
cause whatsoever from the time the Equipment is shipped to Customer.
Section IX of the sample master lease agreement provides that Customer will keep all
Equipment insured for the amounts and against hazards as Petitioner may require. Customer will
appoint Petitioner as Customer's attorney-in-fact to receive payment of and execute or endorse all
documents, checks or drafts in connection with payments made as a result of such insurance policies.
This section also provides that Petitioner may, at Petitioner's option, apply proceeds of insurance,
in whole or in part, to repair or replace Equipment or any portion thereof, or to satisfy any obligation
of Customer or Petitioner hereunder.

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Sales Tax
April 4, 1994
Section XX of the sample master lease agreement provides that where the Equipment is sold
to a third party, Customer will be entitled to any surplus from such sale.
The third factor is that 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 transaction as a sale governed by the provisions of Article 9.
Section XVII of the sample master lease agreement provides that Customer grants Petitioner
a first priority security interest in the Equipment, together with all additions, attachments, accessions,
accessories and accessions thereto whether or not furnished by the Supplier of the Equipment and
any and all substitutions, replacements or exchanges therefor, and any and all insurance and/or other
proceeds of the property in and against which a security interest is granted hereunder.
The fourth factor is that 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 with a retained security interest rather than a lease. The presence of only
a single factor (i.e.), responsibility for maintenance) is considerably 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 with a retained security interest 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 V of the sample master lease agreement provides that all Equipment shall be shipped
directly from the Supplier to Customer.
Section VI of the sample master lease agreement provides that Customer, at its sole expense,
will maintain each unit of Equipment in good operating order, repair, condition and appearance in
accordance with manufacturer's recommendations, normal wear and tear excepted.
The fifth factor is that 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.
Section XX of the sample master lease agreement provides Customer the option, upon the
scheduled expiration of the term of the Lease, to return or purchase, for the applicable Realized
Value all (but not less than all) of the Equipment in accordance with the terms as discussed in 1.
above.

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Sales Tax
April 4, 1994
The combined effect of these factors supports the conclusion that the sample master lease
agreement applied to the transaction presented by Petitioner will result in that Customer and
Petitioner having a security agreement with the Petitioner acting as a financing agency and not a
vendor and that therefore the sale and leaseback will not be subject to sales and compensating use
tax.

DATED: April 4, 1994

/s/
PAUL B. COBURN
Deputy Director
Taxpayer Services Division

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