§ 17053.37-6. Leasing.

(a) In General. For purposes of Regulations 17053.37-1 through 17053.37-11, inclusive, in the case of any leasing transaction in which qualified property is leased by a qualified taxpayer, the rules of this regulation shall apply. Generally, the lessor must pay California sales tax on the lessor's acquisition of the qualified property in order for the lessee to claim the credit for that item of qualified property. Conversely, the lessee cannot claim the JSF Property Credit for an item of property where the lessor acquired the qualified property without paying California sales or use tax and the lessor instead collects use tax payments from the lessee measured by the lessee's rental payments to the lessor. The determination of whether the rules in subsection (b) or subsection (c) of this regulation apply shall be made by reference to the sales and use tax treatment of the lease, rather than the income tax treatment of the lease. Thus, for example, a lease of qualified property that would be treated as a finance lease under income tax principles may still be treated as an operating lease under this regulation. In addition, under California sales and use tax law, a transaction denominated as a lease will instead generally be treated as a sale under a security agreement if the lease contains a nominal option price. For this purpose, California sales and use tax law generally treats the option price as nominal if it does not exceed the lesser of $100 or 1 percent of the total contract price.

EXAMPLE 1: X, a leasing company, agrees to lease qualified property to Y, a qualified taxpayer, for use in Y's manufacturing facility in Garden Grove. Under the terms of the lease, X will lease the property to Y for $100 per year for a term of 10 years. Upon the expiration of the 10-year lease term, Y has an option to acquire the property for $1. Under these facts, the “lease” would be properly treated as a sale under a security agreement from its inception and not as a lease under Revenue and Taxation Code section 6006.3 and California State Board of Equalization Regulation 1660(a)(2)(A), Title 18, California Code of Regulations, so that the rules of subsection (c) of this regulation would apply.

EXAMPLE 2: Assume the same facts as in EXAMPLE 1, except that Y's option price is $125, or 12.5% of the total contract price. Under these facts, notwithstanding that the “lease” may be treated as a finance lease (and thus as a “purchase”) for California franchise and income tax purposes, under California sales and use tax law the “lease” would generally be treated as a lease and the rules of subsection (b) of this regulation would apply.

(1) Lessor Not Entitled to JSF Property Credit. A lessor of qualified property is never entitled to claim the JSF Property Credit with respect to any item of qualified property it leases to another party, regardless of whether the lessor is otherwise a qualified taxpayer.

(2) Binding Contract Rules Applicable to Leases. In the case of any qualified property leased pursuant to any agreement or contract that is treated as a binding contract under the rules of subsection (e) of Regulation 17053.37-4, the allocation rules of subsection (e) of Regulation 17053.37-4 shall apply in determining the amount of the qualified cost to the lessor upon which the lessee is entitled to claim the JSF Property Credit. For this purpose, if a lessor acquires qualified property under the terms of a contract that is treated as a binding contract with respect to the lessee (or a party related to the lessee within the meaning of Internal Revenue Code sections 267 or 318), then any payments or reimbursements made by the lessor, directly or indirectly in the form of a reduction in the amount of lease rental payments to be paid by the lessee under the lease, upon or as a result of the lessor's assumption of the lessee's obligations under the binding contract, shall be treated in the same manner as if the lessor had not assumed the lessee's obligations under the contract. Finally, in any case where a lessor has acquired property prior to January 1, 2001, and thereafter leases such property, the qualified cost to the lessor upon which the lessee would be entitled to claim the JSF Property Credit would generally be zero (assuming the lessor has not paid otherwise qualified costs after January 1, 2001, to improve or otherwise modify the leased property, in which case the lessor would have qualified costs to the limited extent of such post-2000 amounts that were paid).

