NOTICE: Under IC 4-22-7-7, this document is required to be published in the Indiana Register and is effective on its date of publication. It shall remain in effect until the date it is superseded or deleted by the publication of a new document in the Indiana Register. The publication of this document will provide the general public with information about the department's official position concerning a specific issue.

Sales and Use Tax - Taxability of Transactions Involving Energy Savings

Authority: IC 6-2.5-1-11.5; IC 6-2.5-1-21; IC 6-2.5-2-1; IC 6-2.5-3-2; IC 6-2.5-4-10; IC 6-2.5-4-15; IC 6-2.5-5-8; 45 IAC 2.2-1-1; 45 IAC 2.2-4-2; 45 IAC 2.2-4-27; Cowden & Sons Trucking, Inc. v. Indiana Dep't of State Revenue, 575 N.E.2d 718 (Ind. T.C. 1991); AWHR Am.'s Water Heater Rentals, LLC v. Indiana Dept. of State Revenue, 941 N.E.2d 573 (Ind. T.C. 2010).

A company ("Company") is seeking a determination as to the following:

Company is a limited liability company based outside Indiana that provides energy-efficiency products. Company provides the following information regarding its business model and the structure of their transactions:

Company requests that it be determined that its Customers are exempt from paying sales tax on the Service Contract monthly payments in accordance with 45 IAC 2.2-4-2. Alternatively, if the transactions are not found to be exempt, Company inquires as to whether it can provide an exemption certificate as a sale for resale to the Vendor so that the Customer is not charged sales tax on both the original sale of equipment and again on the Service Contract payments.

Indiana imposes an excise tax called "the state gross retail tax" (or "sales tax") on retail transactions made in Indiana. IC 6-2.5-2-1(a). A person who acquires property in a retail transaction (a "retail purchaser") is liable for the sales tax on the transaction. IC 6-2.5-2-1(b). Indiana also imposes a complementary excise tax called "the use tax" on "the storage, use, or consumption of tangible personal property in Indiana if the property was acquired in a retail transaction, regardless of the location of that transaction or of the retail merchant making that transaction." IC 6-2.5-3-2(a).

Except for certain enumerated services, sales of services generally are not retail transactions and are not subject to sales or use tax. 45 IAC 2.2-4-2 clarifies the taxability of services as follows:

A unitary transaction is clarified in 45 IAC 2.2-1-1(a) as follows:

Pursuant to IC 6-2.5-4-10(a), "[a] person, other than a public utility, is a retail merchant making a retail transaction when he rents or leases tangible personal property to another person other than for subrent or sublease." IC 6-2.5-4-10(b) continues: "[a] person is a retail merchant making a retail transaction when the person sells any tangible personal property which has been rented or leased in the regular course of the person's rental or leasing business." Indiana's regulations at 45 IAC 2.2-4-27(b) further states that:

The term "actual receipts" is defined at 45 IAC 2.2-4-27(d):

Pursuant to 45 IAC 2.2-4-27(d)(2), sales tax is due on the lease payments:

If the lease requires the transfer of title upon completion of required periodic payments and payment of an option price that is less than or equal to one hundred dollars ($100) or one percent (1%) of the total required payments, whichever is greater, then sales tax is due at the beginning of the lease. Otherwise, sales tax is due on each lease payment. IC 6-2.5-1-21(a)(2).

Turning to the present matter to determine whether Company's transaction is for a service or a lease of tangible personal property, Company presented five distinctions in order to differentiate the transaction from a lease or sale. The first was that Company retains title and ownership in the technology; however, that is often the case with leases of technology. Further, Company may sell the technology to their Customers at the end of the term, which can also occur in leases. Additionally, contrary to Company's suggestion that the Customers do not have possession of the technology, conflating possession with ownership, the Customers do have the technology in their possession, as they are installed at the Customers' locations.

In AWHR Am.'s Water Heater Rentals, LLC v. Indiana Dept. of State Revenue, 941 N.E.2d 573 (Ind. T.C. 2010), the Indiana Tax Court addressed a similar matter involving a taxpayer which asserted that its transactions were not leases because it did not transfer possession or control of water heaters it installed. The taxpayer claimed that they were "in the business of providing 'worry-free and economical hot water.'" They installed water heaters in customers' homes, and in exchange the customers "agreed to pay a monthly fee to AWHR." Id. at 574. The taxpayer provided the water heaters to its customers "at no charge," bore the expense installing the water heaters, and agreed to make any necessary repairs. It was also agreed that the taxpayer maintained ownership of the water heaters. After an audit, "the Department [of Revenue] determined that AWHR should have collected sales tax from its Indiana customers during the years at issue. More specifically, the Department found that through its Plan, AWHR was leasing tangible personal property to its customers, thereby making the transactions subject to sales tax . . ." Id. The taxpayer maintained that it never transferred ownership and control of the water heaters, and therefore the transactions did not constitute leases.

The Court concluded that the transactions involving water heaters constituted lease transactions, reasoning:

Id. at 576. Like the taxpayer at issue in AWHR, Company may still own the equipment, but its Customers certainly have possession of the equipment when it is installed at the Customers' facilities, which supports a conclusion that the transactions constitute leases.

