Tax Type
Retail Sales and Use Tax
Description
Leases and rentals; Capital lease; Business of leasing; Statute of limitations
Topic
Taxability of Persons and Transactions
Date Issued
10-07-1996
October 7, 1996
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear***********
In your letter, you seek correction of the retail sales and use tax assessment issued to *********(Client). Copies of all references are enclosed.
FACTS
You indicate that your Client is engaged in the business of financing equipment purchases for commercial purposes, rather than leasing equipment as based on the audit findings for the period July 1989 through June 1994 which resulted in an assessment of use tax on untaxed charges for leases of tangible personal property.
You maintain that the Client's agreements are financing arrangements which take the form of capital leases. The lessee makes payments over three to five years, at the end of which time it can purchase the equipment for one dollar. The terms and conditions of the leases identify the Client as the owner of the equipment, and the property is to be returned to the Client at the end of the lease. You state that the Client as the lessor has no residual interest in the equipment when the lessee has paid all rents due under the lease and can then exercise the one-dollar buyout option. The Client pays the purchase price and applicable sales tax when charged by the vendor. The vendor delivers the equipment directly to the lessee and lists the lessee as the primary customer on the purchase order. The Client considers the lessee to be the purchaser and owner, as the lessee is responsible for paying the personal property taxes and insurance. The Client retains a security interest in the equipment to secure lease payments.
In addition, the Client does not warrant or repair the equipment, and does not maintain an inventory of equipment or parts. It does not have a showroom and does not help purchasers select equipment. Its balance sheet shows the leases as trade notes and accounts receivable. It does not carry the equipment it leases as an asset on its balance sheet and does not claim depreciation deductions or investment tax credit for the equipment.
The Client seeks a determination that it is not liable for sales tax on lease payments received, and sales taxes were properly paid to the equipment vendors at the time of sale. To the extent it has any liability for sales tax on lease payments received, the Client requests that credit be given for all sales taxes paid at the time of purchase.
DETERMINATION
Lease v. conditional sale
Code of Virginia § 58.1-602 contains a specific definition of the term "lease" for purposes of the retail sales and use tax:
-
- "Lease or rental" means the leasing or renting of tangible personal property and the possession or use thereof of tangible personal property for a consideration, without transfer of the title to such property.
In this case, the agreement in question identifies the Client and its customer as "lessor" and "lessee," respectively. The agreement states that "Lessor leases to Lessee and Lessee rents from Lessor the personal property listed" and that the "Lessor is the owner" of the equipment. The agreement provides that upon expiration or termination of the lease, the lessee shall return the equipment to a place specified by the lessor and title to any replacement or accessories affixed to the equipment shall be vested in the lessor. The agreement also contains all of the following:
-
- the description of the equipment is referred to as equipment leased and leased equipment;
payment made to the lessor is referred to as rent, rent payment or renewal rental;
the term of the agreement is referred to as initial term of lease;
the agreement number is referred to as lease no.; and
a heading in the agreement states TERMS AND CONDITIONS OF LEASE.
- the description of the equipment is referred to as equipment leased and leased equipment;
All of these provisions and phrases of the agreement make it clear that the agreement in question is a lease. Although you maintain that the buyout provision transforms the agreement from a lease into a sales contract since there is no residual value in the equipment at the end of the lease, I would note that the lessee may purchase the equipment for one dollar only after the lessee has paid all rents in full. As such, title does not pass to the lessee during the rental period but passes to the lessee only when the equipment is actually purchased. Furthermore, the agreement at issue in this case is analogous to the agreement in the Lutherville Supply and Equipment Company v. Commonwealth of virginia, Circuit Court of Fairfax County, Law No. 38958 (1978). In that case, the court declined to accept the taxpayer's characterization of its lease contract with an option to purchase as a conditional sales contract. Thus, this agreement is distinguishable from a conditional sales contract in which title passes to the buyer automatically upon completion of the contract terms.
Furthermore, the department's long-standing policy has been consistently applied, as demonstrated by the numerous public documents (PD) issued on this subject matter. For instance, see PD 89-152 (4/28/89) in which the department held that a one-dollar purchase option does not transform a lease into a sales contract. Also see PD 94-65 (3/16/94) concerning a lease with purchase option. In PD 94-90 (3/25/94), the department held that a lease contract containing an option to purchase was not a conditional sales contract as there was no purchase requirement and without a requirement to purchase there is no purchase price. Based on all of the foregoing, I find that the agreement at issue is a lease and not a conditional sales contract.