EXAMPLE 1: D, a qualified taxpayer, is engaged in the business of manufacturing aircraft landing gear in Palmdale. On September 20, 2000, D enters into a contract with X to acquire 3 machines that are qualified property for a total contract price of $900. Under the terms of the contract, D makes a non-refundable deposit to X of $150 upon execution of the contract, with an additional $150 due on July 1, 2001, and the final payment of $600 payable upon delivery of the machines on February 15, 2002. Assume that this contract is treated as a binding contract under subsection (e) of Regulation 17053.37-4. On January 15, 2002, D decides that it would prefer to instead lease the machines, so D enters into a contract with L, an equipment leasing company, under which L will (i) assume D's obligations under D's contract with X, (ii) lease the qualified property to D for a term of 10 years, and (iii) refund to D the $300 in payments that D has previously made to X. Assume that L will pay California sales tax on its purchase of the qualified property from X. Under these facts, L will be treated as having $750 in qualified costs for which D will be entitled to claim the JSF Property Credit, which is the total amount treated as paid by L after January 1, 2001 ($600 paid directly by L to X under X's contract with D, plus $150 paid by L to D as reimbursement for D's payment on July 1, 2001, but excluding the $150 paid by D to X prior to January 1, 2001).

EXAMPLE 2: Assume the same facts as in EXAMPLE 1, except that instead of L agreeing to refund the $300 in payments that D has previously made to X, L instead reduces the amount of the rental payments to be due from D under the lease. Under these facts, the result is the same as in EXAMPLE 1.

(3) Special Rules Applicable to All Leasing Transactions

(A) Placed in Service. In the case of any leasing transaction, the requirement that qualified property must be placed in service in California in order for a qualified taxpayer to claim the JSF Property Credit shall be treated as having been satisfied at the time when all the terms and conditions of the lease contract have been completed so that the lessee has an unconditional obligation to pay all rents due under the contract to the lessor of the qualified property. However, notwithstanding the preceding sentence, the requirement of subsection (b)(4) of Regulation 17053.37-5 that property be primarily used in qualified activities to manufacture a product for ultimate use in a Joint Strike Fighter must still be satisfied in order for a lessee to claim the JSF Property Credit.

(B) Bid Amount Reduced by Credit. In no event shall any leasing transaction qualify for the JSF Property Credit unless the bid reduction requirements contained in Revenue and Taxation Code section 17053.37, subsection (i)(2), and Regulation 17053.37-7 have been satisfied with respect to the bid which contains the Joint Strike Fighter Property Credit allowable for the qualified property that is the subject of the lease.

EXAMPLE: On July 1, 2001, A, a qualified taxpayer, enters into a contract to lease a drill press from B, an equipment leasing company, for use in A's manufacturing facility in Roseville. Under the terms of the lease contract, A's rental obligations commence at the beginning of the month following the date that A provides B with a written statement that the drill press has been received from C, the original manufacturer of the drill press, and that the drill press has been installed and is in good working order (e.g., A provides a Certificate of Acceptance to B). On January 15, 2002, A executes and delivers the required written statement to B. Under these facts, A is treated as having satisfied the “placed in service” requirement as of February 1, 2002, and, assuming all other requirements of Revenue and Taxation Code section 17053.37 have been satisfied, A is entitled to claim the JSF Property Credit.

(b) Operating Leases. In the case of any lease that is not treated as a sale under Part 1 (commencing with section 6001) of Division 2 of the Revenue and Taxation Code (relating to the payment and collection of California sales and use tax), the rules set forth in this subsection of this regulation shall apply. Any lease subject to the rules of this subsection of this regulation shall be referred to in this regulation as an “operating lease.”

(1) In General. Under Revenue and Taxation Code section 6006, subsection (g)(5), a lease of tangible personal property is generally treated as a sale for California sales and use tax purposes, unless the tangible personal property is leased in substantially the same form as acquired by the lessor or leased in substantially the same form as acquired by the transferor and the lessor or transferor has paid sales tax reimbursement or has paid use tax measured by the purchase price of the property.

EXAMPLE: L, a taxpayer engaged in the equipment leasing business, purchases 20 machine tools for $10 from P, a retailer of machine tools. L intends to immediately lease the machine tools, without modification, to X, a qualified taxpayer engaged in the business of manufacturing aircraft cockpit canopies in Visalia, for a term of 10 years. L pays California sales tax on its purchase of the machine tools, and then leases the machine tools to X. Assume that X does not have an option to purchase the machine tools upon the expiration of the lease term. Since L has paid California sales tax on its purchase of the machine tools and then leased the property in substantially the same form as acquired, L's lease to X is not treated as a sale under Revenue and Taxation Code section 6006, subsection (g)(5), and the rules of this subsection of this regulation apply.

