TECHNICAL ASSISTANCE ADVISORY95-006

SUBJECT: Business Investment & Jobs ExpansionTax Credit -- Qualified Investment in sale/leaseback property.

Property Tax -- Taxability of leasehold interest.

This letter is in reply to a request for a technicalassistance advisory, as provided in W. Va. Code §11-10-5r,based upon facts submitted in support of the said request.

FACTS

The request for a technical assistance advisorystates that a manufacturer has acquired a site in West Virginiafor the purpose of constructing a manufacturing facility. Thefacility is to be constructed and equipped over a period of years. At least fifty new jobs will be created as a result of the placementof the qualified investment property into service in West Virginia.

The manufacturer purchased several acres of landfrom a local development authority. Pursuant to a prior arrangementand in connection with the issuance of industrial developmentbonds, the manufacturer will execute a sale/leaseback arrangementwith an agency or instrumentality of the State of West Virginiawhereby the real property will be conveyed to the West VirginiaState agency or instrumentality and leased back at a fair marketrate based upon the purchase price of the property, the constructioncost of improvements thereon (taking into account future expansionand improvements) and a market interest rate. The manufacturerwill also enter into a similar arrangement for personal propertyrequired to equip the facility.

The lease agreements have initial terms of 20 yearswith provisions for renewals, with each renewal being for a periodof five years. The equipment lease will allow for the substitutionof replacement property for the original property.

DISCUSSION AND ANALYSIS

The manufacturer requests a technical assistanceadvisory to the effect that:

1. Under the circumstances described above the sale/leasebackarrangement will in no way negatively impact the manufacturer'sability to utilize or claim the Super Tax Credit,

2. The original cost of the property subject tothe lease shall be the basis for claiming the Super Tax Credit(subject to the job creation factor and the payroll factor containedin the statute) and that the rent reserved under the primary termof the lease will not be used to determine the measure of qualifiedinvestment for Super Tax Credit purposes,

3. The manufacturer does not have a taxable interestfor property tax purposes in the property subject to the leaseor in the lease itself, and

4. A subsequent reorganization, restructuring orsale of the West Virginia operation or business will not, in andof itself, result in the creation of a taxable interest for propertytax purposes in the property subject to lease or in the leaseitself for the successor corporation or entity.

A. Effect of sale/leaseback on Super TaxCredit

Qualified investment for purposes of the West VirginiaBusiness Investment and Jobs Expansion Tax Credit ("SuperTax Credit") is the applicable percentage of the cost ofproperty purchased or leased for business expansion, as set forthin Section 11-13C-6 of the West Virginia Code. Therefore, althoughit may be necessary to apply a more complex analysis in determiningthe actual cost of the investment in such property for purposesof the Super Tax Credit, use of the sale/leaseback mechanism shouldnot cause a loss of entitlement to the Super Tax Credit basedupon the cost of investment.

B. Basis for determining Super Tax Creditqualified investment.

The Super Tax Credit statute mandates that qualifiedinvestment be the applicable percentage of the cost of propertypurchased or leased for business expansion determined in accordancewith Section 11-13C-6 of the West Virginia Code.

The situation described in the request for thistechnical assistance advisory discusses both a purchase and alease of the property. It appears that Company will purchasereal and tangible personal property, presumably at fair marketvalue from third party vendors, and then enter into agreementswith third party lessors who will purchase the property from Companyand then lease the property back to Company.

The Super Tax Credit law is silent on how such transactionsare to be treated when determining the amount of qualified investmentin sale/leaseback property. Property purchased for business expansionis defined in Section 11-13C-3(b)(19) of the West Virginia Code,and property excluded from the definition of property purchasedor leased for business expansion is defined in Section 11-13C-14(e)(2)of the West Virginia Code. The basic guideline for determiningthe cost base for qualified investment is actual cost. In thecase of a sale and leaseback, when there is no manipulation ofthe amount of qualified investment and the rent reserved for theprimary term of the lease is less than or equal to the cost ofthe property to the lessee prior to the sale/leaseback, originalcost rather than rent reserved for the primary term of the leasemay be used when determining the base for calculating the qualifiedinvestment for purposes of the Super Tax Credit.

When rent reserved for the primary term of the leaseis greater than original cost, the lessee has the option of usingrent reserved for the primary term of the lease as the base forcalculating qualified investment for purposes of the Super TaxCredit, to the extent that rent reserved for the primary termof the lease and the lease itself qualify for Super Tax Credit,the amount of the lease payments are quantifiable (as opposedto nonquantifiable lease payments), and other requirements ofthe Super Tax Credit law are satisfied. If, however, the lesseeis prohibited from expensing lease payments for federal incometax purposes, then, under Section 11-13C-14(e)(5) of the WestVirginia Code, the property must be treated as having been purchasedfor purposes of the Super Tax Credit qualified investment calculation,and the base for determining the amount of qualified investmentwill be the amount allowed for federal income tax purposes asthe basis in the property.

