Introduction:

This directive clarifies the sales tax filing obligation of a lessor that contractually assigns a stream of lease payments to a third party in a factoring arrangement, [1] but retains ownership of the leased tangible personal property. The directive also addresses the sales tax consequences where, in such an arrangement, the lessee fails to make payments to the factor on the assigned lease.

Assignment of Lease Payments to a Factor:

Issue 1:

When a lessor contractually assigns the right to receive a stream of lease payments to a factor, but retains ownership of the leased property, is the lessor or the factor responsible for collection and remission of Massachusetts sales tax on each monthly payment?

Directive 1:

The lessor remains responsible for collection and remission of Massachusetts sales tax on each monthly payment when a lessor assigns the right to a stream of lease payments to a factor, but retains ownership of the leased property. The lessor will be given credit for any tax remitted on its behalf by the factor if the lessor provides the Department of Revenue with adequate documentary evidence of such payment.

Effect of Default by the Lessee:

Issue 2:

When a lessor assigns the right to a stream of lease payments to a factor and retains ownership of the leased property, what is the effect of the lessee's subsequent failure to make lease payments and default under the terms of the lease?

Directive 2:

The lessee's subsequent failure to make lease payments does not alter the lessor's obligation to remit sales tax on an accrual basis when a lessor assigns the right to a stream of lease payments to a factor and retains ownership of the leased property.

Claim for Bad Debt Reimbursement:

Issue 3:

When the lessor has assigned the right to a stream of lease payments to a factor and the lessee defaults, can either the lessor or the factor file a claim for a sales tax bad debt reimbursement?

Directive 3:

Neither the lessor nor the factor may file a claim for a sales tax bad debt reimbursement where the lessor has assigned the right to a stream of lease payments to a factor and the lessee defaults. The lessor does not have a bad debt because it has received payment in full from the factor. The factor is not entitled to a sales tax bad debt reimbursement because the factor was not the vendor.

Discussion:

Massachusetts imposes a sales tax on sales at retail of tangible personal property by any vendor in Massachusetts, at a rate of five percent of the vendor's gross receipts, unless otherwise exempt. See G.L. c. 64H, § 2. A "sale at retail" is a sale of tangible personal property for any purpose other than resale in the regular course of business. G.L. c. 64H, § 1. A sale is also defined to include any transfer of title or possession for consideration, including a lease or rental. Id.

Under Massachusetts law, if a contract is a true lease by a lessor to its customer, each rental period is considered a separate sale, and the lessor must collect sales tax from the lessee on each payment as it becomes due, unless the lessee presents the lessor with a properly completed exemption certificate. The lessor's gross receipts subject to tax for a given period are the amounts coming due during that period under the terms of the rental or lease agreement. See DOR Directive 04-3; Letter Rulings 03-7, 85-27 and 84-75.

In motor vehicle leasing transactions, the retail customer (lessee) generally negotiates the terms and executes the lease contract with a dealer (lessor). The dealer then sells the vehicle and assigns the executed lease contract to a financing corporation. The financing corporation subsequently collects the balance of the lease payments due under the contract from the lessee. See DOR Directive 04-3. In these situations, the purchaser of the lease contracts becomes the lessor for sales tax purposes and must collect and remit tax on the balance of the lease payments.

In contrast, in a factoring arrangement, the lessor only sells the right to receive the stream of lease payments while retaining ownership of the leased property, e.g., equipment. Generally, the stream of payments is sold for a discounted amount to be paid immediately by the factor to the lessor. The lessor may enter into such an arrangement for its own cash-flow purposes or to avoid the risk of default. In a factoring arrangement, the lessor is ultimately responsible for ensuring that the proper sales tax is remitted to the Commonwealth. However, the lessor will be given credit for tax remitted on its behalf by a factor, providing that appropriate proof of such payment is submitted.

A lessor must pay to the Commissioner sales tax on an accrual basis. Continental-Hyannis Furniture Company, Inc. v. State Tax Commission, 318 N.E. 2d 618 (1974). Thus, the lessor remains obligated to remit sales tax and Form ST-9 or ST-7R to Massachusetts, whether or not the lessee makes monthly payments, up until the point where the lessor and the lessee re-negotiate, reach a final settlement of the lessee's obligations under the lease contract, or the account is otherwise determined to be worthless and uncollectible under Section 166 of the Internal Revenue Code. If the lessor and the lessee agree to modify the terms of the original lease contract by entering into a settlement agreement, the lessor is obligated to collect and remit tax only on the amounts due from the lessee under the modified contract. See LR 03-7. Where a lessor receives a payment in settlement of an account, the lessor owes tax on the amount of the payment less any amounts previously reported on the accrual basis.

Any vendor who has paid to the Commissioner an excise on a sale for which credit is given to the purchaser and the account is later determined to be worthless is entitled to reimbursement without interest of the excise paid to the Commissioner on the worthless account. See G.L. c. 64H, § 33 and G.L. c. 64I, § 34. See TIR 00-3. However, the sales tax relief extended by G.L. c. 64H, § 33 and G.L. c. 64I, § 34, to vendors with bad debt losses is unavailable to subsequent purchasers of credit accounts (although for income tax purposes the losses may be deductible by the party that writes off the bad debt).

Where a lessor has assigned the right to a stream of lease payments to a factor and the lessee defaults, the lessor will not have sustained a bad debt for federal income tax purposes and will therefore not be entitled to a sales tax bad debt reimbursement. The lessor has not sustained a bad debt because it received payment from the factor in exchange for the stream of lease payments. Generally, an adjustment for bad debt risk is built into the price that the factor pays for the accounts purchased as well as the finance charges paid by the lessee.

/s/Alan LeBovidge
Alan LeBovidge
Commissioner of Revenue

AL:LEM:wm

April 13, 2005

DD 05-2



[1] Factoring has been defined as the sale of accounts receivable of a firm to a factor at a discounted price. The purchase of accounts receivable from a business by a factor who thereby assumes the risk of loss in return for some agreed discount. Blacks Law Dictionary, Fifth Edition .