Letter Ruling  Letter Ruling 99-9: Sale Lease-Back Agreement

Date:	04/01/1999
Organization:	Massachusetts Department of Revenue
Referenced Sources:	Massachusetts General Laws

Sales and Use Tax

April 1, 1999

You request a ruling on behalf of *************** regarding a transaction "structured as a sales and leaseback" which you maintain is in substance a financing agreement "whereby Lessor is acting as a lender and the sale leaseback is...a loan by Lessor to ***************." You thus characterize *************** payments to Lessor as "loan repayments" and not lease payments subject to tax.
 

Facts
 

You state that *************** is a Delaware corporation "in the business of purchasing 'end user leases' covering [vehicles] originated by *************** dealers." End user leases are "leases at retail to consumers who are typically individuals." [1]
 

Pursuant to a "Sale and Lease-Back Agreement" ("Agreement"), *************** as Lessee, has entered into a transaction with *************** a Delaware business trust, as Lessor, [2] and ***************, [3] as administrative agent for Lessor, in which *************** /Lessee "sells" the vehicles leased under end user leases to Lessor and "immediately 'leases' those vehicles back from Lessor."
 

You state that on each transfer date, [4] *************** "sells [v]ehicles" to the Lessor pursuant to a bill of sale [5] for a fixed amount ("purchase price") [6] and "simultaneously 'leases' the vehicles back from the Lessor." You maintain that the purchase price paid by the Lessor to *************** pursuant to the sale is "in essence a loan by Lessor to ***************.." that "is repaid [by *************** to Lessor] through the payments of principal [7] and interest under the [l]ease and payment of the [b]alance [d]ue [8] at the end of the [l]ease term." You thus characterize the "lease" payments as "correspond[ing] to a principal and interest [loan] amortization schedule."
 

You state that the bill of sale "purports to transfer all of *************** rights and interest in and to the [v]ehicles, and the [Agreement] purports to simultaneously lease the [v]ehicles back to ***************. However, *************** will remain the named owner, or owner and lienholder..., on the [c]ertificate of [t]itle for the [v]ehicles, and the [l]essor will not have any right, title or interest in the [v]ehicles except as expressly set forth in the [Agreement]." You maintain that the terms of the sale and leaseback "[i]n essence...never transfer ownership of the [v]ehicles from *************** to the [l]essor." [9]
 

You state that the Agreement provides that *************** may not "assign any of its rights and obligations [10]...[but] Lessor may assign its rights and obligations with *************** consent..."; the "only restriction on *************** use of the [v]ehicles [is that] *************** shall use the [v]ehicles solely in the conduct of its business."
 

At the end of a lease term, *************** may "exercise a purchase option to purchase all, but not less than all" of the designated vehicles from the Lessor by paying an amount equal to the balance due and certain other charges. [11] You maintain that such a transaction represents "in essence payment of a balloon payment on the original loan made by Lessor."
 

If *************** chooses not to purchase the vehicles, *************** will sell them to a third party. Such sales are undertaken by *************** "in the ordinary course of its business free and clear of Lessor's ownership and/or security interest therein, provided that *************** shall be obligated to pay" to the Lessor any balance due and related charges. Thus, if the proceeds of such a sale exceed the remaining "principal balance" owed by *************** to the Lessor, the excess proceeds remain with *************** if the proceeds are less than the remaining principal balance due the Lessor, *************** is responsible to the Lessor for the difference, subject to a "cap." As a result of this requirement you contend that "in essence, *************** is required to make sure that the Lessor receives payments of its original loan." [12]
 

You state that *************** is "unconditionally obligated to pay rent under any and all circumstances, including danger to or loss of the [v]ehicles." In the event of a default, must pay the Lessor the balance due and any related charges; *************** is also responsible for the payments of all traffic summonses, penalties, title fees, license fees and registration fees related to the vehicles.
 

You also state that the Agreement requires *************** to bear the "entire" risk of any loss, theft, damage to or destruction of the vehicles, and requires that *************** keep all the vehicles insured. [13] As a result of the duties and obligations of *************** pursuant to the Agreement, you contend that " *************** effectively has all the benefits and burdens of ownership of the [v]ehicles."
 

You state that *************** is the "owner of the [v]ehicles for financial reporting purposes in accordance with generally accepted accounting principles ("GAAP") [14] and for federal income tax purposes. *************** currently claims [federal] recovery and depreciation deductions relating to the [v]ehicles for such purposes." For federal income tax purposes "the leases will be treated as a secured loan [15] by the Lessor to *************** and *************** will continue to be treated as the owner of the [v]ehicles and will continue to claim depreciation and recovery deductions with respect to the [v]ehicles."
 

You state *************** "pays all applicable Massachusetts sales and use taxes on the lease payments received from the consumers" and that Lessor will not claim "any tax benefits available to an [o]wner of the [v]ehicles."
 