(2) Applicable Requirements. In the case of an operating lease, the following requirements must be satisfied in order for the lessee to claim the JSF Property Credit.

(A) Lessee Must Be a Qualified Taxpayer. The requirement under Regulation 17053.37-3 that the user of the qualified property must be a qualified taxpayer shall be applied to the lessee and not to the lessor.

(B) Use of Property in Qualified Activities. The requirement under subsection (b)(4) of Regulation 17053.37-5 that property be used in qualified activities in order to be treated as qualified property shall be applied to the lessee and not the lessor with respect to the property that is the subject of an operating lease.

(C) Sales or Use Tax Payment Requirement. Except as provided in subsections (b)(3)(B) or (b)(5)(B) of this regulation (relating to capitalized labor), the lessor must pay California sales tax reimbursement or California use tax on the lessor's construction, reconstruction or acquisition of the qualified property. In any case where the lessor's acquisition of the qualified property is pursuant to a transaction treated as either an occasional sale under Revenue and Taxation Code section 6006.5 or as a sale of mobile transportation equipment (as defined in Revenue and Taxation Code section 6023), the requirement of this subsection of this regulation shall be satisfied only if the lessor makes a timely election under either Revenue and Taxation Code sections 6094.1 or 6244(d) and pays California sales tax reimbursement or California use tax with respect to the lessor's acquisition of the qualified property.

(D) Qualified Costs. The requirement that costs, in order to be treated as qualified costs, must be paid or incurred for the “construction, reconstruction, or acquisition” of qualified property shall not apply to the lessee's lease rental payments. Thus, for example, although a lessee may, under the lessee's method of California tax accounting, currently deduct its lease rental payments, the lessee will still be entitled to claim the JSF Property Credit if the other requirements of this subsection of this regulation are satisfied. However, the rules of Regulation 17053.37-4, including the rules relating to the allocation of costs paid or incurred pursuant to binding contracts, shall apply in determining the amount of qualified costs of the lessor upon which the lessee may determine its JSF Property Credit.

(E) Chargeable to Capital Account. The requirement that costs, in order to be treated as qualified costs, must be properly chargeable to the capital account of the qualified taxpayer shall not apply to the lessee's lease rental payments. Thus, for example, although a lessee may, under the lessee's method of California tax accounting, currently deduct lease rental payments, the lessee will still be entitled to claim the JSF Property Credit if the other requirements of this subsection are satisfied.

(3) Amount of JSF Property Credit Lessee May Claim. In general, a lessee under an operating lease is entitled to claim the JSF Property Credit at the same time and in the same amount as if such lessee had instead constructed, reconstructed, or acquired the qualified property other than by lease.

(A) Qualified Cost to Lessor. Except as provided in subsection (b)(3)(B) of this regulation, the qualified cost to the lessor upon which the lessee is entitled to claim the JSF Property Credit is generally equal to the purchase price amount on which California sales tax reimbursement or use tax has been paid by the lessor. Thus, for example, if a lessor pays $100 for an item of qualified property, plus $8 in California sales tax reimbursement on such item, the qualified cost to the lessor would be $100.

(B) Exception For Capitalized Labor. The qualified cost to the lessor under subsection (b)(3)(A) of this regulation shall also include any capitalized labor that is a direct cost, as that term is used in Internal Revenue Code section 263A and defined in the regulations thereunder, that can be identified or associated with and are properly allocable to the construction or modification of the qualified property. Thus, for example, assume a lessor pays $100 for an item of qualified property, with $20 of a $50 total labor cost properly treated as capitalized direct labor costs that are exempt from California sales or use tax. While the lessor would pay only $4 (8% of $50) in California sales tax reimbursement on the lessor's purchase of the qualified property, the qualified cost to the lessor under this subsection of this regulation would be equal to $70 ($50 + $20).

(4) Special Rules for Operating Leases. The following special rules apply to any lease that is treated as an operating lease under this regulation.

