Laws, Regulations & Annotations
Business Taxes Law Guide – Revision 2016
Sales and Use Tax Annotations
200.0000 CREDIT SALES AND REPOSSESSIONS—Regulation 1641
200.0165 Lease and Leaseback. A company has paid California sales tax reimbursement on equipment it proposes to use in a lease-leaseback financing arrangement with a financing organization. The company will lease this previously acquired equipment (in the same form as acquired) to a financing organization for a limited term of 32 years (the "lease.") Simultaneously with the lease of the equipment, the financing organization will sublease it back to the company for a period up to 14 years (the "sublease.") The leaseback does not exceed 80 percent of the estimated useful life of the equipment.
During the term of the sublease, the company will retain possession, control, and risk of loss of the equipment. The sublease will be on a "net" basis to the financing organization, i.e., the company will be responsible for all maintenance, insurance, property taxes, etc. At the end of the sublease, the company will have the option (but not the obligation) to acquire all of the financing organization's remaining rights under the lease. In addition, the company will have the option, during the term of the sublease, to acquire the financing organization's then-remaining interest in the lease at a price sufficient to preserve the financing organization's anticipated return on the sublease. The lease and the sublease will be noncancellable. If any equipment is destroyed, the company will be obligated to pay the financing organization an amount which will be sufficient to preserve the financing organization's anticipated return with respect to that item of equipment.
Although the company will retain title to the equipment, the company anticipates that the financing organization will depreciate its economic interest in the leased equipment for both federal and state income tax purposes. The equipment involved in the lease has a useful life of 20 years.
It is true that the initial lease transaction is for a term of 32 years, which far exceeds the useful life of the equipment. In other circumstances, especially where there has been a transfer of possession, such transaction would be recharacterized for sales and use tax purposes as a sale (title transfer) transaction at inception. Here, however, the transaction must be looked at in its entirety. The term of the leaseback is 14 years, a period shorter than the expected life of the equipment. This is a financing transaction which has been structured to produce an income tax benefit. The circumstances here are not sufficient to justify application of the sales and use tax recharacterization rules. Instead, the transaction will be recognized as structured and, since the lessor (company) paid sales tax reimbursement on the purchase price of the equipment, neither the lease and nor the sublease are subject to taxation. 3/15/96.