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Revenue Administrative Bulletin 2023-13

Revenue Administrative Bulletin 2023-13

SALES AND USE TAXES - LESSORS

(Replaces Revenue Administrative Bulletin 2020-16)

Approved: August 15, 2023

 

Note: A taxpayer may rely on this Revenue Administrative Bulletin (RAB) until it is revoked by Treasury or until a law on which this RAB is based is altered by legislation or by binding judicial precedent. See MCL 205.6a and RAB 2016-20.

RAB 2023-13. This Revenue Administrative Bulletin (RAB) updates the guidance previously issued under RAB 2020-16, which described when lessees and lessors are liable for use tax on lease transactions and explained the sales and use tax treatment of tangible personal property acquired for lease or rental.  The substantive changes in this update are limited to addressing the enactment of Public Acts 673 and 679 of 2018 (2018 Acts), which became effective March 29, 2019, and Public Acts 20 and 21 of 2023 (2023 Acts), which became effective April 26, 2023.  The updates also reflect revisions to Mich Admin Code, R 205.132 which became effective on August 11, 2023. For purposes of sales and use tax, the terms “lease” and “rental” have the same meaning and are used interchangeably in this RAB.  “Tangible personal property” will sometimes be referred to in this RAB as “property.”  For guidance on the applicability of sales and use tax on the lease or rental of tangible personal property by a marketplace facilitator, please refer to RAB 2021-22. 

INTRODUCTION

Sales (or use) tax is due on the sales price (or purchase price) of tangible personal property, that is not eligible for an exemption, at the time the lessor acquires the property unless the lessor elects to pay use tax on the rental receipts as explained in Part IV of this RAB.

ISSUES

I.     What constitutes a lease of tangible personal property?

II.     Is the lessor election available for a single mixed transaction if the property is incidental to the services provided?

III.     Who is a “lessor” under the Use Tax Act?

IV.     What is the effect of making a lessor election to pay use tax?

V.     When is a lessee liable for use tax?

VI.     What is the effect of using the property for non-leasing purposes?

VII.     What is the tax base of rental receipts?

VIII.     How are leases sourced?

IX.     Does a lessor owe use tax on property that is exempt from use tax or that is leased to a lessee that is exempt from use tax?

X.     Is use tax owed on a sublease?

ANALYSIS AND CONCLUSIONS

I.     Lease or rental of tangible personal property. 

“Lease or rental” means transfer of possession or control of tangible personal property for a fixed or indeterminate term for consideration and may include future options to purchase or to extend. MCL 205.51a(m); MCL 205.92b(m).

A lease or rental includes an agreement covering motor vehicles or trailers with terminal rental adjustment clauses that allow the contract payments to be increased or decreased by reference to the amount realized upon the sale or disposition of the property as defined in section 7701(h)(1) of the Internal Revenue Code of 1986, 26 USC 7701(h)(1). MCL 205.51a(m)(iv); MCL 205.92b(m)(iv).

A lease or rental of tangible personal property may include a purchase option (“buy out”) at the end of the lease or rental term based on the residual value of the tangible personal property as set forth in the lease or rental agreement.  If that purchase option is exercised by the consumer, and an exemption does not apply, sales tax is due based on 6% of the purchase option price as that transaction involves a sale at retail under MCL 205.52.

Example 1.  Customer leases a vehicle from Car Dealer with a lease term of 36 months.  Lease payments due each month are $250.00 which includes use tax.  Under the lease agreement, Customer has a “buy-out” option that allows Customer to purchase the vehicle at its residual value of $10,000.00.  At the end of the lease term, Customer exercises the buy-out option to purchase the vehicle from Car Dealer for the residual value.  Car Dealer owes sales tax of $600 on the retail sale of the vehicle to Customer as part of the lease buy-out transaction.  Under MCL 205.73(1), Car Dealer may charge and collect the $600 sales tax from Customer.

A lease or rental does not include installment sales. Nor does a lease or rental include a security agreement or a deferred payment plan where title or possession is transferred after the completion of the required payments or where title is required to transferred after completion of required payments and the payment of a de minimis purchase “option price.” MCL 205.51a(m)(i)-(ii); MCL 205.92b(m)(i)-(ii).  The purchase “option price” is de minimis if it is not more than the greater of $100 or 1% of the total payments. Id.  While the transactions described in this paragraph are not lease or rental transactions, the transactions would be subject to tax if they otherwise involve a sale at retail of tangible personal property.