(A) Limitation on Qualified Costs. In determining a lessor's qualified cost under the rules of this subsection of this regulation, the allocation rule specified in Regulation 17053.37-4 shall apply to any costs actually paid by the lessor (or treated as paid by the lessor under the rules in this regulation) pursuant to a contract that was binding on January 1, 2001. Thus, for example, if a lessor has a binding contract to acquire qualified property for $100 as of January 1, 2001, and has paid a non-refundable deposit of $20 prior to January 1, 2001, and thereafter pays the remaining $80 purchase price, the lessor's qualified cost upon which a lessee may claim the JSF Property Credit could not exceed $80 ($100 purchase price less $20 actually paid prior to January 1, 2001, pursuant to a binding contract).

(B) Reduction in Qualified Cost to Lessor. In the case of any re-lease of qualified property by a lessor to another qualified taxpayer, the qualified cost to the lessor under subsection (b)(3)(A) of this regulation as to the subsequent lessee shall first be reduced by the amount of qualified cost taken into account by any predecessor lessee. However, the preceding sentence shall not apply to the extent that the predecessor lessee was required to recapture any JSF Property Credit allowed to the predecessor lessee under the recapture rules in Regulation 17053.37-8.

EXAMPLE 1: L, a taxpayer engaged in the equipment leasing business, acquires two cranes from R, a manufacturer of cranes in Oxnard, for $100. L intends to immediately lease the cranes to M, a qualified taxpayer, for use by M in its manufacturing facility located in Ventura. Assume the lease is properly treated as an operating lease under this regulation and that L pays sales tax to R of $8 (8% of $100) at the time of L's purchase. Under these facts, M will be entitled to claim a $10 JSF Property Credit (10% of $100) since L's qualified cost is $100.

EXAMPLE 2: Assume the same facts as in EXAMPLE 1, except that at the end of the lease term L re-leases the cranes to P, a qualified taxpayer, which manufactures synthetic resins and composite materials at a facility in Moorpark. Under subsections (b)(3)(A) and (b)(4)(B) of this regulation, L's qualified cost upon which P may claim the JSF Property Credit is zero ($0) since L's qualified cost is $0 ($100 original qualified cost to L, less $100 qualified cost taken into account by a predecessor lessee, M, when claiming the JSF Property Credit).

EXAMPLE 3: Assume the same facts as in EXAMPLE 2, except that M, the initial lessee, cancels the lease with L after 10 months, with L repossessing the cranes. Under these facts, M would be required to recapture (pursuant to Regulation 17053.37-8) the entire $10 JSF Property Credit previously claimed by M, and L's qualified cost upon L's re-lease of the cranes to P would be $100 ($100 original qualified cost to L, less $100 qualified cost taken into account by a predecessor lessee, M, plus $100 of qualified cost recaptured upon M's cancellation of the lease with L).

(C) Qualified Cost to Successor Lessor. In any case where a successor lessor acquires qualified property from a lessor that is subject to a lease (including any qualified property that is not currently being leased but which the successor lessor intends to re-lease) in a transaction that is not treated as a sale for California sales and use tax purposes, the qualified cost to the successor lessor for purposes of the JSF Property Credit shall be reduced by the amount of qualified cost of the predecessor lessor that was taken into account by any lessee in computing a credit under the JSF Property Credit. However, the preceding sentence does not apply in any case where the transaction in which the successor lessor acquires the qualified property from the predecessor lessor is treated as a sale for California sales and use tax purposes.

EXAMPLE 1: G is engaged in the equipment leasing business. G acquires three drill presses from Q, a manufacturer of drill presses, for $300. G immediately leases the printing presses to D, a qualified taxpayer, for use by D in D's machine tool facility in Santa Barbara. Assume the lease is properly treated as an operating lease under this regulation, and that G pays sales tax to Q of $24 ($300 X 8%) at the time of purchase. Under these facts, D would be entitled to claim a JSF Property Credit of $30 (10% of $300, G's qualified cost of the drill presses). Three years later G sells the drill presses to H, who is also engaged in the business of equipment leasing, for $250. Assume that G terminates its lease with D prior to the sale of the drill presses to H, and that H delivers a resale certificate to G so that H's purchase is exempt from California sales and use tax. Assume further that D agrees to re-lease the drill presses from H following H's acquisition of the drill presses from G. D terminates its lease two years after H's purchase of the drill presses, and H then re-leases the drill presses to E in a transaction treated as an operating lease under this regulation, for use by E in its tool and die facility in Bakersfield. Under these facts, H's qualified cost upon which E may claim the JSF Property Credit is $0 ($250 paid by H to G, less $300 qualified cost taken into account by a predecessor lessee, D).

