In a sale-leaseback of manufacturing equipment, is the sale to the leasing company exempt, and are the lease payments back exempt?

Plain-English summary

A wafer manufacturer owned manufacturing equipment less than six months old and wanted to sell it to a leasing company, then lease it back. The company was explicit that this was a true lease, not a financing arrangement -- no nominal buyout, and title would not automatically pass back at the end; instead the manufacturer would have an option to buy the equipment back at fair market value when the lease ended. The manufacturer asked two questions: is the sale to the leasing company exempt, and are the lease payments exempt?

The sale is exempt. The Commission agreed the sale of the equipment to the leasing company qualifies as an exempt purchase for resale -- the leasing company is buying the equipment to lease it out, not to consume it.

The lease payments are not exempt, for two independent reasons:

1. The statutory sale-leaseback exemption doesn't apply. Effective July 1, 1995, Utah Code § 59-12-102(13)(c) exempts lease payments under a sale-leaseback arrangement, but only if (a) the lessee already paid sales tax on its original purchase before the leaseback, (b) the transaction is intended as financing, and (c) the lessee capitalizes the property and accounts for lease payments as financing payments. The manufacturer's deal failed on two of these: if the original purchase had used the manufacturing exemption (no sales tax paid), condition (a) fails; and because the company described this as a true lease rather than a financing arrangement, condition (b) fails outright.

2. The manufacturing equipment exemption doesn't apply either. The Commission walked through the exemption's requirements: the equipment must be tangible personal property (not real property or a real-property improvement); it must have a useful life of at least three years; it can't be used for non-manufacturing activities like shipping the final product; and it can't be "replacement equipment" -- equipment serving the same purpose as existing equipment retired within 12 months of the new equipment's purchase (though the ruling notes replacement equipment was slated to get a phased-in partial exemption starting July 1, 1996: 30% in 1996, 60% in 1997, 100% by 1998). Most fatally, the equipment must be leased for a new or expanding manufacturing operation -- meaning activities substantially different from before, at a new physical location, or increasing production/capacity. Because the leased-back equipment would do exactly what it did before the sale-leaseback, the transaction doesn't meet any of these tests. It's the same operation, not a new or expanding one, so the manufacturing exemption doesn't cover the lease payments.

What this means for you

Manufacturers considering a sale-leaseback of existing equipment

Selling your own equipment to a leasing company is exempt as a resale, but don't assume the lease payments back will be tax-free. If it's a true lease (not financing) of equipment that keeps doing the same job, the lease payments are taxable.

Businesses trying to use a sale-leaseback to access the financing exemption

To fit within Utah's sale-leaseback financing exemption, structure the deal so the lessee capitalizes the property, treats payments as financing (not lease) payments for accounting purposes, and originally paid sales tax on the initial purchase -- a "true lease" with a fair-market-value buyout option won't qualify.

Manufacturers relying on the manufacturing equipment exemption for a leaseback

The manufacturing exemption requires a genuinely new or expanding operation. Simply changing who holds title to existing equipment -- while the equipment keeps doing the same work -- doesn't convert an existing operation into a "new or expanding" one.

Common questions

Q: Is the sale of equipment to a leasing company in a sale-leaseback taxable?
A: No, that sale is exempt as a purchase for resale.

Q: Are the lease payments in a sale-leaseback automatically exempt too?
A: No -- they're only exempt if the arrangement meets Utah's statutory sale-leaseback financing exemption (§ 59-12-102(13)(c)) or independently qualifies for the manufacturing exemption.

Q: What disqualifies a "true lease" sale-leaseback from the financing exemption?
A: The exemption requires the deal to function as financing -- capitalized on the lessee's books, payments treated as financing payments. A true lease (no title transfer, no nominal buyout) doesn't meet that description.

Q: Can a sale-leaseback of existing equipment qualify for the manufacturing new-or-expanding exemption?
A: Only if the leased equipment is actually used for a new or expanding operation. Equipment that just keeps performing its pre-existing function doesn't qualify, even if ownership changed hands.

Q: Is replacement manufacturing equipment always fully taxable?
A: As of this 1995 ruling, yes for purchases before July 1, 1996, but the legislature had passed a phase-in of a partial exemption for replacement equipment: 30% starting mid-1996, 60% starting mid-1997, and 100% starting mid-1998.

