Tax Type
Retail Sales and Use Tax
Description
Leases and rentals; Lease of property between related companies
Topic
Taxability of Persons and Transactions
Date Issued
10-20-1998
October 20, 1998
Dear*************:
This is in reply to your letter on behalf of an unidentified client (the "Taxpayer'). I apologize for the delay in the department's response.
FACTS
The Taxpayer is a corporation organized under the laws of the Commonwealth. For liability protection purposes, the Taxpayer proposes to transfer its business operations to another entity ("Newco'). The legal organization of Newco will be one of the following:
You indicate that in each contemplated organization, the Taxpayer will retain legal title to all its tangible personal property (the "Equipment'). The Taxpayer will grant use of the Equipment to Newco under one of the following arrangements:
At issue in this case is the application of the retail sales and use tax to the proposed transactions under each of the contemplated legal organizations.
RULING
Before addressing the specific transactions, I will respond to your inquiries regarding a single member LLC or a QSSS. Public Document 97-343 (8/28/97) concerns a taxpayer forming a single member LLC which elects not to be treated as a separate entity for federal income tax purposes under Treasury Regulations Sec. 301.7701-1 et seq. ("check the box' regulations). In that determination, the department reiterated its conformity to the Internal Revenue Code in computing Virginia taxable income. Accordingly, if a single member LLC or a QSSS is disregarded as a separate taxable entity for federal income tax purposes, it will be disregarded as a separate taxable entity for Virginia income tax purposes.
For sales and use tax purposes, however, the single member LLC and the QSSS remain separate legal entities. As separate legal entities, the single member LLC, the QSSS, and any affiliated companies are governed by the applicable sales and use tax laws, regardless of which "check the box' elections the entities choose. This treatment of affiliated corporations for sales and use tax purposes is consistent with established policy. See Public Document 88-215 (7/27/88), for example, in which the Tax Commissioner determined that virtually any transaction involving consideration, including transfers or rentals between affiliated companies, is subject to the sales and use tax. Thus, in your scenarios, if the Taxpayer leases Equipment to Newco, the Taxpayer is a dealer as defined in Code of Virginia Sec. 58.1-612. As a dealer, the Taxpayer is required to register with the department for a certificate of registration and collect and remit the tax on its taxable sales, leases, or rentals. Newco would also be subject to the sales and use tax laws as a separate and distinct legal entity.
With this determination in mind, I will address your specific proposed arrangements whereby the Taxpayer makes the Equipment available to Newco.
Code of Virginia Sec. 58.1-602 defines the term "sale' to mean "any transfer of title or possession, or both, exchange, barter lease or rental, conditional or otherwise, in any manner or by any means whatsoever, of tangible personal property . . . for a consideration. . . .' That same section defines "lease' as "the leasing or renting of tangible personal property and the possession or use thereof by the lessee or renter for a consideration, without transfer of the title to such property.' Accordingly, virtually any transaction involving consideration, including transfers or leases between affiliated companies, is subject to the sales and use tax.
Arrangement 1. Newco pays no consideration to the Taxpayer for the Equipment. This arrangement does not constitute a "sale' or "lease' as defined above. Any future purchases of Equipment by the Taxpayer are taxable to the Taxpayer on the cost price of the Equipment. The transfer of the Equipment to Newco (for no consideration) is not a taxable transaction. This conclusion would be the same under each alternative form of legal organization set out above.
Arrangements 2 and 3. The Taxpayer leases the Equipment to Newco for a consideration. These leases represent taxable leases of the Equipment. The Taxpayer operates as a dealer and must collect the tax from Newco on the periodic lease payments. Alternatively, the Taxpayer can take from Newco a certificate of exemption indicating that the Equipment will be used in an exempt activity. Further, the Taxpayer can make future purchases of Equipment exempt of the tax for resale. This conclusion would be the same under each alternative form of legal organization set out above.
The final element which must be addressed concerns the amount of consideration paid by Newco to the Taxpayer under Arrangement 3. The term "sales price' is defined in Code of Virginia Sec. 58.1-602 as:
You suggest that the amount of consideration paid by Newco for the use of the Equipment is the proper measure of tax, even if the consideration is deeply discounted. You base this conclusion on Public Document 96-361 (12/9/96) and other cellular phone cases. In those rulings, customers purchase cellular telephones from a retailer at a discounted price if the customer agrees to sign a contract through the retailer for cellular telephone service. The telephone service is offered by a third-party telephone service carrier. The department determined that the proper measure of the sales tax for the cellular telephone is the discounted sales price charged to customers.
