August 5, 2003

You request a letter ruling in which you ask about the application of the Massachusetts sales tax, G.L. c. 64H, to certain leasing transactions. In particular, you ask how the sales tax applies to agreed upon amounts accepted by the lessor in full settlement of leases of equipment to commercial establishments following a default by the lessee. You also ask whether the lessor owes tax on monthly payments that are forgiven by the lessor as part of the settlement and whether it makes a difference if the lessee returns the property prior to entering into the settlement. In support of your request, you state the following facts.

I. FACTS

*************** ("Leasing Company") is in the business of leasing point of sale processing equipment ( i.e., credit card terminals and related equipment) to merchants nationwide for use in their businesses. Leasing Company entered into a non-cancelable 48-month agreement referred to as an Equipment Finance Lease ("the Agreement") with *************** ("Customer"). The Agreement specifically described the transaction as a "lease and not a financing of the equipment" by Leasing Company.

Under the terms of the Agreement, Leasing Company purchased the equipment at Customer's request from a vendor and arranged for delivery to Customer. Leasing Company retained title to the equipment at all times. At the end of the 48-month lease term, Customer had the option to purchase the equipment from Leasing Company at fair market value, not to exceed 10% of the aggregate lease payments.

The transaction between the parties may be summarized as follows:

  1. Customer timely made 19 lease payments to Leasing Company commencing in July, 2000 through January, 2002.

  2. Leasing Company timely collected sales tax on these payments from Customer, and remitted them to the Commissioner.

  3. Leasing Company continued to pay sales tax to the Commissioner for the next 7 months (February, 2002, through August, 2002), notwithstanding Customer's failure to make any lease payments.

  4. Sometime between February, 2002 and August 2002, Customer returned the equipment to the Leasing Company.

  5. Apart from the settlement amount, Leasing Company required no further payments from Customer that would have been due under the original agreement.

  6. Customer made full payment of the settlement amount to Leasing Company in September, 2002.

  7. In total, sales tax was remitted on 38 of the 48 months of lease payments due under the original Agreement.

II. ISSUE

You ask whether Leasing Company must remit sales tax with respect to the monthly payments that are forgiven by the Leasing Company in consideration for the settlement. You also ask whether it makes a difference if Customer returned the property prior to entering into the settlement.

III. SHORT ANSWER

No. Leasing Company must remit tax only on amounts covered by the settlement agreement, less any tax it previously remitted for those months. Therefore, it owes tax on 38 months of payments, ending with the payment that would have been due through August, 2003. It does not owe tax for the remaining 10 months due under the original agreement, (September, 2003 through June, 2004) since these amounts were forgiven as part of the settlement. This holds true whether or not the equipment was returned during the Customer's period of default.

IV. 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. See G.L. c. 64H, § 1. "Gross receipts" is defined as the total sales price received by a vendor as consideration for retail sales. See G.L. c. 64H, § 1.

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 proper exemption certificate. The lessor's gross receipts subject to tax for a given period are those amounts coming due during that period under the terms of the governing rental agreements. Accordingly, a lessor must pay to the Commissioner any tax due on an accrual basis, regardless of whether the lessee pays him. See DOR Directive 97-4: Letter Rulings 84-75; 85-27; and Continental- Hyannis Furniture Company, Inc. v. State Tax Commission, 318 N.E. 2d 618 (1974).

Based on the terms of the Agreement and the parties' treatment of the transaction as a lease ( i.e., Leasing Company collected monthly sales tax from Customer and remitted it to the Commissioner) we conclude that the transaction is a true lease, rather than an installment sale [1] ( i.e., a financing of the equipment by Leasing Company). Accordingly, Leasing Company properly remitted sales tax for each monthly period as lease payments became due, including months during which the customer was in default on its lease obligations.

1. Application of the sales tax to the settlement

The Massachusetts sales tax is based on a vendor's gross receipts for a particular period. We first address the sales tax treatment of the "settlement" received by Leasing Company in September, 2002. Payment received as part of the settlement are included in the sales price upon which the sales tax is calculated for the period. See, generally DOR Directive 97-4, Directive 4(a). The amount received should be first applied to payments due prior to the settlement. Any payment received in excess of this amount should be reported to the Commissioner as part of the gross receipts received under the lease agreement. If the amount received as part of the settlement was less than the total amount due prior to the date of the settlement, the remaining amount would generally be deemed a bad debt. [2]

Here, the settlement amount was greater than the amount due prior to the date of settlement. It resulted in an increase to Leasing Company's gross receipts for that period in an amount equal to the 19 months of additional lease payments. Accordingly, Leasing Company was required to remit tax on the entire settlement amount, less any sales tax it already remitted for the seven months during the period of Customer's default on its original lease payment obligations from February through August, 2002. Since the settlement amount is in consideration for a retail sale that occurred under the terms of the original agreement, it is entirely taxable regardless of whether Customer returned the property prior to entering into the settlement. Thus, in total, tax is due on the 38 months of the original lease, ending in August, 2003.

2. Application of sales tax to months remaining under original agreement

We now address whether tax is due on any months forgiven by Leasing Company in consideration for the settlement. Under Massachusetts law, the term "sales price" includes "the total amount paid by a purchaser to a vendor as consideration for a retail sale, valued in money or otherwise." G.L. c. 64H, § 1. Here, Leasing Company received a settlement representing the equivalent of 19 additional monthly payments in consideration for forgiving any further payments. As indicated above, this settlement amount is part of the sales price subject to tax.

If Leasing Company and Customer agree to modify the terms of the original lease contract by entering into a settlement agreement as described above, the Leasing Company is obligated to collect and remit tax only on the amounts due from the lessee under the modified contract. The settlement relieved the Customer of any further obligation to make payments that would have otherwise been due. Thus, no tax is due on the 10 remaining months commencing in September, 2003 through June 2004. Assuming that the settlement does not exceed the total due as of the date of settlement, Leasing Company has no tax liability for payments that would have been due under the original lease, but are now forgiven.

V. CONCLUSION

For reasons discussed above, we conclude that the amount received by Leasing Company in settlement of the original Agreement constituted full and final payment of Customer's obligations under the original lease. This entire amount is subject to tax. Leasing Company properly paid tax on 38 months of the original agreement. Since the settlement neither included nor required any further payment for amounts that would have been otherwise due, Leasing Company it is not liable for payment of sales tax on the 10 months remaining under the original lease, commencing in September, 2003 through June, 2004.

Very truly yours,

/s/Alan LeBovidge

Alan LeBovidge
Commissioner of Revenue

AL:LEM:wrd

LR 03-7



[1] In the case of installment sales, the vendor's "gross receipts" subject to tax for a given period are measured by the total sales price for all sales made during the period, with no allowance for credit extended by the vendor. Thus, in contrast to true leasing arrangements, sales tax on contracts that are installment sales based on the total sales price would be due up front at the time of sale. See LR 85-27. See also Letter Rulings 80-16; 82-19; 83-17; 84-75.

[2] When a lessee of tangible personal property fails to make monthly payments or otherwise defaults on his or her obligations under a lease, the lessor must report lease payments on an accrual rather than cash basis. If tax is remitted on accounts later determined to be worthless and written off as bad debts, the lessor may file a claim for reimbursement of tax paid in accordance with Technical Information Release 92-2. See, generally, G.L. c. 64H, § 2, 3; DOR Directive 97-4, Directive 4(c). Based on the facts as you state them, because the default and settlement occurred in the same taxable year, it does not appear that Leasing Company remitted or was required to remit tax on an account that was later determined to be worthless and written off as a bad debt.