II.     Services distinguished from a lease of tangible personal property.

A single transaction that involves a mixture of non-taxable service(s) and a lease of taxable tangible personal property must be analyzed to determine the nature of the transaction. If the transaction is for a service, then it does not constitute a lease of tangible personal property and the lessor election does not apply. Any tangible personal property used in the completion of the service is merely incidental to the service. Sales or use tax applies at the time the service provider acquires or uses the property.

The “incidental to service” test was established in Catalina Marketing Sales Corp v Michigan Dep’t of Treasury, 470 Mich 13 (2004). The Michigan Supreme Court established six factors for determining if a transaction is a sale of a service or a sale of tangible personal property:

  • what the buyer sought as the object of the transaction;
  • what the seller or service provider is in the business of doing;
  • whether the goods were provided as a retail enterprise with a profit-making motive;
  • whether the tangible goods were available for sale without the service;
  • the extent to which the intangible services have contributed to the value of the physical item transferred; and
  • any other factors relevant to the particular transaction.

While all the factors may be considered, the first factor bears the most weight.

In addition to the “incidental to service” test, the General Sales Tax Act (GSTA) and the Use Tax Act (UTA) provide a specific standard for determining the nature of a purported lease transaction involving both equipment and an operator.  In general, if an operator is supplied along with property, and the operator is necessary for the equipment to perform as designed, then the transaction is a service and not a “lease” of property. To be considered “necessary” for the equipment to perform as designed, the operator must do more than maintain, inspect, or set up the property. MCL 205.51a(m)(iii); MCL 205.92b(m)(iii). Aircraft, watercraft, and bus charter companies are examples of service providers. Charter companies provide tangible personal property and a crew or person who retains control of the property during the period of service. The charter agreements are service contracts.

Because the 2018 Acts include a definition for the term “lease,” the general definition of a “lease” under the GSTA and the UTA does not apply to the school bus exemption provided by the 2018 Acts.  In general, the 2018 Acts addressed the use tax liability that would arise when private private-sector contractors entered into agreements with public school districts to provide transportation for their students to/from school and school-authorized activities using buses which were purchased by the contractors exempt from sales tax, under the lessor election described in Part IV of this RAB, and purportedly leased to the school districts.  When such agreements also provided the bus driver to operate the bus, those transactions did not qualify as leases and so the election was invalid.  To address this, a “lease” for purposes of the school bus exemption established by the 2018 Acts is “any transfer of possession or control for a fixed or indeterminate term for consideration and may include future options to purchase or extend.” MCL 205.54a(1)(t)(i); MCL 205.94(1)(ff)(i).  A notable difference between the general definition of a “lease” and the definition of a “lease” applicable to the school bus exemption is that a “lease” for purposes of the school bus exemption does not include the exception for when leased property is supplied along with the operator of that property.  See also Mich Admin Code, R 205.132(4).  For example, if a transaction involves the provision of a school bus along with the operator of the school bus (e.g., driver), the transaction will not be disqualified from being a “lease” for purposes of the school bus exemption established by the 2018 Acts as it would be under the general definition of a “lease” under the GSTA and UTA.  The school bus exemption is described in further detail in Part IX of this RAB.

III.     Lessor defined.

A “lessor” is a “person engaged in the business of renting or leasing tangible personal property.” Mich Admin Code, R 205.132 (emphasis added). “Business” is defined in the Use Tax Act as “all activities engaged in by a person or caused to be engaged in by a person with the object of gain, benefit, or advantage, either direct or indirect.” MCL 205.92(h).

The mere existence of a lease does not establish that a person is a lessor. The person must show that the lease is intended to produce a profit. A business purpose that is unrelated to the lease is not sufficient to establish that the person is a lessor. For instance, if the lease payments are intended to only recover the cost of the property but the lessor expects the property to appreciate in value during the term of a lease the expectation of appreciation does not establish that the leasing activity is engaged in for profit.

