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Today’s economy has allowed rental and leasing companies to flourish. Many jurisdictions impose a sales tax on the rental or lease of tangible personal property. And along with this tax imposition comes some sales tax applicability nuances depending on the type of lease, associated services and the type of property being leased.
Some sales tax concepts for the leasing industry are simple; others are more complicated. For example, a lessor, by definition, owns property and leases the use of that property to a lessee. The property that is owned by the lessor creates sales tax nexus wherever the equipment resides, a straightforward concept for the most part. The taxability of the lease itself and certain related services is much more complex.
The back story
Understanding that complexity requires some background. In June 2018, the U.S. Supreme Court decided in South Dakota v. Wayfair, Inc. et al. that an out-of-state seller could establish “nexus” through economic activity, not just physical presence. Provisions of Wayfair allowed the state to collect sales tax from companies with at least $100,000 in gross revenue sourced to the state of South Dakota. Other states quickly followed suit, setting individual economic nexus triggers based on a remote sellers’ in-state revenue or transactions.
Economic nexus did not supersede the concept of physical nexus. You still create nexus through a physical presence in a state - by having a store or office space or by storing inventory there, or often simply by having sales or service reps doing business in the state. One key nexus-creating activity is owning property in a particular jurisdiction.
Most tax laws describe a “rental” agreement as a commitment of 30 days or less. A “lease” is generally a longer-term commitment, typically 12 months or more in most states. (Short-term lease or rental agreements, in some jurisdictions, carry a higher tax rate.)
Among other important definitions are “real property” and “tangible personal property.” In most states, the long-term lease of real property is generally not a taxable event. Tangible personal property is generally taxable whether sold, leased, or rented.
“Operating” and “finance” (capital) leases can also have different tax treatment. For sales and use tax purposes, an operating lease is for temporary use of an item with no intention to transfer ownership of that property at the end of the term of the lease. In most states, sales tax is imposed on the stream of payments for an operating lease. Responsible parties can charge sales tax up front if the tax initially charged is the same as what would be due over the course of the arrangement.
A finance lease is considered a sale for sales tax purposes – where the sales tax is calculated and due on the value of the equipment at the beginning of the finance lease. The sales tax can be financed within the lease terms. (Finance charges in a finance lease are generally not subject to sales tax.)
The structure of the contract for a finance lease must stipulate that the intent of ownership will remain with the lessee. This means either that the terms of lease are such that the full value of the item is paid for during the course of the lease arrangement or, if it has a residual value at the end of the lease, there’s a nominal purchase price.
With operating leases, many ancillary services become part of the gross receipts and are taxable. In a finance lease, however, these items can sometimes be excluded from the sales tax calculation if separately stated in the contract and/or the invoicing (i.e. delivery, installation, etc…).
Arrangements have their own conditions
Leasing includes other details with sales tax implications that must also be considered. For example, in most long-term operating lease contracts, charges for delivery, maintenance, and the reimbursement of property tax are charged to the lessee. In most states, the sales tax is due on the total gross receipts derived from the lease or rental of tangible personal property – causing the delivery, maintenance and even the property tax charges to be subject to sales tax.
However, in a “financing lease”, the charges for ancillary or vertical services such as delivery, maintenance or associated finance charges can be excluded from the taxable base if separately stated in the contract and on the invoice.
Rental/lease with operator. Let’s say a company is leasing equipment that requires the operation thereof to be performed by the lessor (i.e. a forklift or bobcat). This type of lease is referred to as a rental or lease with operator and in most states is not a transaction that is subject to sales tax due to it being categorized as a professional service. In essence, the lessee is not securing the right to use the tangible personal property, but rather the service of the operator that requires the use of the tangible personal property.
Location, location, location
Sales tax situs is the location in which a taxable event occurs. In situations where leased property is delivered to and used by the lessor in a fixed location, the tax situs is quite simple. However, in some situations, the property may not be used by the lessor at a fixed location. Multi-state usage is common with contractors/lessors leasing equipment on a long-term basis (i.e. Excavators, bulldozers, loaders, cranes, and dump trucks). In theory, the sales tax should be calculated based on where the use of the equipment occurs.
In these cases, the lessor might not know where the equipment is being used at all times and may not be able to apply the appropriate sales tax at any given time. In the absence of such knowledge, the lessor is obligated to assess the sales tax based on the best available information at the time of the lease. In some instances, an additional use tax responsibility becomes that of the lessor where the equipment is used.
As you can see, the management of the sales tax obligations for a company leasing products or equipment is not as simple as one may assume. And it is definitely not something you want to leave to chance when you think of potential penalty and interest, if not additional tax, from the lack of (or erroneous) compliance combined with an unlimited statute of limitations. Not collecting sales tax when required could be a costly mistake you don’t want to make. Many businesses end up outsourcing their requirements in order to minimize both the risk and cost associated with sales tax compliance. By trusting experts you can ensure you avoid the risk and maintain compliance.