EXAMPLE 2: Assume the same facts as in EXAMPLE 1, except that G does not terminate its lease with D prior to G's sale of the drill presses to H. Under California sales and use tax law, the sale by G to H would be subject to California sales tax and H would not be entitled to deliver a resale certificate to G. As a result, assume H pays California sales tax reimbursement to G on the $250 purchase price. Since H has paid California sales tax reimbursement to G, H's qualified cost upon which E may claim the JSF Property Credit is $250.

(D) Acquisition by Lessee of Leased Property. In any case where a lessee (or any party related to the lessee within the meaning of Internal Revenue Code sections 267 or 318) of qualified property acquires the leased property from the lessor within one year of the date the qualified property is first used by the lessee, then the purchase of the qualified property by the lessee shall be treated as a disposition of the property by the lessee and any JSF Property Credit claimed by the lessee must be recaptured by the lessee under the rules of Regulation 17053.37-8. However, if the lessee (or related party) pays California sales or use tax on the acquisition of the qualified property, then the rules of Regulation 17053.37-4 shall apply to the acquisition and the lessee-purchaser may be entitled to claim the JSF Property Credit with respect to its costs of acquisition.

EXAMPLE 1: J, a qualified taxpayer, leases five lathes which are qualified property from Z, which is engaged in the equipment leasing business, for use in J's manufacturing facility in Folsom. Assume J's lease is treated as an operating lease under this regulation, and that J has claimed the JSF Property Credit. Nine months after J first uses the lathes, J exercises an option under the lease to acquire the lathes from Z for their fair market value. Under the rules of this regulation, and Regulation 17053.37-8, J would be required to recapture any JSF Property Credit claimed by J. However, if J paid California sales or use tax on the purchase of the lathes, then J may have qualified costs on J's purchase from Z under the rules of Regulation 17053.37-4.

EXAMPLE 2: Assume the same facts as in EXAMPLE 1, except that K, a wholly owned subsidiary of J, instead purchases the lathes from Z. Under the rules of this regulation, since K is related to J under both Internal Revenue Code sections 267 and 318, K's acquisition of the lathes will be treated as a disposition by J of the qualified property and J will be required to recapture the JSF Property Credit. If K continues to lease the lathes to J, then the rules of subsection (b)(4)(C) of this regulation shall apply in determining whether K will have qualified cost in the lathes upon which J may claim a JSF Property Credit upon K's acquisition of the lathes. On the other hand, if K cancels the lease with J (assuming K may legally do so) and uses the lathes in a qualified activity conducted by K, then, assuming K has paid California sales or use tax on its acquisition, K may have qualified costs under the rules of Regulation 17053.37-4 assuming K continues to use the lathes in a qualified activity instead of re-leasing the lathes.

(5) Sale-Leaseback Transactions. In the case of any sale-leaseback transaction, the following rules shall apply:

(A) General Rule. Except as provided in subsection (b)(5)(B) of this regulation, in the case of any sale-leaseback transaction in which a lessor does not pay California sales or use tax upon acquisition of an item of qualified property, the qualified cost to the lessor upon which the lessee would be entitled to claim the JSF Property Credit shall be zero.

EXAMPLE: On January 15, 2001, F, a qualified taxpayer engaged in the business of manufacturing aircraft navigational instruments, purchases three glass grinders that are qualified property from Y, the manufacturer of the glass grinders. Y collects California sales tax on the purchase by F. On January 30, 2001, F places the three grinders in service in its manufacturing facility in Crescent City. On May 15, 2001, G, which is engaged in the equipment leasing business, purchases the three grinders from F and immediately leases them back to F. Under the rules of this regulation, and Regulation 17053.37-8, F would be required to recapture any JSF Property Credit claimed by F. In addition, since this transaction would not be treated as an “acquisition sale and leaseback” under Revenue and Taxation Code section 6010.65, G must pay California sales or use tax on G's purchase of the grinders in order for F to claim any JSF Property Credit under the rules of this regulation. If G delivers a resale certificate upon its acquisition of the grinders, so that G does not pay California sales or use tax upon G's acquisition of the grinders, then no JSF Property Credit could be claimed by F upon F's lease of the grinders from G.

