SUMMARY QUESTION: Whether the distribution and leaseback of the facilities described is exempt from Florida sales tax as a financing arrangement/mortgage? ANSWER - Based on Facts Below: In reviewing all of the relevant documents related to the transaction, it was determined that this particular transaction was more akin to a "financing arrangement" than a "lease" for purposes of Chapter 212, F.S. The following factors were considered during our determination: (1) Recognizing the clear and unambiguous language of the relevant documents while keeping in mind that substance is always preferred over form; (2) Recognizing that, for there to be a mortgage, there must be a debt secured thereby; (3) Examining if "rent" is fixed to debt service, as opposed to the rental market value of the property; (4) Determining whether the buyer/lessee is a single purpose financing corporation created prior to the transaction in order to facilitate the loan process; (5) Examining whether the short-term and long-term risks pass to the "so-called buyer"; and (6) Recognizing that the proper recording of a "debt" requires the transfer of title shortly after the end of a "lease" term. Other factors exist, however, these six (6) were considered most relevant under the specific facts presented. ********************************************************** Mar 31, 2004 Re: Technical Assistance Advisement 04A-025 Whether a Transaction Creates a Lease or Financing Arrangement/Mortgage Sales and Use Tax Section 212.031, Florida Statutes ("F.S.") Rule 12A-1.070, Florida Administrative Code ("F.A.C.") Dear :
This response is in reply to your letter dated January 16, 2004 (postmarked February 11, 2004), requesting the Department's issuance of a Technical Assistance Advisement ("TAA") pursuant to Section 213.22, F.S., and Chapter 12-11, F.A.C., regarding the Department's position as to whether a transaction involving commercial real property is a "lease" or a "financing arrangement/mortgage." An examination of your letter has established that you have complied with the statutory and regulatory requirements for issuance of a TAA. Therefore, the Department is hereby granting your request for issuance of a TAA. Provided along with your letter were the following documents: (a) Articles of Amendment for "Subject"; (b) Articles of Incorporation for "Parent"; (c) Operating Agreement of "Applicant," which sets forth the ownership structure of "Applicant"; (d) Lease Agreement between "Applicant" and "Subject"; (e) Mortgage document and promissory note; and (f) Contract/Commitment Letter between "Applicant," "Parent," "Subject," and "Lender." ISSUE Is the distribution and leaseback of the facilities described exempt from sales tax as a financing arrangement/mortgage under Florida Sales tax law? FACTS Based on your letter, the following parties can be identified: "Taxpayer/Subject" is the operating entity that was purchased by "Parent." "Taxpayer/Subject" occupies the real property in question and is frequently referred to as the "lessee" within the various documents. "Applicant" is the single purpose entity through which the "Lender" made the loan to "Parent" so that "Parent" could purchase "Taxpayer/Subject." "Applicant" is the named borrower on the "Mortgage and Assignment of Rents and Fixture Filing" as
well as the "Promissory Note." "Applicant" is also listed in the County's Official Records as the owner of the property in question and is frequently referred to as the "lessor" within the various documents. Your letter provides, in part: Parent owns 100% of the outstanding equity of Subject and Applicant. Subject and Applicant are both "disregarded entities" for federal and Florida income tax purposes. Parent required financing from Lender to undertake the purchase of real property and all improvements thereon, and to acquire the Subject's stock. Subject operated an existing multi-brand retail automobile, parts and service operation. Immediately following Parent's purchase of Subject's stock, Parent filed IRS Form 8869, Qualified Subchapter S Subsidiary Election, which effectively liquidated Subject for federal and Florida income tax purposes. Effective August 1, 2003, Parent formed Applicant as a single-member limited liability company based upon a condition of the loan of funds which requires title to the real property to be acquired in a "bankruptcy-remote single purpose entity." As stated in Section 1.2 of the operating agreement, the purpose of this single purpose entity is to engage solely in the following activities: (a) to acquire those certain parcels of real property, together with all improvements thereon, located in the City of... (hereinafter, the "Property"); (b) to own, hold, sell, assign, transfer, operate, lease, mortgage to Lender, and otherwise deal with the Property; (c) to borrow the necessary amount of funds from Lender to acquire the Property and to issue notes and other documents to evidence and secure the borrowing; and (d) subject to the Separateness Covenants (defined in
