Ruling 95-3, Sales and Use Taxes / Transfer of Title / Lease of Tangible Personal Property
A company ("the Company") enters into an arrangement with its customer (the "Customer") which it calls a "sale and leaseback." Typically the Customer owns tangible personal property in Connecticut, such as manufacturing equipment, furniture, store fixtures or office equipment. The Customer paid sales and use tax when it purchased the property. The Customer wishes to refinance existing debt associated with the property, or to receive cash for the property, in such manner that the property (and debt, if any) is removed from, and cash is added to, the Customer's financial reporting balance sheets.
In order to effect the "sale and leaseback," the Company and the Customer execute a document called a "Bill of Sale," by means of which the Customer purports to convey the property to the Company for a nominal price. The "Bill of Sale" expressly states that the contemplated conveyance is solely for the purpose of granting the Company a security interest in the property and that the Customer will retain "legal title" to the property, and that all property will remain in the possession of the Customer. The Company and the Customer also execute a document called a "Master Lease Agreement," pursuant to which the Company purports to "lease" the property back to the Customer. The payments due to the Company under the "Master Lease Agreement" correspond to a three-year principal and interest amortization schedule for loaned funds. At the end of the initial three-year term of the "lease," the Customer may either "return" the property to the Company for sale or other disposition, "purchase" the property from the Company for a predetermined specified amount, or extend the agreement for an additional term for a predetermined "rental" amount, which may differ from the original "rental" amount. At the end of the extension period, the Customer may "purchase" the property for a nominal price, typically $1.00.
For financial reporting purposes, the "Bill of Sale" will qualify as a sale from the Customer to the Company, and the "Master Lease Agreement" will be treated by the Customer as an operating lease under the rules of the Financial Accounting Standards Board (FASB No. 13). For commercial law and federal tax purposes, however, the Company will not be the owner of the property, but rather a secured party, and will file financing statements with the Secretary of the State. Pursuant to the "Master Lease Agreement," the Customer will remain in possession of the property, will be solely responsible for the maintenance and repair of the property, will bear the entire risk of any loss or damage to the property, and will be required to insure the property. The Customer will be responsible for all taxes in connection with the property, and will also have whatever tax benefits are available to it by virtue of ownership or possession of the property, including the right to depreciate the property. The Customer will not deduct the entire amount of its "lease" payments for income tax purposes, as it would be entitled to do if it were a lessee of the property, but will instead deduct only the amount of its payments that constitutes interest on the principal financed.
Whether title to the property is actually transferred from the Customer to the Company by the "Bill of Sale," and whether the "lease" of the property from the Company to the Customer under the "sale and leaseback" arrangement between them is subject to sales and use taxes under Conn. Gen. Stat. §12-407(2)(j).
Conn. Gen. Stat. §12-407(2) defines "sale" and "selling" to include "(a) [any transfer of title ... of tangible personal property for a consideration ..." as well as "(j) the leasing or rental of tangible personal property ..." An exception to the general rule that all transfers of title to tangible personal property are taxable is made for "casual or isolated sales," which are infrequent and nonrecurring sales made outside the ordinary course of business. Conn. Agencies Regs. §12-426-17.
In order to determine whether the "sale and leaseback" arrangement gives rise to sales and use tax liability under Conn. Gen. Stat. §12-407(2)(j), it is first necessary to determine whether the "Bill of Sale" actually conveys title to the property from the Customer to the Company. Although an actual transfer of title to the property from the Customer to the Company would probably be viewed as a casual or isolated sale, and would not, in itself, be subject to sales and use taxes, such an actual sale would clearly indicate that ownership of the property had been transferred from the Customer to the Company, which would in turn tend to suggest that the Company was actually leasing property owned by it to the Customer.