The second distinction is that Customers are charged for meeting performance criteria (in the example of a lighting solution, "lumen output and wattage delivery") instead of being charged a fee for the equipment, and may not be charged anything if the performance of the equipment is not to the level stated in the Service Contract. However, as 45 IAC 2.2-4-27(d)(1) states, "[t]he rental or leasing of tangible personal property, by whatever means effected and irrespective of the terms employed by the parties to describe such transaction, is taxable." (Emphasis added). Furthermore, the payment of a monthly fee is not determinative, as 45 IAC 2.2-4-27(d)(1) goes on to explain that any consideration received, even on a production basis, would be considered gross receipts:

Turning to the third distinction that the contract does not provide a list of the technology to be installed, instead listing the output of the installed system in the building, this appears to be a standard service-level agreement ("SLA"), common in leases of technology. The technology involved is still tangible personal property, whether specific items are listed upfront or not.

The fourth distinction is that the technology is not permanently installed, but many things rented or leased by a business are not permanently attached to a business's property (e.g., copiers, printers, etc.). These types of equipment could also be reclaimed by the lessee under certain criteria, including nonpayment by the lessor, just like the technology at issue.

Finally, the fifth distinction is that utility fees are not included in the Customer's monthly payment, and therefore Company maintains that the monthly service payment should not be subject to sales tax as it applies to utility/electric charges. However, this is not convincing either. In situations where someone rents or leases a water softener or water heater, for instance, the lessee would be expected to pay their own utility fees, but the lease or rental payments would still be subject to sales tax.

It is also dubious that energy savings or energy solutions constitutes a true service, and Company has not done enough to establish that this is a service. Many types of equipment that are leased (computer hardware, water heaters, copiers, etc.) are guaranteed by the lessor to perform better and to provide savings, including energy savings. Applying the serviceperson test found at 45 IAC 2.2-4-2, Company does not satisfy all of the requirements of 45 IAC 2.2-4-2(a). Applying the first part of the test, it is not clear that Company is in the business of primarily selling and furnishing services, and not selling or leasing tangible personal property. 45 IAC 2.2-4-2(a)(1). Company would also fail the second part of the test, as it has not been proven that the technology is used for the purpose of providing the technology incident to a service. 45 IAC 2.2-4-2(a)(2).

Applying the test for bundled transactions, where the retail transaction includes both a service and tangible personal property, reveals a similar conclusion. IC 6-2.5-4-15 provides that "[a] person is a retail merchant making a retail transaction when the person sells tangible personal property as part of a bundled transaction." IC 6-2.5-1-11.5 defines "bundled transaction" in pertinent part for a retail transaction that includes a service and the provision of tangible personal property as follows:

The requirements for determining the "true object" of a transaction are not defined in statute. The Indiana Tax Court held in Cowden & Sons Trucking, Inc. v. Indiana Dep't of State Revenue, 575 N.E.2d 718 (Ind. T.C. 1991), that the determination of whether a sale was a retail transaction turned on whether the "true object" of the transaction was service or property. In Cowden, the taxpayer was a hauler who only on occasion sold stone at cost to his customers as a convenience, and therefore the Court concluded that the "true object" of the transaction was the provision of service and not the sale of stone.

The technology is essential to the use of the service and is provided exclusively in connection with the service. However, it would appear that the true object of the transaction is the technology. The technology is what Customers actually want, because of the potential for energy savings. To that point, Company "does not guarantee energy savings," but instead it "guarantees function," which further implies that Customers are paying for the technology. The energy savings, to the extent that they are achieved, are a benefit of the technology provided. Without the technology, there would be no benefit. Therefore, if there was a service involved, this would be considered a bundled transaction for a lease of tangible personal property, and thus sales tax is required to be collected from Customers.

For all of these reasons, Company's transactions are determined to be a lease of tangible personal property, which is considered a gross retail transaction per IC 6-2.5-4-10. Therefore, the technology monthly fee is subject to Indiana sales and use tax as a fee charged for leasing tangible personal property. However, to Taxpayer's second question, IC 6-2.5-5-8 provides that:

Since Company purchases the technology for the purpose of leasing it, Company would be able to provide an Indiana General Sales Tax Exemption Certificate (Form ST-105) to the Vendor so that Company is not charged sales tax on the original sale, and Customers are only charged sales tax on the Service Contract payments.

The monthly fee charged by Company is subject to Indiana sales and use tax as a fee charged for leasing tangible personal property. However, Company may provide an Indiana General Sales Tax Exemption Certificate (Form ST-105) to the Vendor on the technology it purchases for purpose of leasing the technology to its Customers.

This ruling is issued to the taxpayer requesting it on the assumption that the taxpayer's facts and circumstances as stated herein are correct. If the facts and circumstances given are not correct, or if they change, then the taxpayer requesting this ruling may not rely on it. However, other taxpayers with substantially identical factual situations may rely on this ruling for informational purposes in preparing returns and making tax decisions. If a taxpayer relies on this ruling and the Department discovers, upon examination, that the fact situation of the taxpayer is different in any material respect from the facts and circumstances given in this ruling, then the ruling will not afford the taxpayer any protection. It should be noted that subsequent to the publication of this ruling a change in statute, regulation, or case law could void the ruling. If this occurs, the ruling will not afford the taxpayer any protection.