Section 5.2), to exercise all powers enumerated in the Act necessary or convenient to the conduct, promotion or attainment of the business or purposes otherwise set forth in the Operating Agreement. But for Lender's express requirement, Parent would not have formed Applicant, and Subject would have acquired title to the Property directly. Parent capitalized Applicant with a $100 initial capital contribution. Parent's additional capital contributions were based solely on the down payment required to acquire the property. Lender loaned the balance of the Property's purchase price to Applicant (the "Loan") and secured the Loan with a mortgage on the Property (the "Mortgage"). Parent and Subject were required to guarantee the performance of Applicant's obligation under the Loan and Mortgage. Concurrent with the execution of the financing arrangement with the aforementioned parties, Applicant entered into a lease agreement (the "Lease") with Subject. Applicant, as Lessor, and Subject, as Lessee, entered into the Lease, under which Applicant will "lease" the property to be occupied by Subject. The term of the Lease is coterminous with the Loan. The Lease provides cross default provisions with the Loan. The intent of the Lease Agreement is to provide Subject with the benefits and burdens of owning the Property and for Subject to provide Applicant with funds for Applicant to satisfy its obligations to Lender with respect to the Loan and Mortgage. TAXPAYER POSITION Your letter provides, in part: The statutory definitions for the terms "lease," "let" and "rental" provide little guidance concerning what transactions will be deemed to create a lease with respect
to real property. [See] Fla. Stat. s. 212.02(10). The Department of Revenue has, however, previously considered a transaction similar to Applicant's transaction described above. [See] Bridgestone/Firestone, Inc. v. Department of Revenue, DOAH Case Number 92-2483, 15 FALR 4874 (1993)... APPLICABLE STATUTES AND RULES Section 212.02, F.S., provides in part: (2) "Business" means any activity engaged in by any person, or caused to be engaged in by him or her, with the object of private or public gain, benefit, or advantage, either direct or indirect... (10)(i) "License," as used in this chapter with reference to the use of real property, means the granting of a privilege to use or occupy a building or a parcel of real property for any purpose. (12) "Person" includes any individual, firm, copartnership, joint adventure, association, corporation, estate, trust, business trust, receiver, syndicate, or other group or combination acting as a unit and also includes any political subdivision, municipality, state agency, bureau, or department and includes the plural as well as the singular number. Section 212.031(1)(a), F.S., provides in part: It is declared to be the legislative intent that every person is exercising a taxable privilege who engages in the business of renting, leasing, letting, or granting a license for the use of any real property... Section 212.031(1)(c), F.S., provides in part: For the exercise of such privilege, a tax is levied in an
amount equal to 6 percent of and on the total rent or license fee charged for such real property... Section 212.031(1)(d), F.S., provides: When the rental or license fee of any such real property is paid by way of property, goods, wares, merchandise, services, or other thing of value, the tax shall be at the rate of 6 percent of the value of the property, goods, wares, merchandise, services, or other thing of value. Section 697.01(1), F.S., provides: All conveyances, obligations conditioned or defeasible, bills of sale or other instruments of writing conveying or selling property, either real or personal, for the purpose or with the intention of securing the payment of money, whether such instrument be from the debtor to the creditor or from the debtor to some third person in trust for the creditor, shall be deemed and held mortgages, and shall be subject to the same rules of foreclosure and to the same regulations, restraints and forms as are prescribed in relation to mortgages. Section 12A-1.070, F.A.C., provides in part: (4)(a) The tenant or person actually occupying, using, or entitled to use any real property from which rental or license fee is subject to taxation under s. 212.031, F.S.,... shall pay the tax to his immediate landlord or other person granting the right to such tenant or person to occupy or use such real property. (b) The tax shall be paid at the rate of 5 percent prior to February 1, 1988, and 6 percent on or after February 1, 1988, on all considerations due and payable by the tenant or other person actually occupying, using, or entitled to use any real property to his landlord or other person for the privilege of use, occupancy, or the right to use or
occupy any real property for any purpose. (c) Ad valorem taxes paid by the tenant or other person actually occupying, using, or entitled to use any real property to the lessor or any other person on behalf of the lessor, including transactions between affiliated entities, are taxable. (d) Common area maintenance charges paid by a tenant to the lessor for the privilege or right to use or occupy real property are taxable. (e) Utility charges paid by a tenant to the lessor for the privilege or right to use or occupy real property are taxable, unless the lessor has paid the sales tax to the utility company on such utilities consumed by the tenant, and the utilities billed by the lessor to the tenant are separately stated on the lessor's invoice to the tenant at the same or lower price as that billed by the utility company to the lessor. (19)(a) The lease or rental of real property or a license fee arrangement to use or occupy real property between related "persons," as defined in s. 212.02(12), F.S., in the capacity of lessor/lessee, is subject to tax. (b) The total consideration, whether direct or indirect, payments or credits, or other consideration in kind, furnished by the lessee to the lessor is subject to tax despite any relationship between the lessor and the lessee. (c) The total consideration furnished by the lessee to a related lessor for the occupation of real property or the use or entitlement to the use of real property owned by the related lessor is subject to tax, even though the amount of the consideration is equal to the amount of the consideration legally necessary to amortize a debt owned by the related lessor and secured by the real property occupied, or used, and even though the consideration is ultimately used to pay that debt.