Although the term "transfer of title" is not defined in the Sales and Use Taxes Act, the Connecticut Supreme Court has discussed issues relating to the transfer of title, for purposes of Conn. Gen. Stat. 12-407(2) and similar taxing statutes, on several occasions. See, e.g., New England Petroleum Corporation v. Groppo, 214 Conn. 444, 572 A.2d 970 (1990) and New England Yacht Sales, Inc. v. Commissioner, 198 Conn. 624, 504 A.2d 506 (1986). In New England Yacht Sales the court examined at length the concept of passage of title, especially in relation to the standards set forth in the Uniform Commercial Code. The court noted that the determinative issue under the code is the explicit agreement of the parties concerning passage of title. "Section 2-401 (1) purports to allow the parties to control passage of title, as between them, by contract terms." (Emphasis in original.) White & Summers, Uniform Commercial Code (2d Ed. 1980) § 3-11, p.139.
Id., at 633. In other words, as long as there is no dispute between the parties themselves, their explicit understanding regarding passage of title, as evidenced by the terms of their written agreement with respect to that issue, will control.
Although New England Yacht Sales dealt with the issue of when and where title passed, not whether or not it ever did pass, the intent of the Company and the Customer, as evidenced by the terms of their agreement, ought to control in the instant matter as well. The only problem with applying this principle to the facts at hand is that these parties have two different sets of intentions. For purposes of financial reporting, the parties intend that title to the property will indeed pass, so that the property and debt will be off the Customer's balance sheets. For that reason they have executed documents entitled "Bill of Sale" and "Master Lease Agreement." For other purposes (including for purposes of Connecticut sales and use taxes) the parties apparently intend that title to the property will not pass from the Customer to the Company. The parties wish to enjoy the benefits of both arrangements.
The "Bill of Sale" contains the provision that "the conveyance contemplated hereby is solely for the purpose of granting to Buyer [the Company] a security interest in the Equipment and Seller [the Customer] shall retain legal title of such Equipment." In view of this explicit language, the evident intention of the parties with respect to whether or not title to the property passes from the Customer to the Company is that title to the property does not so pass, notwithstanding the fact that the "Bill of Sale" is replete with terms ordinarily associated with an actual sale. The use of those terms, inapposite as they may be to the parties' agreement that title does not pass, does not override that agreement.
If the "Bill of Sale" is not what its name implies, then what of the "Master Lease Agreement"? Whether the "Master Lease Agreement" is actually a lease depends upon whether title has passed from the Customer to the Company:
When used with reference to tangible personal property, [the] word "lease" means a contract by which one owning such property grants to another the right to possess, use and enjoy it for [a] specified period of time in exchange for periodic payment of a stipulated price, referred to as rent.
Black's Law Dictionary 800 (5th ed. 1979). Since the Company as lessor" is leasing property it does not own to the Customer as "lessee," which does own it and has owned it all along, the "Master Lease Agreement" cannot be said to constitute the "lease or rental of tangible personal property" for purposes of Conn. Gen. Stat. §12-407(2)(j).
The "sale and leaseback" arrangement between the Company and the Customer may be contrasted with another set of transactions, sometimes also referred to as a "sale and leaseback," wherein a manufacturer/retailer of tangible personal property such as computer hardware sells the property to a customer, which transfers title to the property immediately or soon after purchasing it to a leasing company, which then leases the property back to the customer. This series of transactions, probably more properly termed a "sale/sale/leaseback," consists of two taxable events surrounding a nontaxable one: first, a taxable passage of title of the property from the retailer/manufacturer to the customer; second, a passage of title from the customer to the leasing company that, since it is not in the ordinary course of the customer's business, is a nontaxable casual sale (but by the same token cannot be a purchase for resale); and third, a taxable leasing of the property from the leasing company to the customer. The Department's position that both the first and third of these transactions are taxable remains unchanged by this ruling.
The "Bill of Sale" for the "purchase" of property from the Customer by the Company does not transfer title to the property. Since the Customer continues to own the property, the "lease" of the property from the Company to the Customer under the "sale and leaseback" arrangement between them is not actually a lease, and is therefore not subject to sales and use taxes under Conn. Gen. Stat. §12-407(2)(j).
January 31, 1995