The cellular phone cases address a sale of property between unrelated parties. Conversely, the Taxpayer in your case is leasing, Equipment to Newco, a wholly owned subsidiary of the Taxpayer. The discounted consideration given by Newco or reported by the Taxpayer in Arrangement 3 does not represent the true or actual consideration. Rather, it would be an amount below the Equipment's fair lease value. In this regard, Code of Virginia Sec. 58.1-618(C) provides that:
This statute is designed to prevent tax avoidance that may arise in lease transactions between related companies. The discounted sales price in the cellular phone cases was negotiated between unrelated parties. Further, the discounted sales price in the cellular phone cases was only a part of the consideration. Purchasers in those cases also paid for a telephone service contract. Retailers received additional consideration (over and above the sales price of the telephone) via commissions from the telephone service providers.
Accordingly, I do not agree that the discounted sales price at issue in the cellular phone cases is analogous to your Arrangement 3. Upon review of such a transaction, the department would adjust the amounts paid by Newco, or reported by the Taxpayer, to reflect the Equipment's fair lease value.
I trust that this information answers your concerns. You may call ***** in the department's Office of Tax Policy at ***** if you have any questions.
Dear*************:
This is in reply to your letter on behalf of an unidentified client (the "Taxpayer'). I apologize for the delay in the department's response.
FACTS
The Taxpayer is a corporation organized under the laws of the Commonwealth. For liability protection purposes, the Taxpayer proposes to transfer its business operations to another entity ("Newco'). The legal organization of Newco will be one of the following:
- A. Newco will be a Limited Liability Company (LLC) having the Taxpayer as its sole member.
B. Newco will be a Qualified Subchapter S Subsidiary (QSSS) as described in the Internal Revenue Code with the Taxpayer as its sole shareholder. Under this organization, the Taxpayer will also be an S corporation.
C. Newco will be a wholly owned subsidiary of the Taxpayer. The two corporations file consolidated federal and Virginia state income tax returns.
- D. Both the Taxpayer and Newco are either S corporations, or Limited Liability Companies, or one is an S corporation and the other is a Limited Liability Company. In each of these three organizations, the Taxpayer and Newco share identical ownership.
You indicate that in each contemplated organization, the Taxpayer will retain legal title to all its tangible personal property (the "Equipment'). The Taxpayer will grant use of the Equipment to Newco under one of the following arrangements:
- 1. There is no written lease agreement between the Taxpayer and Newco for use of the Equipment and no consideration will be paid by Newco to the Taxpayer.
- 2. There will be a written lease agreement between Newco and the Taxpayer under which Newco will pay $100,000 (the full fair lease value) per year to the Taxpayer for the use of the Equipment.
- 3. There will be a written lease agreement between Newco and the Taxpayer under which Newco will pay some fraction of the full fair lease value per year to the Taxpayer for the use of the property. For example, Newco pays $100 per year to the Taxpayer for the equipment.
At issue in this case is the application of the retail sales and use tax to the proposed transactions under each of the contemplated legal organizations.
RULING
Before addressing the specific transactions, I will respond to your inquiries regarding a single member LLC or a QSSS. Public Document 97-343 (8/28/97) concerns a taxpayer forming a single member LLC which elects not to be treated as a separate entity for federal income tax purposes under Treasury Regulations Sec. 301.7701-1 et seq. ("check the box' regulations). In that determination, the department reiterated its conformity to the Internal Revenue Code in computing Virginia taxable income. Accordingly, if a single member LLC or a QSSS is disregarded as a separate taxable entity for federal income tax purposes, it will be disregarded as a separate taxable entity for Virginia income tax purposes.
For sales and use tax purposes, however, the single member LLC and the QSSS remain separate legal entities. As separate legal entities, the single member LLC, the QSSS, and any affiliated companies are governed by the applicable sales and use tax laws, regardless of which "check the box' elections the entities choose. This treatment of affiliated corporations for sales and use tax purposes is consistent with established policy. See Public Document 88-215 (7/27/88), for example, in which the Tax Commissioner determined that virtually any transaction involving consideration, including transfers or rentals between affiliated companies, is subject to the sales and use tax. Thus, in your scenarios, if the Taxpayer leases Equipment to Newco, the Taxpayer is a dealer as defined in Code of Virginia Sec. 58.1-612. As a dealer, the Taxpayer is required to register with the department for a certificate of registration and collect and remit the tax on its taxable sales, leases, or rentals. Newco would also be subject to the sales and use tax laws as a separate and distinct legal entity.