Pursuant to Devonair Enterprises, LLC v Dep’t of Treasury, 297 Mich App 90 (2012), to be in the business of leasing property for profit, the lessor must satisfy each of the following requirements:

  • the rates and terms of the lease must be consistent with arm’s-length leases;
  • the taxpayer must hold itself out to the public as a lessor; and
  • the lease period must be sufficient to produce revenue consistent with other leasing businesses.

IV.     Lessor election to pay use tax on rental receipts.

A lessor may elect to pay use tax on rental receipts. MCL 205.95(4). To make the election to pay on rental receipts, the lessor must satisfy each of the following requirements in accordance with MCL 205.92(h), MCL 205.95(1), Mich Admin Code, R 205.132, and Devonair:

  • the lessor must be in the business of leasing, which requires a profit motive;
  • the transaction must involve the rental of tangible personal property (as opposed to the provision of a service); and
  • the lessor must register with Treasury to pay use tax unless the lessor already holds a sales tax license.

If the lessor makes that election, the property is exempt from sales tax and use tax at the time the property is acquired. MCL 205.54d(a). If the lessor does not make the election, the property is taxed at acquisition, but rental receipts are exempt from use tax. MCL 205.94a(a).

The lessor election is made by registering for use tax with Treasury directly or under the Streamlined Sales and Use Tax Agreement. A lessor that holds a sales tax license does not need to separately register for use tax.

If the lessor is leasing an aircraft, MCL 205.95(4) provides that the lessor must register for use tax by the earlier of:

  • the first date use tax is due on the rental receipts, or
  • 90 days after the lessor brings the aircraft into Michigan.

If the lessor election is made, tangible personal property purchased by the lessor for repair or for replacement parts in connection with the leased property is exempt from sales or use tax.  Generally, the value of the repair or the replacement parts is reflected in the stream of taxable rental receipts.

V.     Lessee Liability - Musashi Auto Parts of Michigan Inc v Dep’t of Treasury.

In Musashi Auto Parts of Michigan Inc v Dep’t of Treasury (unpublished per curiam opinion of the Court of Appeals, issued December 13, 2012 (Docket No. 305268)), the court addressed whether a lessee is liable for use tax when the invoices from the lessor do not indicate that the lessee was charged use tax on the rental. Specifically, Musashi was a manufacturer whose employees wore uniforms rented from a uniform supply company in Michigan. Treasury audited Musashi for use tax and assessed a use tax deficiency since the lessor did not charge use tax on the rental. Musashi did not claim an exemption when renting the uniforms. Under the facts presented, the court concluded that “lessors are obligated to pay the use tax, without any type of corresponding responsibility belonging to lessees.” Id.

Treasury acquiesces to the holding in Musashi and will not assess a lessee for use tax on the rental of tangible personal property as the remittance of use tax on rental receipts is the obligation of the lessor.  If the lessor places the economic burden of the tax on the lessee, the charge must be separately itemized.  Mich Admin Code, R 205.132(7). 

Although not at issue in Musashi, there are two exceptions to the Musashi holding dictated by statute and caselaw.  First, if the lessee provides a facially proper claim of exemption to the lessor that the lessee was actually not eligible to claim, the lessee, rather than the lessor, is liable for the unpaid tax. MCL 205.104b (see also RAB 2021-18 for more information regarding proper claims of exemption).  Second, a lessee may be held liable if the lease is not executed in Michigan and the lessor relinquishes total control of the property when leasing the property from another state or country. NACG Leasing v Dep’t of Treasury, 495 Mich 26, 30 (2014).  See also WPGP1 v Dep’t of Treasury, 240 Mich App 414 (2000), and Czars, Inc v Dep’t of Treasury, 233 Mich App 632 (1999).

Example 2: Lessee leases uniforms from Lessor and does not provide a claim of exemption.  The invoice from Lessor does not indicate that use tax was charged to Lessee.  Lessee is not liable for use tax on the rental payments.

Example 3: Lessee leases an excavator from Lessor and provides Lessor a claim of exemption indicating that the property is exempt because it will be used in an exempt extractive operation.  However, Lessee only uses the excavator to build a golf course, which does not qualify for the extractive operations exemption.  Since Lessor may rely on Lessee’s claim of exemption (absent certain situations, such as fraud), Lessee is liable for use tax on the rental price of the excavator.