DISCUSSION The issue presented requires us to make a determination as to whether the transaction involving Applicant and Subject is a "financing arrangement/mortgage" or a "lease." The distinction between the two is significant for Florida sales tax purposes. In Florida, the renting of commercial real property is a taxable privilege. See Section 212.031, F.S. While some transactions may be governed by a document entitled "Lease," the true character of the transaction may be more akin to a "financing arrangement" or "mortgage," and in such event, the transaction would not be subject to Florida sales tax under Chapter 212, F.S. See Bridgestone/Firestone, Inc. v. Department of Revenue, DOAH Case 92-2483, 15 FALR 4874 (1993). Various factors have been identified in addressing this issue. The clear and unambiguous language of the relevant documents will be respected (See Emergency Associates of Tampa, P.A. v. Sassano, 664 So.2d 1000 (Fla. 2d DCA, 1995)), keeping in mind that substance is always preferred over form (See Markell, et al. v. Hilbert et al., 140 Fla. 842, 192 So. 392 (Fla. 1939)). For there to be a mortgage, there must be a debt secured thereby. See Bank of Miami Beach v. Fidelity and Casualty Company of New York, 239 So.2d 97 (Fla. 1970). A financing arrangement may be found where the "rent" is fixed to debt service as opposed to the rental market value of the property. See Sun Oil Company v. Commissioner of Internal Revenue, 562 F.2d 258 (3rd Cir. 1977). Where the buyer/lessee is a single purpose financing corporation, a financing arrangement may be found. See Bridgestone/Firestone. A review as to whether the short-term and long-term risks pass to the "so-called buyer" is relevant to our analysis. See Bridgestone/Firestone. Finally, the proper recording of a "debt" requires the transfer of title shortly after the end of a lease term. See Bridgestone/Firestone. 1. The plainly and clearly articulated intent of the parties. A review of the "Lease Agreement" provides the following provisions:
WHEREAS, pursuant to the Loan Agreement, Lessee was required to acquire title to the Premises in a bankruptcyremote, special purpose entity (the "SPE Requirement"). WHEREAS, Lessor was formed solely for the purpose of satisfying the SPE Requirement. WHEREAS, Lessor is not in the business of engaging the conveyance of the lease or the grant of a license to use real property, rather Lessor was created to serve as an integral part of the Loan transaction. WHEREAS, the parties to this Lease intend that this Lease shall be treated as a financing arrangement, rather than a lease or rental agreement. The clear and unambiguous language of the "Lease Agreement" must be given its plain and ordinary meaning. See Emergency Associates of Tampa, P.A. v. Sassano, 664 So.2d, 1000 (Fla. 2d DCA, 1995). It would appear that the parties intended this transaction to be a financing arrangement rather than a lease or rental arrangement. Because substance must triumph over form, our analysis must go beyond the words of the "Lease Agreement" in determining the true intent of the parties. 2. The existence of a debt or other obligation. "It is well settled in this and other jurisdictions that there can be no mortgage unless there is a debt to be secured thereby or some obligation to pay money." Bank of Miami Beach v. Fidelity and Casualty Company of New York, 239 So.2d 97, 99 (Fla. 1970), quoting Nelson v. Stockton Mortgage Co., 1930, 100 Fla. 1191, 130 So. 764. The Florida Supreme Court continued its analysis by citing to Holmberg v. Hardee, 90 Fla. 787, 108 So. 211 (1926): In Holmberg this court pointed out that a deed absolute in form cannot be held to be a mortgage without proof of an