Personal Property Tax Treatment
I am also not persuaded by the personal property tax treatment of the agreement in question. In many instances, the characterization of items is dissimilar for purposes of different taxes. You refer to an opinion of the Attorney General (6/7/88) in which the primary objective to be considered for personal property tax application is "whether the lessor has contracted to receive full value for the property, not reasonably anticipating its return." I would note, however, that there is no similar policy, test or requirement set out in the statute or regulations for retail sales and use tax purposes. Rather, the key factor for retail sales and use tax purposes is to determine whether the agreement transfers the equipment's title to the customer upon completion of the required payments. In this case, the title to the equipment remains with the Client upon completion of all rental payments. Only at the time that the one-dollar buyout option is exercised would title transfer to the lessee.
Leasing Business Defined
Code of Virginia § 58.1-603 imposes the retail sales tax "upon every person who engages in the business of selling at retail or distributing tangible personal property in this Commonwealth...or who leases or rents such property within this Commonwealth..." This statute further sets out that the sales tax applies to the "gross proceeds derived from the lease or rental of tangible personal property, where the lease or rental of such property is an established business, or part of an established business, or the same is incidental or germane to such business."
This section clearly confirms that it is the intent of the sales and use tax law to tax those leases made by one in the business of making such leases. Therefore, the issue is whether the Client is in the leasing business.
"Business" is defined in Code of Virginia § 58.1-602 as "any activity engaged in by any person, or caused to be engaged in by him, with the object of gain, benefit or advantage, either directly or indirectly." As the Client is the purchaser of the property to be leased and total charges for rent are in excess of the cost and associated expenses of the property, I must conclude that the Client is engaged in an activity with the object of direct gain, benefit or advantage.
Furthermore, I would note that there is no statute which requires a business to maintain an inventory or possess the property prior to the lease or sale or such. Also, it is apparent from the documents presented that the Client purchases equipment for the sole purpose of leasing to customers. Accordingly, based on the definition of "business" for sales and use tax purposes and the direct benefit received by the Client in leasing equipment, I find that the Client is in the business of leasing tangible personal property and thus engaged in transactions subject to the retail sales and use tax.
Dealer responsibilities
Code of Virginia § 58.1-612(A)(5) defines a "dealer" for retail sales and use tax purposes as any person who "[I]eases or rents tangible personal property for a consideration, permitting the use or possession of such property without transferring title thereto." Virginia Regulation 630-10-57 further explains the tax treatment of leases and requires that any person engaged in the business of leasing or renting tangible personal property to others must register with the department and collect and pay the tax on gross proceeds. As the Client is engaged in a leasing or rental business, I find that the Client is a dealer as defined above and is required to be registered with the Department of Taxation for the collection and remittance of the retail sales and use tax on leases or rentals of equipment.
Statute of limitations
When a taxpayer has failed to file a sales tax return, Code of Virginia § 58.1-634 grants the department the authority to assess sales tax at any time within six years from the date that the tax became due and payable.
Although the Client engaged in the business of leasing or renting tangible personal property during the period of audit, the Client was not registered for the collection and remittance of the retail sales tax during the audit period. As such, the Client failed to file any retail sales tax returns (Form ST-9) during such period. Based on the above cited authority, I find that the auditor is justified in conducting a six-year examination of the client's sales records.
Credit for Tax Previously Paid
Although the Client may have paid the Virginia retail sales tax on the cost price of equipment purchased for lease or rental purposes, the auditor was correct in assessing the sales tax as the purchase and subsequent lease of the equipment are separate and distinct transactions.
Nonetheless, given the facts that the Client regularly paid the sales tax charged by its vendors on the cost price of the equipment at issue throughout the audit period, and this is the Client's first retail sales and use tax audit, I will allow a credit for the tax paid by the Client on such purchases, provided the Client can furnish the actual purchase invoices to the department's auditor to verify the payment of the tax. Upon verification by the auditor of the tax paid, the credits will only be applied against the sales tax owed on the gross proceeds received from the untaxed rentals and leases assessed in this case. The Client will be liable for any difference between the tax paid on such purchases and the tax due on the related gross proceeds.
Within the next 15 days, an auditor from the department's *************District Office will be contacting you to schedule a meeting to review the requested information. If you have any questions regarding the revision of this audit, please contact ********** at **************.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/11087R
Rulings of the Tax Commissioner