How to Calculate Tax on a Lease
Most people are familiar with leasing a car, but did you also know you can lease an airplane, a copier, or a computer? Leasing is commonly defined as an agreement between a lessor and a lessee, where the lessor conveys the right to use an asset for an agreed period of time in return for an agreed payment or series of payments. The flexibility provided is appealing to business owners and has caused rapid growth in the leasing industry in the past 50 years. Coupled with the growing complexity of the sales and use tax laws surrounding leasing transactions, the result is an increasing need for businesses to turn to a third party system to manage the legal nuances and calculate the sales and use tax consequences of each element of a leasing transaction.
Typing and Sourcing a Lease
Dissecting a leasing transaction for tax purposes can be extremely difficult due to the multiple considerations that must be made from beginning to end. In the U.S., upon entering the leasing arena, it is necessary to first determine the type of lease and the location where tax must be paid/collected. 
Determining both the lease type and the tax collection point are simple if your contracts are straight-forward and all of the assets you are dealing with originate and terminate in the same location. It is not as easy once you begin a multi-jurisdictional business, or if your assets are on wheels. In order to determine where to properly pay and collect tax, you must be familiar with each state’s individual sourcing rules, which vary from state to state.
The Effect of the Streamlined Sales Tax Project ( SSTP) on Lease Sourcing
In the past decade, many states have attempted to make sourcing rules and lease tax obligations more clear by joining the SSTP. To date, there are 24 states that are full and associate members of the project, which is a collaborative effort among member states to simplify sales and use tax collection and administration. The SSTP has its own set of rules that member states must adopt regarding sourcing of leasing transactions. These rules are outlined in the SSTP.
Knowing the Amount and Paying the Tax
After determining the sourcing location of a leasing transaction, you must look at the amount of tax that needs to be paid, the time when the tax must be paid (during the life of the lease) and who must pay the tax. The amount of tax that needs to be paid can be a result of the general sales and use tax rate or can be the result of a special lease tax rate, which may or may not take the place of the general rate. Some states, such as Massachusetts, apply the same tax rate to leases as they do to sales, while other states, such as Alabama, have completely separate lease and rental rates. To add confusion to the situation, the duration of the lease can also result in additional rates of tax or surcharges. Conversely, some states offer sales tax limitations. There can also be jurisdiction-based exemptions or tax reductions, like Urban Enterprise Zones. As if figuring out the nuances that determine the amount of the tax is not enough, there are multiple variations on the laws governing the mode by which sales and use tax can be paid domestically. States known as upfront states collect tax in full at the inception of the least. Stream states collect tax upon each individual lease payment, either upfront or on the lease stream. There are also a few states which exempt leasing transactions altogether and require the lessor pay tax when the asset is purchased for future lease. . For these reasons, tracking leases and with the correct tax can be an administrative nightmare if your company does business across many states.
The End of a Lease
What happens when a lease comes to an 
end? If the lease is a true operating lease, the answer is easy. The lessee takes the asset and goes along his/her way. In the case of a buy-out some states choose to tax the least as you would a regular sale of tangible personal property. Other states require that buy-outs are taxed at the initial inception of the lease. What if the lessee decides not to exercise the buy-out option? How about in Maine where leases are generally exempt from tax? Once a buy-out is exercised, tax must be paid on the buy-out amount, as well as on all lease payments made up to that point! Imagine if you have hundreds of leasing transactions running in Maine and you have to track each individual one? With recent technology developments in automated tax calculation software, figuring out these transactions can actually be as easy as letting the system know that the transaction needs to be recalculated merely through passing information that indicates that the buy-out is being exercised. Based on the multitude of rules that each state can require, an automated system needs to have the underlying logic that allows it to grow, change, and adapt itself to the ever-changing rules.
Leasing Worldwide
Despite market challenges that all global businesses face, the interest in leasing in the worldwide arena is also on the rise. In general, the lease of equipment is subject to VAT, CSTor GST internationally. Fair Market Value leases and conditional sales are usually used for equipment and the VAT treatment varies depending on the country. Some countries such as Azerbaijan fully exempt lease transactions, while other countries such as the Czech Republic and Russia fully tax lease transactions. In some countries such as Bulgaria only the interest element is exempt from VAT. Taxable equipment leases are usually subject to standard VAT rates, which range from 2% to 27% depending on the country. Additionally, the classification of the lease will dictate whether supply of goods or supply of services rules apply. Many of the same issues that face a customer in the US are also a concern worldwide and must be studied and addressed by the tax calculation system.
Conclusion
There are many tax parameters to think about when structuring leasing transactions and many more to think about as the lease continues to the point of termination. Things get even more complex if the asset relocates during the term of the lease. An advanced 
automated tax calculation engine that can technically adapt its functionality to keep up with the ever-changing scope of the laws surrounding leasing transactions may seem a little costly up-front, but can save you immeasurable amounts of time and human capital in the long run. For more information read our TaxPack on leasing. Contact us to learn how Taxware products and outsourced Tax Service can reduce risk and improve indirect tax processes for your organization.