VI.     Non-lease use invalidates a lessor election.

As a general rule, a lessor that elects to pay use tax on rental receipts may not use the property for purposes unrelated to its leasing business. If the lessor does use the property for a purpose other than leasing, then the lessor election is invalid and use tax is due on the purchase price of the property as of the date of acquisition, less any use tax paid on rental receipts.

Example 4: Lessor, a company, purchases an aircraft to use in its leasing business. The owner of the Lessor uses the aircraft to fly the owner’s family to a resort for a week’s vacation. The owner does not have a lease arrangement with the Lessor and does not pay a fair market value lease payment for the use of the aircraft. The Lessor has used the aircraft for a purpose unrelated to its leasing business and has invalidated its lessor election. 

Despite the general rule and consistent with the 2018 Acts, Treasury will not invalidate a lessor election concerning a school bus eligible for the exemption under MCL 205.54a(1)(t) or MCL 205.94(1)(ff), as described further in Part IX of this RAB, solely because the school bus is used (to a limited degree) to provide transportation related services for a non-school sanctioned function.

VII.     Tax base of rental receipts.

If a lessor elects to pay tax on its rental receipts instead of on its acquisition cost, then the lessor must pay the use tax on the total rental receipts, including payments made to compensate the lessor for the cost of the property; materials; labor or services necessary to complete the transaction; taxes other than use taxes; and, under certain conditions and subject to the 2023 Acts, delivery and installation. These charges are part of the tax base even if they are separately stated except that, beginning April 26, 2023, the 2023 Acts provide that delivery and installation charges are excluded from the tax base if those charges are separately stated on the invoice, bill of sale, or similar document provided to the purchaser, and the seller maintains its books and records to show separately the transactions used to determine the use tax. MCL 205.92(f).

VIII.     Sourcing.

For sourcing the lease or rental of tangible personal property, other than “transportation equipment” or motor vehicles, trailers, semitrailers, or aircraft that are not transportation equipment, the following rules as set forth in MCL 205.69(2) and MCL 205.110(2) apply:

  • If the lease or rental does not require recurring payments, the payment is sourced in the same manner as provided for a retail sale under MCL 205.69(1) and MCL 205.110(1).
  • If the lease or rental requires periodic payments, the first rental payment is sourced in the same manner as provided for a retail sale under MCL 205.69(1) and MCL 205.110(1) and subsequent payments are sourced to the leased property’s primary location for each period covered by the lease based on the address of the property provided by the lessee in good faith for the lessor’s business records. Intermittent use of the property at other locations (e.g., business property that accompanies employees on business trips or service calls) does not alter sourcing.

Sourcing the lease or rental of a motor vehicle, trailer, semi-trailer or aircraft that is not transportation equipment is subject to the following as provided under MCL 205.69(3); MCL 205.110(3):

  • If the lease or rental requires periodic payments, each payment is sourced to the leased property's primary location based on the address of the property provided in good faith by the lessee for the lessor's business records. Intermittent use of the property at other locations does not alter sourcing.
  • If the lease or rental does not require recurring payments, the payment is sourced in the same manner as provided for in retail sale under MCL 205.69(1) and MCL 205.110(1).

The lease or rental of "transportation equipment" is sourced in the same manner as provided for a retail sale under MCL 205.69(1) and MCL 205.110(1). MCL 205.69(4); MCL 205.110(4).

Lease or rental transactions/payments that are to be sourced in the same manner as provided for retail sales under MCL 205.69(1) and MCL 205.110(1) are to be sourced as follows:  To the location where the property is received by the lessee or where the lessor has been instructed to deliver the property.  If the transaction/payment cannot be sourced to that location, then it is sourced to the lessee address maintained by the lessor in its business records maintained in the ordinary course of its business and used in good faith.  If the transaction/payment cannot be sourced based on the address in the lessor’s records, then the transaction/payment is sourced based on information obtained in good faith at the time of the transaction (including the lessee’s check or other payment instrument).  Finally, if there is insufficient information to apply any of the above sourcing rules, the transaction/payment is sourced to the shipping address.

For purposes of the sourcing rules “transportation equipment” means 1 or more of the following:

(i) Locomotives and railcars utilized for the carriage of persons or property in interstate commerce.