(B) Acquisition Sale and Leaseback. In the case of any transaction that is properly treated as an “acquisition sale and leaseback” under Revenue and Taxation Code section 6010.65, the requirement of subsection (b)(2)(C) of this regulation (relating to payment of California sales or use tax) shall be deemed satisfied by the lessor. If a transaction is treated as an “acquisition sale and leaseback” under this subsection of this regulation, then the qualified cost to the lessor under subsection (b)(3)(A) of this regulation shall be equal to the amount upon which the lessee paid California sales or use tax, plus any capitalized labor costs determined under subsection (b)(3)(B) of this regulation. However, the rules of this subsection of this regulation shall only apply if, and to the extent that, the costs originally incurred by the lessee to acquire, construct, or reconstruct the qualified property were treated as qualified costs under Regulation 17053.37-4.

EXAMPLE 1: On December 1, 2001, P, a calendar year qualified taxpayer engaged in the business of manufacturing composite material, purchases and immediately places in service two mixing tanks that are qualified property from Z, the manufacturer of the mixing tanks. Z collects sales tax on the purchase by P. On January 15, 2002, R, which is engaged in the equipment leasing business, purchases the two mixing tanks from P and immediately leases them back to P. Since R's acquisition and leaseback occurs within 90 days of P's first functional use of the mixing tanks, and assuming the other requirements of Revenue and Taxation Code section 6010.65 are satisfied, P's sale to R and R's leaseback to P are treated as an “acquisition sale and leaseback” under Revenue and Taxation Code section 6010.65 and the rules of subsection (b)(5)(B) of this regulation would apply. Under the rules of this regulation, and Regulation 17053.37-8, P would be required to recapture any JSF Property Credit claimed on P's 2001 California return. However, R would be “deemed” to have paid California sales or use tax upon R's acquisition of the mixing tanks from P, and P would be entitled to claim an JSF Property Credit on its 2002 California return in an amount equal to R's qualified cost, as determined under subsections (b)(3)(A) and (b)(3)(B) of this regulation. For this purpose, R's qualified cost could not exceed P's qualified cost determined under Regulation 17053.37-4.

EXAMPLE 2: Assume the same facts as in EXAMPLE 1, except that P purchases and places the mixing tanks in service on December 1, 2000, and R purchases the mixing tanks from P and immediately leases them back to P on January 15, 2001. Under these facts, even though the transaction would be treated as an “acquisition sale and leaseback” under Revenue and Taxation Code section 6010.65, since P's qualified cost under Regulation 17053.37-4 would be equal to zero, R's qualified cost under this regulation would similarly be equal to zero, and thus no JSF Property Credit would be allowed to R.

EXAMPLE 3: Assume the same facts as in EXAMPLE 1, except that P purchased the mixing tanks under a contract that was treated as a binding contract under the rules in Regulation 17053.37-4. Assume further that 25 percent of P's total cost for the mixing tanks was actually paid prior to January 1, 2001, so that P's qualified cost for the mixing tanks was equal to 75 percent of the total cost of the tanks. Under these facts, since P's qualified cost under Regulation 17053.37-4 would be equal to 75 percent of P's total cost for the mixing tanks, R's qualified cost under this regulation could not exceed the amount of P's qualified cost, irrespective of the total amount paid by R to P to purchase the mixing tanks.

(6) Lessor Reporting Requirement. In the case of any lease treated as an operating lease under this regulation, the lessor shall provide the lessee with a statement within 45 days after the close of the lessee's taxable year for which the JSF Property Credit is allowable to the lessee. This statement shall contain the amount of the lessor's qualified cost (as calculated under this regulation) upon which the lessee is eligible to compute the JSF Property Credit and the amount of such qualified cost upon which the lessor has paid California sales or use tax. For purposes of providing this statement only, if a lessor is legally obligated to remit California sales or use tax with respect to its acquisition of qualified property, but has not yet remitted such amounts solely due to timing differences between the lessor's California sales and use tax return filing period and the lessee's taxable year, then the lessor may treat the amounts upon which the California sales or use tax liability arises as “qualified costs to the lessor.” The statement required by this subsection of this regulation should not be filed with the lessee's tax return for the taxable year, but shall instead be made available to the Franchise Tax Board upon request.