obligation to be secured by it, "either in the form of an antecedent debt between the parties, or a loan, debt, or assumption of liability." (emphasis added). [emphasis in original opinion] A review of all of the documents provided demonstrates that the intent of the parties was to secure financing and that the "Lease Agreement" was a requirement of the Lender. Further, a debt does exist as evidenced by the Applicant being the named "Borrower" on the mortgage provided. 3. Nature of the "Basic Rent". In determining that a transaction involved a financing agreement and not a lease, it has been noted that the lessee pays monies the sum of which is directly related to the loan amount rather than a sum that is representative of fair market rent. In Bridgestone/Firestone's analysis of Sun Oil Company v. Commissioner of Internal Revenue (562 F.2d 258 (3rd Cir. 1977)), a financing agreement was found wherein: [T]he rents (had) no visible connection with the economic value of the property but (were) evidently related to a fixed interest return on the advances. Bridgestone/Firestone at 4889, para. 38. According to the Lease Agreement, the "Base Rent" is an amount equal to the principle and interest payable to Lender, paid directly to the Lender and "... shall be paid absolutely net to Lender, so that this Lease shall yield to Lender the full amount thereof, without setoff, deduction or reduction." Lease Agreement at Section 3(a). The Subject /lessee is also required to pay all expenses and taxes related to the property as "additional rent." Lease Agreement at Section 4. At this point, we note that Rule 12A-1.070(19)(c), F.A.C., provides that mortgage payments made by a lessee on behalf of a related party lessor are subject to Florida sales tax because the payments are viewed as "consideration" for the right to use or occupy commercial real property. Additionally, Rule 12A- 1.070(4)(c), (d) and (e), F.A.C., provide that ad valorem taxes,
common area maintenance fees and utility bills paid by a lessee for the benefit of the lessor are also subject to Florida sales tax. 4. The purpose of "Applicant". In determining the practical business substance of the transaction, it is also necessary to determine if the buyer is a single purpose financing corporation... Bridgestone/Firestone, at 4884, para. 27 In the Bridgestone/Firestone case, "FIRELCO" was formed especially to aid Firestone in its goal of "off-balance sheet financing." Bridgestone/Firestone, at 4880, para. 8. The Hearing Officer found that FIRELCO was indeed a single-purpose financing corporation. Id., at 4884, para. 28. As described in the "Operating Agreement" between Parent and Applicant, Applicant was formed as a "single purpose entity" for the limited business purposes described above in the "Facts" section of this response. Further, the Contract/Commitment Letter between the Lender and the parties describes Applicant as a "bankruptcy-remote, special purpose entity." The formation of a "bankruptcy-remote, special purpose entity" is part of an "... asset-securitization strategy that puts ownership of the company's valuable assets in an entity separate from the one that is at risk for liability." Lynn M. LoPucki, The Death of Liability, 106 Yale L.J. 1, 24 (October, 1996). Explained further: To achieve bankruptcy remoteness, the SPV's [Special Purpose Vehicle] organizational structure strictly limits its permitted business activities. The goal is to prevent creditors (other than holder of the SPV's securities) from having claims against the SPV that would enable them to file an involuntary bankruptcy petition against the SPV.... Steven L. Schwarcz, The Alchemy of Asset Securitization, 1 Stan. J.L. Bus & Fin. 133, 135-136 (Fall, 1994).
