If a parent company spins off an equipment subsidiary and that subsidiary then leases the equipment back to the parent or a sister company, is tax due on the lease payments?

Subject

Corporation — Leases From Parent To Subsidiaries/Brothers/Sisters — Lease Payments Between Related Corporations Are Taxable

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9311L1271E01

Plain-English Summary

A parent company (referred to in the letter as Corporation ABC, Inc., or "ABC") reorganized its operations by spinning off two of its business lines into separate subsidiary corporations: Company B, Inc. and Equipment Company A, Inc. All of the equipment ABC had owned — equipment on which ABC had already paid tax at the time of original purchase — was transferred to Equipment Company A. The taxpayer asked whether tax would be due when Equipment Company A then leased that equipment back to either ABC or to its sister company, Company B.

The Comptroller explained that Rule 3.331(b)(3)'s joint ownership transfer exemption only applies where the purchaser (or lessee) actually owns a joint or undivided interest in the property itself, together with the seller (or lessor). It does not apply merely because the related companies happen to share common ownership through corporate stock. Because Equipment Company A rents equipment to ABC and Company B on a per-job, as-needed basis, and because the lessee in these arrangements gets no ownership interest in the equipment (only the right to use and possess it for a period of time), these rentals are classified as operating leases under Rule 3.294. Since the only "joint ownership" connecting these related corporations is common corporate stock ownership — not joint ownership of the equipment itself — the joint ownership transfer exemption does not apply. As a result, the lease payments Equipment Company A receives from ABC or Company B are taxable.

The letter draws one important distinction: the equipment that was transferred or sold to Equipment Company A as part of the original reorganization (before any of these leases began) does qualify for the joint ownership transfer exemption, so that initial transfer itself was not subject to tax. Going forward, if Equipment Company A buys new equipment specifically to rent out, it may give its supplier a resale certificate instead of paying tax at purchase — but it must then collect and remit tax on the rental payments it receives for that equipment.

What This Means For You

If you're restructuring a business by spinning off an equipment-holding subsidiary: The initial transfer of already-taxed equipment into the new subsidiary during the reorganization can qualify for the joint ownership transfer exemption under Rule 3.331(b)(3), per this letter. But that one-time exemption does not carry forward to cover future lease or rental payments between the related companies.

If a subsidiary then leases that equipment back to its parent or a sister company: Don't assume common ownership shields the arrangement from tax. This letter is explicit that shared corporate stock ownership alone is not the kind of "joint ownership" the exemption requires — the exemption requires an actual joint or undivided ownership interest in the specific property being leased. Absent that, lease/rental payments between related corporations are taxable, just as they would be between unrelated parties.

If your subsidiary buys new equipment specifically to rent out (rather than for its own use): This letter confirms the standard resale-certificate mechanic still applies in a related-party context — the subsidiary can give a resale certificate to its equipment supplier instead of paying tax up front, but it then must collect and remit tax on what it charges in rent.

Q&A

Q: Does common corporate ownership (e.g., a parent and its subsidiaries) qualify for the joint ownership transfer exemption on equipment leases between them?
A: No. The letter quotes Rule 3.331(b)(3) directly: the exemption requires the purchaser/lessee to hold a joint or undivided interest in the property itself with the seller/lessor. It "does not apply to sales between related corporations or other entities where the only joint ownership is the ultimate ownership of the corporation stock."

Q: Are the lease payments Equipment Company A receives from ABC (the parent) and Company B (the sister company) taxable?
A: Yes. Because these are operating leases under Rule 3.294 — the lessee has no ownership interest in the equipment, only use and possession for a period — and because the only joint ownership between these related corporations is stock ownership, the lease payments are taxable.

Q: Was the original transfer of equipment from ABC to Equipment Company A during the reorganization taxed?
A: No. The letter states that equipment purchased before the reorganization and then "transferred or sold" to Equipment Company A does qualify for the joint ownership transfer exemption. It is only the subsequent lease payments that are taxable, not that initial transfer.

Q: If Equipment Company A buys new equipment specifically to rent out going forward, does it pay tax when it buys the equipment?
A: Not necessarily — the letter says Equipment Company A may give a resale certificate to its supplier in lieu of paying tax on the purchase, but it must then collect and remit tax on the rental payments it receives for that equipment.

Original ruling text

November 17, 1993

Dear **:

Thank you for your letter of October 15, 1993, regarding the taxability
of lease payments between either a parent and subsidiary or two subsidiaries.
The subsidiaries are the result of the parent reorganizing it's operations.

As I understand it, the parent company, now named Corporation ABC Inc.
(ABC), has spun-off two of it's different operations into two separate
subsidiary corporations. The two subsidiaries are Company B, Inc. and
Equipment Company A, Inc. EQUIPMENT COMPANY A is the recipient of all equipment
owned by ABC. All of this equipment was purchased for ABC's own use and tax was
paid on the equipment at the time of purchase. You question whether tax is due
when EQUIPMENT COMPANY A leases the equipment to either ABC or COMPANY B.

Subsection (b)(3) of Rule 3.331 is restated below:

It is necessary the purchaser (or lessee), either before or after the
sale (or lease), own a joint or undivided interest in the property with the
seller (or lessor). The joint ownership transfer exemption does not
apply to sales between related corporations or other entities where the
only joint ownership is the ultimate ownership of the corporation stock.

We spoke by phone on November 10, 1993. In our conversation, you told
me that EQUIPMENT COMPANY A rents the equipment on a per job basis. If a
piece of equipment is needed, EQUIPMENT COMPANY A will purchase the equipment
for rental on the job. These rentals are classified as operating leases per
Rule 3.294.

Under the terms of an operating lease, the lessee does not have an
ownership interest in the leased equipment. Rather, the lessee is giving
consideration for use and possession of the equipment for a specific period of
time. Please refer to Section (a) of Rule 3.294. The sale (or lease in this
case) is between related corporations where the only joint ownership in the
equipment is in the ownershipof corporate stock. Therefore, the lease payments
EQUIPMENT COMPANY A receives from either ABC or COMPANY B are taxable.

The equipment purchased prior to the reorganization of ABC that was
transferred or sold to EQUIPMENT COMPANY A does qualify for the joint
ownership transfer exemption.

If EQUIPMENT COMPANY A purchases equipment for the purpose of rental, a
resale certificate may given, in lieu of tax, to it's supplier. EQUIPMENT
COMPANY A must then collect and remit tax on the equipment rental.

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 1-800-531-5441, ext. 50037. The regular Austin number is 512-475-0037.
You also may write to Tax Administration Division.

Sincerely,

Lindey Osborne
Tax Administration Division

NOTE: Previous Accession Number 9311085L.5 and/or 9311085L