Citations and references

Statutes cited:

• Utah Code Ann. § 59-12-102(13)(c) (sale-leaseback financing-arrangement exemption, effective July 1, 1995)
• Utah Code Ann. § 59-12-104(15) (manufacturing exemption for new or expanding operations)

Source

• Landing page: https://tax.utah.gov/commission/rulings/
• Original PDF: https://files.tax.utah.gov/tax/commission/ruling/95-089.pdf

Original ruling text

95-089

Response December 19, 1995

Request

December 11, 1995

Utah State Tax Commission

Attn: XXXXX

210 North 1950 West

Salt Lake City, UTAH 84134

RE: Opinion on Sale and Use Tax transaction

Dear XXXXX

I am requesting an opinion on a sales and use tax transaction involving a sale and lease-back of manufacturing equipment. The transaction is as follows:

XXXXX owns manufacturing equipment that is less than six months old. XXXXX would like to sell the manufacturing equipment to a lease company then lease them back from the lease company. The lease is a true lease and not a financing arrangement. There will be no minimal buy out nor will title pass at the end of the lease to XXXXX. XXXXX will have the option to purchase the assets at fair market value at the end of the term.

Our questions to this transaction are as follows:

1 ) Will the sale to the lease company be exempt from sales tax?

2) Will the lease payments to the lessor be exempt from sales and use tax?

It is our opinion that the sale to the lease company is an exempt sale for resale. It is also our opinion that the lease of machinery and equipment by a manufacturer for use in new or expanding operations are exempt. XXXXX is a manufacturer of wafers.

I would like to thank you in advance for your prompt attention to this matter and I am hopeful of an expeditious response. Please call me if you any questions.

Cordially,

XXXXX

December 19, 1995

XXXXX

RE: Advisory Opinion - Applicability of sales tax to sale-lease back arrangement

Dear XXXXX

We have received your request for an advisory opinion regarding the taxability of a transaction in which your company intends to sell a piece of manufacturing equipment to a leasing company, then lease it back. We offer the following guidance on this issue:

As to XXXXX sale of equipment to the lease company, we agree that the transaction is exempt from sales tax as a purchase for purchase for resale.

Turning to the taxability of the lease payments, Utah law imposes sales and use tax on leases of personal tangible property unless a statutory exemption applies. However, the state legislature recently amended the definition of taxable retail sale to address sale-leaseback arrangements. Section 59-12-102 (13) (c) of the Utah Code now provides that as of July 1, 1995, lease payments made under a sale-leaseback agreement are exempt from sales tax if:

(1) the lessee pays sales tax on its initial purchase and then enters into a sale lease back transaction which transfers title to the property to the lessor,

(2) the transaction is intended as a form of financing for the property to the purchaser-lessee, and

(3) the purchaser-lessee capitalizes the subject property for financial reporting purposes, and accounts for the lease payments as payment made under a financing arrangement.

From your description of the transaction, XXXXX is precluded from this provision for two reasons. First, if, on its initial purchase, your company took advantage of the sales tax exemption on purchases of manufacturing equipment, the transaction fails to meet the first condition set out in (1) above. Second, you state that this is not a financing arrangement. Therefore, the transaction fails to meet the condition set out in (2) above. Because the transaction that you describe does not fit within the sale-leaseback provision, we review it in light of other statutory provisions.

XXXXX lease of that equipment is entitled to exemption only if the transaction qualifies under the provisions for a manufacturing equipment exemption. You have not described the equipment involved, but the following information will help you determine whether the equipment qualifies:

(1) The manufacturing equipment exemption applies only to tangible personal property, not real property or tangible property that is purchased and becomes an improvement to real property.

(2). Machinery or equipment with a useful economic or accounting life of less than three years is not eligible for the exemption.

(3) Machinery or equipment used for an activity that is not part of the manufacturing process, such as equipment used to transport or ship the final product, does not qualify for the exemption .

(4) Manufacturing machinery or equipment which is purchased as a normal operating replacement is currently subject to sales tax. Replacement equipment is defined as equipment which serves the same purpose as existing equipment. If the existing equipment is retired from service within 12 months before or after the purchase of new equipment, the new equipment is considered replacement equipment.

Although normal operating replacements purchased before July 1, 1996 are fully taxable, the state legislature recently passed a bill which phases in an exemption for manufacturing replacement equipment over the next few years. The exemption rates which will apply to replacement equipment are set out below.

a. For tax years beginning July 1, 1996, 30% of the exemption is allowed.

b. For tax years beginning July 1, 1997, 60% of the exemption is allowed.

c. For tax years beginning July 1, 1998, 100% of the exemption is allowed.

(5) Finally, the lease must be made for a new or expanding manufacturing in Utah. To qualify as a new or expanding operation, the manufacturing, processing or assembling activities must be:

a. substantially different in nature, character or purpose from prior activities;

b. begun in a new physical location in Utah; or

c. increase production or capacity.

This last condition is problematic for your company because this leaseback transaction does not appear to meet any of the qualifications set out in (5) above because the machine will perform the same process after the sale-leaseback that it did before. In that case, your lease arrangement fails as a lease of equipment for a "new or expanding operation."

If you have additional questions or additional facts that would change the outcome of this opinion, please let us know.

For the Commission,

Alice Shearer

Commissioner