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Dec 1989

New Jersey: sales tax on leases. (State & Local Taxation)

by Murphy, Henry J.

    Abstract- An amendment to the New Jersey Sales and Use Tax Act requires full payment of sales taxes applying to leases at the time that leases are entered into. The amendment shifts the burden of the tax on to the lessor, who is now considered the end user of the property. The amendment may have serious adverse affects on the cash flow of lessors' taxable property. After June 26, 1989, the lease sales tax will be payable in a lump sum at the time the lease is entered into and applies to leases of more than 28 days. The lessor can elect to pay six percent of either the purchase price of the leased property or six percent of the total anticipated payments from leased property. Currently, there is no mechanism to recover the sales tax remitted to the state if a lessee defaults on the lease and no adjustments for leases adjusted to less than 28 days.

A recent amendment to the New Jersey Sales and Use Tax Act may adversely affect the cash flow of lessors of taxable property by requiring the full payment of applicable sales tax at the time of entering into a lease and by shifting the burden of tax to the lessor. Prior to amendment, the rental of tangible personal property used in the state, unless otherwise exempt, was subject to 6% sales tax. Such amounts were remitted to the state by lessors as they were billed to and collected from lessees in periodic rent payments.

Effective for leases entered into on and after June 26, 1989, the sales tax applicable to a lease transaction will be payable in a lump sum by the lessor at the time the lease is entered into. No sales tax is collected from the lessee, since the lessor will be considered the end user of the property. If not previously registered, lessors must secure a sales tax certificate of authority from the Division of Taxation within three days of purchasing property for lease in the state. The new rules apply only to leases of property for periods of more than 28 days. Leases for shorter periods will continue to be taxed on a transaction by transaction basis under existing rules.

In calculating the amount to be remitted to the state, the lessor may elect to pay 6% of either of the following amounts: 1) the purchase price of the property subject to the lease; or 2) the total anticipated payments attributable to the leased property.

A new election is available with respect to each lease or when property which has been previously leased is transferred to a new lessee. No credit is allowed for the value of property traded in when calculating the tax on the basis of the purchase price. The amendment does not change the status of exempt transactions. Therefore, leases entered into with exempt organizations, or for exempt uses, such as machinery used in a manufacturing process, will continue to be exempt from sales tax.

A new form, the Lessor Certification (ST-40), has been developed which is to be executed by the lessor and retained by both parties to the lease. The lessor is required to certify payment of the applicable tax liability or indicate that the transaction is exempt from tax. The form is not filed with the state, but is retained for audit purposes. No change in the remittance schedule is required for leases executed prior to June 26, 1989. The sales tax applicable to such leases will continue to be remitted to the state as collected from the lessee.

Upon termination of a pre-June 26, 1989, lease followed by a subsequent renewal or execution of a new lease, sales tax must be paid on the original purchase price of the property. An option to calculate the tax by reference to the expected new lease payments is not available. However, a credit will be allowed for the periodic taxes that were collected from the lessee and remitted to the state on prior payments. If such amounts equal or exceed the tax on the purchase price, no further remittance is required. The purpose of this provision is to put pre-June 26 leases on an even footing with new leases. If the property is sold at the conclusion of the pre-June 26 lease, the proceeds are subject to tax as a retail sale.

Out-of-State Lessors Are Not

Treated Kindly

For example, the presence of leased tangible personal property in the state is deemed to be a place of business for purposes of all taxation, thus laying to rest any doubt regarding nexus for corporate franchise tax liability. Further, property purchased by a non-resident for lease outside, but subsequently moved into the state for lease, is then subject to use tax. Similar to newly acquired property, the lessor has the choice of paying tax on either the property's original cost or the amount of remaining lease payments.

This is not the greatest of deals, since resident owners of taxable property who move it into the state after outside usage for more than six months receive more favorable treatment. Such taxpayers are permitted to calculate the use tax on current market value, not the original cost of the property. Therefore, it would appear to be more advantageous to a non-resident lessor to compute the tax on the basis of expected lease payments in NJ. However, a lessor who makes such an election must continue that practice for lease renewals of the same property, and the eventual sale of the property will be treated as a retail (taxable) sale. Although a credit is generally allowed for prior sales taxes paid to another state where property is moved into and becomes taxable in NJ, its availability as an offset in leasing transactions is unclear. While not mentioned in the state's initial bulletin on the sales tax amendment, it would appear to be allowable for sales taxes paid to those states which permit comity. Clearly, multi- state lessors have special planning to deal with.

Lessees are not totally protected from the tax rise, either, since the revised Act permits the state to proceed against the lessee if the lessor fails to pay the applicable tax. In such cases the tax will be based on the total of the periodic payments required under the lease. Therefore, lessees should insist upon a properly executed Form ST-40 from the lessor when taking possession of property after June 25, 1989, under a new lease or renewal of an existing lease.

There are Some Wrinkles

Certain provisions may result in financial hardship on the part of the lessor. For example, where the lessor elects to remit sales tax on the basis of anticipated periodic rentals and the lessee defaults before the end of the lease period, no mechanism exists to recover the sales tax attributable to any forfeited lease payments. Similarly, where property was initially purchased with the intention of leasing it for more than 28 days and tax was paid by the lessor based on the original cost, no adjustment is available if the property is subsequently converted to rentals for less than 28 days, thereby causing the periodic rental payments to become subject to tax.

Early information from the Division of Taxation has not, of necessity, covered all possible situations, especially in the area of renewals and options. For example, where a pre-June 26 lessee continues to hold property on a month-to-month basis following the end of the original lease term, when is the lessor required to remit the tax based on original cost, net of prior periodic payments, as prescribed? In the case of a new lease where the lessor elects to remit sales tax on the basis of anticipated lease payments, are renewal periods at the lessee's option to be taken into account? These and other situations which have been brought to the Division's attention should be addressed in forthcoming regulations.

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