C. Property Tax: Taxability of leaseholdinterest

Under West Virginia's ad valorem property tax law,leased property is generally assessed and taxed in the name ofthe owner of the leased property and the leasehold interest ofthe lessee is not separately assessed and taxed. This is because,when the lease is a market value lease, the leasehold interestdoes not have a separately determinable market value. The lessorreceives market value rental payments and owns the reversionaryinterest in the property. Thus, the entire value of the property,both present and future interests, inures to the benefit of thelessor. The lessor enjoys the full value of its property.

When, however, the leasehold interest has a separatelydeterminable market value, such as a lease with payment termsmore favorable to the lessee than would arise under a market valuelease of the same property, the lessor is receiving a value forits property which is less than the full value of the property,and the leasehold estate owned by the lessee has a separate valueas a result of the difference between the fair market value leaserate and the favorable lease rate.

The request for this technical assistance advisorystates that Company will execute a sale/leaseback arrangementwith the West Virginia Economic Development Authority in whichthe real property will be conveyed to the West Virginia EconomicDevelopment Authority and leased back at a fair market rate basedupon the purchase price of the property, the construction costof improvements thereon (taking into account future expansionand improvements) and a market interest rate. Company will enterinto a similar arrangement for personal property required to equipthe facility.

If the lease is a fair market value lease, thenCompany will not have a separately assessable and taxable interestfor property tax purposes in either the property subject to thelease or in the lease itself.

D. Effect of a restructuring

A reorganization, restructuring or sale of the WestVirginia operation or business of Company will not, in and ofitself, result in creating for the successor corporation or entitya taxable interest for property tax purposes in the property subjectto lease or in the lease itself, if the lease remains a fair marketvalue lease. Judgements on market value are made annually.

CONCLUSIONS

Based upon facts submitted for purposes of thisruling, the Tax Commissioner hereby finds and rules:

1. Effect of sale/leaseback on Super TaxCredit. -- Under the circumstancesdescribed above, the sale/leaseback arrangement will in no waynegatively impact Company's ability to utilize or claim the SuperTax Credit.

2. Basis for determining Super Tax Creditqualified investment. -- If rentreserved for the primary term of the lease is less than or equalto the cost of the property to the lessee prior to the sale/leaseback,and if there appears to be no manipulation of the amount of qualifiedinvestment, then Company may use original cost rather than rentreserved for the primary term of the lease when determining thebase for calculating the qualified investment for purposes ofthe Super Tax Credit.

If rent reserved for the primary term of the leaseis greater than original cost, then the lessee has the optionof using rent reserved for the primary term of the lease as thebase for calculating qualified investment for purposes of theSuper Tax Credit, if the rent reserved for the primary term ofthe lease and the lease itself qualify pursuant to the requirementsof the Super Tax Credit law regarding lease terms, quantifiablelease payments (as opposed to nonquantifiable lease payments)and other requirements of the Super Tax Credit law. However,if the lessee is prohibited from expensing lease payments forfederal income tax purposes, then, under Section 11-13C-14(e)(5)of the West Virginia Code, the property must be treated as havingbeen purchased for purposes of the Super Tax Credit qualifiedinvestment calculation, and the qualified investment must be basedon the amount allowed for federal income tax purposes as the basisin the property.

3. Taxability of a leasehold interest.-- Company's interest in a fair market value lease, as describedin the request for a technical assistance advisory, will not bea separately assessable and taxable interest for ad valorem propertytax purposes in either the property subject to the lease or inthe lease itself.

4. Effect of a restructuring.-- A reorganization, restructuring or sale of the West Virginiaoperation or business of Company will not, in and of itself, resultin creating for the successor corporation or entity a taxableinterest for property tax purposes in the property subject tolease or in the lease itself, if the lease remains a fair marketvalue lease. Judgements on market value are made annually.

The conclusions reached in this technical assistanceadvisory are based upon the facts submitted and application ofcurrent law. In the event there is a material change in the facts,or if it is determined that material facts were omitted or arematerially different from those furnished to us for purposes ofthis ruling, or there is a material change in the applicable law,the conclusions reached in this advisory may no longer apply.

Declaration of Precedential Value.-- Under W. Va. Code §11-10-5r(b), a technical assistanceadvisory has no precedential value, except to the taxpayer whorequests the advisory, unless the Tax Commissioner specificallystates that it has precedential value. Due to the specializednature of the question presented for ruling, this technical assistanceadvisory is declared to have no precedential value, and may notbe relied upon by any person other than the specific taxpayerwho requested the advisory.

Publication. -- UnderW. Va. Code §11-10-5r(e), the Tax Commissioner is requiredto release technical assistance advisories to the public afterthey are modified to delete identifying characteristics. Thisadvisory will be released as Technical Assistance Advisory 95-006.

Should you have any questions about this technicalassistance advisory, please contact this office at your earliestconvenience.


Issued: January 26, 1996 James H. Paige III

Secretary/Tax Commissioner