Ruling
 

You request a ruling that the "lease" between *************** and the Lessor constitutes a financing agreement and as such is not subject to Massachusetts sales and use taxes. [16]
 

The Department will treat a sale and leaseback transaction as a non-taxable financing arrangement if the facts and circumstances indicate that the transaction is a financing, and neither title nor possession transfer to the lessor. See Letter Ruling 96-6. The transaction undertaken by *************** and the Lessor pursuant to the Agreement as represented constitutes a financing agreement and as such is not subject to Massachusetts sales or use taxes.
 

Discussion
 

1. Sales and Use Taxes
 

General Laws Chapter 64H, § 2 imposes an excise upon sales at retail in the commonwealth by any vendor of tangible personal property or telecommunications services, unless explicitly exempt. The excise is imposed at the rate of five percent of the gross receipts of the vendor from all such sales. Id. General Laws Chapter 64I, § 2 imposes an excise upon the storage, use or other consumption in the commonwealth of tangible personal property or telecommunications services purchased from any vendor for such use. The excise is imposed at the rate of five percent of the sales price of the property or services. Id. Sales upon which taxes have been collected under Chapter 64H are exempt from use tax. G.L. c. 64I, § 7(a).
 

For sales and use taxes, "sale" is defined as "any transfer of title or possession, or both, exchange, barter, lease, rental, conditional or otherwise, of tangible personal property or the performance of services for a consideration, in any manner or by any means whatsoever...." G.L. c. 64H, § 1; G.L. c. 64I, § 1; see also Zayre Leasing Corp. v. State Tax Commission, 365 Mass. 351 (1974) ("sales" includes leases and rentals).
 

2. Sale and Leaseback
 

Leases are generally subject to Massachusetts sales or use tax. However, the Department will look to the facts and circumstances of each case when determining if a nominal sale-leaseback transaction is in fact a financing arrangement. [17] When making this determination, the Department will consider the following factors dispositive:
 

1. title and possession remain with the seller-lessee; [18]
 

2. the seller-lessee retains the benefits and burdens of ownership of the property [19] such as risk of loss, entitlement to gain, maintenance of insurance, and responsibility for taxes; and
 

3. the seller-lessee is eligible to claim the federal income tax deductions and credits accorded an owner. See Letter Ruling 96-6.
 

In this case, *************** retained legal title to the property; thus, although *************** was obligated to deliver a bill of sale to the Lessor, *************** remained the named owner and Lessor had no right, title or interest in the property. Lessor therefore did not have the right to possess the property pursuant to the Agreement nor did the parties' activities manifest such an intent.
 

In this case, *************** paid the insurance premiums, maintenance expenses and taxes with respect to the property. Thus, the risk of economic loss and physical damage to the property borne by *************** was analogous to that of a property owner, while the Lessor's risks and obligations with regard to the property were consistent with those of a lender. As noted, for federal income tax purposes *************** will be treated as the vehicles' owner and will claim depreciation and recovery deductions with respect to the vehicles.
 

In this case, the parties treated the transaction as a financing, i.e., *************** did not report the transaction for federal income tax purposes as a sale, opting instead to claim the depreciation and recovery deductions accorded to owners. In addition, the Lessor acquired no equity or other interest in the property beyond that stipulated in the Agreement and, unlike *************** no potential for gain upon disposition of the property accrued to the Lessor beyond that stipulated in the Agreement.
 

Conclusion
 

The transaction between *************** as Lessee and Auto Lease Trust as Lessor constitutes a financing agreement and as such is not subject to Massachusetts sales or use taxes.
 

Very truly yours,
 

/s/Frederick A. Laskey
 

Frederick A. Laskey
Commissioner of Revenue
 

FAL:DMS:kt
 

LR 99-9

[1] Per the Agreement, an end user lease is "a closed end vehicle lease agreement between Lessee as lessor, and a Person, as lessee, pursuant to which Lessee leases a Vehicle to an end user...." All definitions quoted in this Ruling are from the Agreement.

[2] You characterize the Lessor as a "financing agency...not a buyer or seller of the [v]ehicles."

[3] This ruling assumes each party to the transaction negotiates at arms length.

[4] Transfer date "is the date on which a transfer occurs." A transfer "means the payment of the aggregate [p]urchase [p]rice for vehicles by Lessor on any one date."

[5] Bill of sale "means the bill of sale and cross receipt with respect to the [v]ehicles sold to the Lessor and simultaneously leased to ********** on each [t]ransfer [d]ate...."

