A leasing company leases computer hardware to a client and collects tax on the lease payments. Because its lease agreement doesn't allow resale of software, the leasing company instead gives the client funds to buy the software directly from a vendor, and never takes title or possession of the software. Is that software funding a taxable financing lease, and can the software and hardware be scheduled together?

Plain-English summary

A leasing company asked the Comptroller how to treat the software portion of a combined hardware-and-software lease deal with a client.

The leasing company leases computer hardware to the client: it buys the hardware tax-free (as inventory for lease) and collects sales tax on the lease payments, as normal for a taxable lease. But the leasing agreement doesn't allow the software to be resold or subleased, so the leasing company can't lease the software the same way. Instead, it gives the client the money to buy the software directly. The client negotiates its own deal with the software vendor, places the order, and pays sales tax to the vendor on the negotiated price. Critically, the leasing company never takes title or possession of the software — it only ever holds title and possession of the hardware.

The Comptroller ruled that because the leasing company never owns or possesses the software, its arrangement with the client for the software isn't a lease at all — it's a loan. Since it's a loan, the leasing company does not have to add sales tax to the client's repayments of principal and interest on the software funds. However, that loan must be scheduled (billed/tracked) separately from the taxable lease of the hardware — the two can't be combined into a single lease schedule.

What this means for you

Equipment leasing and financing companies

If you lease hardware but can't lease software under the same deal (for example, because software license terms bar you from holding or subleasing it), providing the client funds to buy the software directly can be structured as a loan rather than a lease — as long as you never take title or possession of the software. A true loan's principal and interest repayments are not subject to sales tax, unlike lease payments. Keep the loan billed on a separate schedule from the taxable equipment lease; don't fold the two together on one invoice or schedule.

Businesses leasing combined hardware/software packages

If your leasing company can't legally lease you the software (due to its own agreement with the software vendor or licensor), expect to negotiate and pay for the software directly with the vendor — and to pay sales tax to that vendor on the negotiated price, separately from the sales tax you pay on your hardware lease payments.

Accountants and tax professionals

This letter draws a clean line for financing-vs-loan characterization in mixed equipment deals: title and possession are the deciding facts. If the financing party never holds title or possession of an asset, funds it advances toward that asset are a loan (not taxable as a lease), but they must be tracked separately from any genuine taxable lease in the same transaction.

Common questions

Q: Is the software funding in this deal treated as a lease or a loan?
A: A loan. Because the leasing company never obtains title or possession of the software, its arrangement to fund the client's software purchase is a loan, not a financing lease.

Q: Does the leasing company have to collect sales tax on the client's loan repayments for the software?
A: No. The leasing company is not required to add tax to repayments of principal and interest on the software loan.

Q: Can the software loan and the hardware lease be billed together on one schedule?
A: No — the letter states the loan for the software must be scheduled separately from the lease of the hardware.

Q: Who pays sales tax on the software itself, and when?
A: The client pays tax directly to the software vendor on the negotiated price when it purchases the software, since the client (not the leasing company) is the one buying the software.

Q: What made this a loan instead of a financing lease in the Comptroller's eyes?
A: The leasing company never obtained title or possession of the software — it only provided the funds. The client negotiated with and purchased directly from the software vendor.

Q: Can I rely on this letter for my own leasing arrangement?
A: No. This opinion is based on the facts presented, and if there are any additional or different facts, the opinion may change. Texas STAR letters can be relied on only by the taxpayer to whom they were issued.

Citations and references

No specific statutes or rule numbers were cited in this letter.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9206L1175G13

Original ruling text

June 15, 1992

Dear **:

Thank you for your letter of May 20, 1992, requesting the taxability of a lease
agreement between ** and a client.

As I understand it, ** has entered into a lease agreement to
provide a client with computer hardware and software. The hardware is purchased
by ** tax free since tax will be collected on the lease payments.
However, because a requirement in the leasing agreement does not allow for the
resale of the software, *** provides the client the funds to
purchase the software. The client then negotiates and places an order with the
software vendor. Tax is paid by the client to the software vendor on the
negotiated price of the software. ** never obtains title or
possession of the software. You question whether the software portion of the
lease payment is taxable and whether the hardware and software should be
scheduled separately.

The funds provided for the software constitute a loan rather than a financing
lease. ** would not be required to add tax to a repayment of
principal and interest. However, the loan for the software must be scheduled
separately from the lease of the hardware.

This opinion is based on the facts presented. If there are any additional or
different facts, the opinion may change.

If you have any questions or need additional information, you may call toll
free 1-800-252-5555 Ext. 50037 or the regular Austin number is 512-475-0037.
You may also write to Tax Administration Division.

Sincerely,

Lindey Osborne
Tax Administration Division