We can see, then, that the sole business purpose of Applicant is to be a single purpose entity with "bankruptcy remoteness." Under the Operating Agreement, Applicant has strictly limited permitted business activities. Under financial and lending concerns more fully articulated in the above cited articles, "asset securitization" through the creation of entities such as Applicant is "... by far the most rapidly growing segment of the U.S. credit markets." LoPucki, at 24. 5. Short Term and Long Term Risks and Benefits. In determining the practical business substance of the transaction, it is also necessary to determine... if the short-term and long-term risks and benefits associated with ownership pass to the so-called buyer... Bridgestone/Firestone, at 4884, para. 27 Under the terms of the Lease, the Subject/lessee assumes most, if not all, of the short term and long term risks and benefits. This would indicate that Subject is the true owner of the property and that the Applicant/lessor is the single purpose entity established for lending purposes. The short and long term risks that fall on the Subject/lessee can be found in Sections 7 ("Alterations, Improvements and Repairs"), 8 ("Insurance"), 10 ("Indemnity"), 11 ("Casualty and Condemnation") and 12 ("Environmental Matters"). These short and long term risks that fall on the lessee would be more traditionally be the responsibility of a lessor/owner. 6. Recording as "debt" and transfer of title. The Hearing Officer in Bridgestone/Firestone considered the standards issued by the Financial Accounting Standards Board ("FASB"). For a "lease" to be reported as a "debt," FASB Statement No. 13 requires that "the lease transfers ownership of the property to the lessee." Bridgestone/Firestone, at 4882, para. 16. FASB 13 has been superseded, in part, by FASB Statement No. 98, which provides in part: A lease involving real estate may not be classified as a
sales-type lease unless the lease agreement provides for the transfer of title to the lessee at or shortly after the end of the lease term... FAS 98 Summary. Section 18 of the "Lease Agreement" provides that Subject/lessee "shall purchase" and Applicant/lessor "shall sell" the property on the earlier of: (1) the "expiration date" (defined in the Lease as thirty days following the termination of the Loan term); or (2) on the date of condemnation or if the property cannot be reasonably replaced or repaired following fire or other casualty (see Section 11(e) of the Lease). CONCLUSION Based on all the documents provided, the "Lease Agreement" between Applicant and Subject is part of a "financing arrangement/mortgage," rather than a lease. Florida sales tax, under Section 212.031, F.S., would not be due on this transaction. This conclusion is based on the following factors. 1. The Lease Agreement plainly and clearly articulates the intent of the parties. This language is supported by the other documents provided. 2. This transaction, at its center, is all about securing a loan. The documents provided demonstrate the intent of the parties in securing a loan, rather than creating a "leasing" situation. The "Lease Agreement" was a vehicle deemed necessary in securing the loan. 3. Basic Rent is directly tied to servicing the debt obligation rather than to a fair market value rent. Standing alone, these payments would be subject to Florida sales tax under Rule 12A-1.070(19), F.A.C. However, in the context of the other facts presented, this factor contributes to the determination that the transaction is a non-taxable financing arrangement/mortgage. 4. The Applicant is a sole purpose financing entity created specifically to facilitate Subject's loan
application. Significantly, the creation of Applicant was prior to the parties structuring this transaction and not afterwards. Finally, the Applicant is strictly limited to those business activities detailed in the Operating Agreement. 5. The Short Term and Long Term Risks and Benefits fall to Subject/lessee, which would indicate ownership. 6. Thirty days subsequent to the loan terminating, title to the property will be sold to Subject, thereby satisfying the requirement of FASB 98 as it relates to the recordation of "debt." This response constitutes a Technical Assistance Advisement under Section 213.22, F.S., which is binding on the Department only under the facts and circumstances described in the request for this advice as specified in Section 213.22, F.S. Our response is predicated on those facts and the specific situation summarized above. You are advised that subsequent statutory or administrative rule changes, or judicial interpretations of the statutes or rules, upon which this advice is based, may subject similar future transactions to a different treatment than expressed in this response. You are further advised that this response, your request and related backup documents are public records under Chapter 119, F.S., and are subject to disclosure to the public under the conditions of s. 213.22, F.S. Confidential information must be deleted before public disclosure. In an effort to protect confidentiality, we request you provide the undersigned with an edited copy of your request for Technical Assistance Advisement, the backup material and this response, deleting names, addresses and any other details which might lead to identification of the taxpayer. Your response should be received by the Department within 15 days of the date of this letter. Sincerely, Eric R. Peate Senior Attorney
Technical Assistance and Dispute Resolution (850) 922-4714 ERP/ Ctrl # 58823