With this determination in mind, I will address your specific proposed arrangements whereby the Taxpayer makes the Equipment available to Newco.
Code of Virginia Sec. 58.1-602 defines the term "sale' to mean "any transfer of title or possession, or both, exchange, barter lease or rental, conditional or otherwise, in any manner or by any means whatsoever, of tangible personal property . . . for a consideration. . . .' That same section defines "lease' as "the leasing or renting of tangible personal property and the possession or use thereof by the lessee or renter for a consideration, without transfer of the title to such property.' Accordingly, virtually any transaction involving consideration, including transfers or leases between affiliated companies, is subject to the sales and use tax.
Arrangement 1. Newco pays no consideration to the Taxpayer for the Equipment. This arrangement does not constitute a "sale' or "lease' as defined above. Any future purchases of Equipment by the Taxpayer are taxable to the Taxpayer on the cost price of the Equipment. The transfer of the Equipment to Newco (for no consideration) is not a taxable transaction. This conclusion would be the same under each alternative form of legal organization set out above.
Arrangements 2 and 3. The Taxpayer leases the Equipment to Newco for a consideration. These leases represent taxable leases of the Equipment. The Taxpayer operates as a dealer and must collect the tax from Newco on the periodic lease payments. Alternatively, the Taxpayer can take from Newco a certificate of exemption indicating that the Equipment will be used in an exempt activity. Further, the Taxpayer can make future purchases of Equipment exempt of the tax for resale. This conclusion would be the same under each alternative form of legal organization set out above.
The final element which must be addressed concerns the amount of consideration paid by Newco to the Taxpayer under Arrangement 3. The term "sales price' is defined in Code of Virginia Sec. 58.1-602 as:
-
- The total amount for which tangible personal property or services are sold, including any services that are a part of the sale, valued in money, whether paid in money or otherwise, . . . without any deduction therefrom on account of the cost of the property sold, the cost of the materials used, labor or service costs, losses or any other expenses whatsoever.
You suggest that the amount of consideration paid by Newco for the use of the Equipment is the proper measure of tax, even if the consideration is deeply discounted. You base this conclusion on Public Document 96-361 (12/9/96) and other cellular phone cases. In those rulings, customers purchase cellular telephones from a retailer at a discounted price if the customer agrees to sign a contract through the retailer for cellular telephone service. The telephone service is offered by a third-party telephone service carrier. The department determined that the proper measure of the sales tax for the cellular telephone is the discounted sales price charged to customers.
The cellular phone cases address a sale of property between unrelated parties. Conversely, the Taxpayer in your case is leasing, Equipment to Newco, a wholly owned subsidiary of the Taxpayer. The discounted consideration given by Newco or reported by the Taxpayer in Arrangement 3 does not represent the true or actual consideration. Rather, it would be an amount below the Equipment's fair lease value. In this regard, Code of Virginia Sec. 58.1-618(C) provides that:
-
- In the case of the lease of tangible personal property, if the consideration given or reported by the dealer, in the judgment of the Tax Commissioner, does not represent the true or actual consideration, then the Tax Commissioner is authorized to fix the same and assess and collect the tax thereon in the same manner as above provided, with penalties to the extent such have accrued. The assessment so made shall be deemed prima facie correct. (Emphasis added.)
This statute is designed to prevent tax avoidance that may arise in lease transactions between related companies. The discounted sales price in the cellular phone cases was negotiated between unrelated parties. Further, the discounted sales price in the cellular phone cases was only a part of the consideration. Purchasers in those cases also paid for a telephone service contract. Retailers received additional consideration (over and above the sales price of the telephone) via commissions from the telephone service providers.
Accordingly, I do not agree that the discounted sales price at issue in the cellular phone cases is analogous to your Arrangement 3. Upon review of such a transaction, the department would adjust the amounts paid by Newco, or reported by the Taxpayer, to reflect the Equipment's fair lease value.
I trust that this information answers your concerns. You may call ***** in the department's Office of Tax Policy at ***** if you have any questions.
Rulings of the Tax Commissioner