(ii) Trucks and truck-tractors with a gross vehicle weight rating of 10,001 pounds or greater, trailers, semitrailers, or passenger buses, which are registered through the international registration plan and operated under authority of a carrier authorized and certificated by the United States department of transportation or another federal authority to engage in the carriage of persons or property in interstate. MCL 205.69(6)(b) and MCL 205.110(6)(b).

IX.     Exempt transactions.

If the lessee of the property is an entity that is exempt from tax under the UTA or the property itself is exempt from use tax, then the lessor is not liable for use tax on the rental receipts. See generally MCL 205.94 and 94a. The lessor must obtain from the lessee a proper exemption claim or the required identifying information. MCL 205.62; MCL 205.104b.

Subject to the condition below, beginning with tax periods commencing on March 29, 2019, the 2018 Acts exempt the sale (or purchase) or lease of a school bus or transportation-related services, and parts or adaptive equipment that are used in the repair, maintenance, accommodation, or modification of a school bus and which are affixed or to be affixed to a school bus, from sales and use taxes.  MCL 205.54(1)a(t); MCL 205.94(1)(ff).

Although the 2018 Acts define a “school bus” as having the same meaning as that term is defined under MCL 257.1807, the 2018 Acts do not define the terms “adaptive equipment,” “accommodation,” “affix,” or “modification.” MCL 205.54a(1)(t)(iii) and MCL 205.94(1)(ff)(iii).  For purposes of this exemption, Treasury will apply the following meaning (or understanding) to those terms:

  • Adaptive equipment: Specialized equipment to accommodate persons with special needs or disabilities. In the context of school buses, this could include equipment such as power lift systems, ramps, platforms, barriers (to prevent wheelchairs from falling off platforms or ramps), wheelchair tiedowns and anchors, harnesses or seatbelts, ingress/egress doors.
  • Accommodation: Relating to the adaptive equipment such as changes made to a school bus to accommodate riders' individual [or special] needs.
  • Affix: To attach to something else; to attach physically. See RAB 2016-2.
  • Modification: The 2018 Acts include a “modification” in the list of exempt uses for the “parts,” such that a part that is a component of a generic modification of the school bus (e.g., installation of a fan, stop sign, lights, or GPS device) is eligible for the exemption if the part is ultimately affixed to the school bus.

The exemption provided by the 2018 Acts is conditioned on the school bus or services being “primarily” used in the performance of a contract entered into with an authorized representative of a “school” for the transportation of preprimary, primary, or secondary school pupils to or from a school or school-related events authorized by the administration of the school. MCL 205.54a(1)(t); MCL 205.94(1)(ff). The 2018 Acts define a “school” as a “public school” or “public school academy” as those terms are defined in MCL 380.5.  MCL 205.54a(1)(t)(ii); MCL 205.94(1)(ff)(ii).  Accordingly, private and parochial schools do not qualify as a “school” for purposes of these exemptions; nor do colleges or universities. 

Consistent with the 50% threshold described in Jackson v Eastern Mich Univ Found, 215 Mich App 240, 245 (1996), Treasury will apply the following test to determine if the school bus is “primarily” used for the exempt purpose described in the 2018 Acts:

  • If a taxpayer uses a school bus more than 50% of the time for the school-related purposes described in the 2018 Acts, Treasury will consider the use to be “primarily” for the exempt purposes described in the 2018 Acts.
  • If a taxpayer uses a school bus 50% or less of the time for the school-related purposes described in the 2018 Acts, the taxpayer will be subject to a rebuttable presumption that the school bus was not “primarily” used for the exempt purposes described in the 2018 Acts.

X.         Subleasing.

 

If a lessor leases tangible personal property to a lessee, and sales or use tax was paid upon the lessor’s acquisition of the property, any subleasing of the property by the lessee (sublessor) is not subject to tax. MCL 205.94(1)(a) and MCL 205.94a(a). Additionally, a sublessor is not liable for use tax on rental receipts if it pays use tax to its lessor on the original lease of the property. 

In a leaseback arrangement where the sublessor leases the property back to the original lessor, use tax will be owed by the sublessor if the original lessor did not pay sales or use tax on the property when it first purchased the property or if the original lessor did not pay use tax on the property under a lessor election.