[6] The "purchase price" equals ********** "aggregate book value" for the vehicles as of the last day of the month preceding the month in which the transfer date for such vehicles occurs. "Aggregate book value" is calculated as an amount, "reflected on the books of **********equal to (1) the capitalized cost of the [v]ehicle, net of accumulated depreciation..., and (2) the additional capitalized costs, net of accumulated depreciation, including...(a) monthly lease charges, (b) capitalized service contracts, and (c) additional advances capitalized, capitalized up-front taxes and payments related to capitalized acquisition fees."

[7] Principal charge is an "amount approximately equal to the aggregate principal component of rent schedules to be paid [monthly]...whether or not such payments are received by **********, as adjusted by ********** to reflect all payments of [b]alance [d]ue for any [v]ehicle...."

[8] Balance due is "the original [p]urchase [p]rice or loan amount for a [v]ehicle less the principal payments related to such [v]ehicle that have been received by the Lessor...as of the date of termination (i.e., the remaining principal balance of the loan...)."

[9] You note that pursuant to the Agreement "Lessor agrees to purchase the [v]ehicles from ********** for the purpose of leasing the [v]ehicles to **********....Lessor [does] not take possession of the [v]ehicles, and [does] not intend to take possession of the [v]ehicles...."

[10] During the lease term ********** may sublease the vehicles, i.e., ********** "may permit the [v]ehicles to be used and operated pursuant to [e]nd [u]ser [l]eases" provided that each such lease term does not extend beyond a specified date, and each such lease is "pledged to Lessor as [a]dditional [c]ollateral" and is subject to the terms of the Agreement; in addition, "all obligations of ********** shall continue in full effect as obligations of a principal and not of a guarantor or surety, as though no sublease has made."

[11] In addition to the "balance due," ********** must pay any accrued but unpaid "[b]asic [c]harge, [a]dditional [c]harge and any other amounts due and payable...with all costs of the disposition of the Lessor's right, title and interest in the [v]ehicles to ********** being borne entirely by **********."

[12] This ruling assumes "original loan" refers to the "purchase price" paid by Lessor to **********.

[13] You state that Lessor and Trustee ("'Trustee' means ********** , a Delaware banking corporation, not in its individual capacity, but solely as trustee under the Owner Trust Agreement, and any successor....") are named as additional insured with respect to all such liability insurance, and Lessor is named as co-insured and loss payee on all such casualty insurance.

[14] You state that "for financial reporting purposes under GAAP," ********** and the Lessor will "treat the lease as an operating lease" whereby the Lessor will include "the vehicles on its balance sheet and ********** will include only the lease payments as accrued in its income statement."

[15] You state that the Agreement provides that ********** "grants to Lessor a continuing, first priority security interest in the [v]ehicles and [a]dditional [c]ollateral...." However, in the event the transactions "are characterized by a court or governmental authority as a loan, the Lessee agrees that (a) the Agreement shall be deemed to be a security agreement within the meaning of Article 9 [of the UCC] of any applicable jurisdiction; [and] (b) the conveyance of the [v]ehicles...shall be deemed to be a grant by the Lessee to the Lessor of a security interest...."

[16] In the alternative, you request a ruling that the sale from ********** to the Lessor is exempt from Massachusetts sales and use taxes as a sale for "resale," and that the lease from Lessor to ********** is exempt from Massachusetts sales and use taxes as a sale for "resale." Although this ruling does not reach the merits of the alternative argument, it does not appear that either the "sale" by ********** to the Lessor, or the "lease" from the Lessor to **********, are "sales for resale." See G.L. c. 64H, §§ 1,2. Neither ********** nor the Lessor are engaged in the business of selling end user leases in the regular course of business, nor do they intend such transactions to be sales for resale. See Letter Ruling 86-9; compare with International Business Machines Corp. v. Commissioner of Revenue, Appellate Tax Board, Docket Nos. 170420-170426, October 24, 1997.

[17] In nominal sale and leaseback transactions, whether a transaction is a "sale, a lease, or a financing arrangement is a question of fact, which must be ascertained by the intent of the parties" as determined by their written agreements and the facts and circumstances of the case, rather than the denomination applied to the activity by the parties. See Hagaard v. Commissioner, 24 T.C. 1124 (1955), as cited in Priv. Ltr. Rul. 97-48005 (August 19, 1997).

[18] In the sale and leaseback context, the fact that the seller retains title, or that title would revert to the seller along with the rights and remedies under manufacturers' warranties, evidences a financing arrangement. See Sun Oil Company v. Commissioner of Internal Revenue, 562 F. 2d 258 (1977); Rev. Rul. 72-543, 1972-2 C.B. 87. A financing arrangement differs from a sale or a lease in that the buyer-lessor in a financing "typically does not want use or possession of the property." See, e.g., Priv. Ltr. Rul. 97-48005 (August 19, 1997).

[19] See Larsen v. Commissioner, 89 T.C. 1229 (1987), and Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221 (1981), as cited in Priv. Ltr. Rul. IRS 97-48005 (August 19, 1997).