February 4, 2011
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Question
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Ken,
One of my tax clients, who on my advice purchased your contracts, has a question. I can answer the business and tax parts, but not the legal questions.
He is leasing camera installations and uses your contracts. He has the lease set up as an operating lease (as your contracts allow) in which he owns the equipment. There is no purchase option. He is asking me how much to put in the space for the price of the equipment. I told him that that is primarily a legal question. From an accounting standpoint, since he is in Texas, the local ad valorem taxing authorities would tax him on the value of the equipment since he still owns it. From a tax standpoint, it would be best to have a low value, but I am thinking that this is a substance over form issue and the only value is the market value. He asked about making this a capital lease with a purchase option, but I am concerned that this may turn it into an installment sale raising some legal issues.
Bottom line, I think that he should value the equipment on the lease at the price that he would sell it for. What do you think?
Mitch Reitman
S.I.C. Consulting, Inc.
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Answer
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The alarm contracts are drafted for two primary purposes, 1) protect against liability and 2) build equity. These is accomplished by the various defensive provisions and encouraging recurring monthly revenue for a fixed contract term that continue through automatic renewal.
Leasing systems gives the alarm company the strongest hold on the subscriber relationship because once the system is installed the subscriber is less likely to want to switch alarm service providers and incur another installation cost. The Standard Form Contracts that are leases provide for a valuation of the equipment [in a Monitoring Contract it's the communication software and a transmitter if a separate one is installed]. The valuation of the equipment does not come into play unless there is a default by the subscriber, in which event the alarm company has the option of selling the equipment for the agreed value.
You will note that the Standard Alarm Contracts also define the installed equipment as personal property, carefully explaining that the installed equipment is not to be treated as a fixture and considered part of the realty. This characterization of the equipment runs afoul of sales tax provisions and
The valuation does not take into consideration tax consequences. Ad valorem tax, excise tax, sales tax, use tax, - all may come into play because of the personal property provision. But some states change the rules regarding the enforcement of the Exculpatory Clause, Limitation of Liability Clause and the Indemnity Provision when installation, maintenance or service involves real property. The enforcement of those provisions outweigh the tax consideration.
Taxing authorities of course may not consider themselves bound by the contract terminology, and thus allow installations to be treated as capital improvements rather than removable personalty, or ignore contracts that attempt to avoid tax consequences by calling an apple an orange. Because my practice involves protecting alarm companies in defense situations, and not tax issues, the potential for conflict exists. Tax Issues come up time to time and I leave those issues to accountants.
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Another tax question
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Ken
First nothing has been discussed with regards to New York State sales tax on leased fire alarm systems. If you have a large installations, lets say for $50,000.00, and the customer want to claim a capitol improvement so not to pay sales tax on the installation, he can not since the alarm company's contract states in its agreement that the system is theirs and can be removed upon completion of the lease.
Capitol improvements address real property and I don't know how one cannot claim this is not real property as well as the laws governing limited liability issues as it applies to real property in your agreement. Unlike a burglar alarm system the components of the fire alarm system are permanently affixed to the building regardless of what anyone says. Even though you say it can be removed the same argument can be used with bricks in a wall can be removed and reused. Try to make that hold up in court.
If you allow your customer to claim a capitol improvement and take their signed form you can be held liable for the tax. State that to your customer and then try and close the sale. What are your comments on this issue with regards to capitol improvement sales tax?
Second when filing a fire alarm system, lets say for now in New York City, you have to file with the Buildings and Fire Departments. The filings with the buildings department with regards to the fire alarm system are based upon the system becoming a permanent fixture of the building as any other building and structural items.
Therefore as recently confirmed upon removal you have to file with both these agencies for the removal with a licensed profession engineer etc. Just removing this system is not acceptable and leaves you open to tremendous liability and fines. So there is a great expense if you remove the system without doing so. What do you think about this and the limitation of your agreement regardless if you say this is the responsibility of your customer at the end or termination of the leased fire alarm system?
anon / fire alarm installer
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Answer
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Historically the courts in New York have enforced the personal property provision in the Standard Alarm Contracts in defense cases. Taxing authorities may ignore the personal property provision, or may not even be aware of it. Whether installed equipment becomes a fixture and part of the realty is not always clear. Some fixtures fall into a gray area because they could be removed. In those ambiguous cases the contract terminology is persuasive in tipping the balance between removable personalty and permanently attached fixture. If the equipment can be removed with little damage to the building, it can be treated as personalty. Most of the equipment that makes up a fire alarm system can be removed with a screw driver and wire cutter. That's not the same as bricks forming a structural wall.
Though taxing authorities may treat an installation one way for tax purposes the courts may continue to treat the installation another way for contract enforcement purposes. One is not necessarily bound by the other.
I am not aware of any court decisions in New York [or elsewhere] where this issue has been challenged and decided. In New York courts have treated alarm systems equally, as personalty when the contract provision calls for that treatment. There has been distinction for fire alarm systems, but the issue did not turn on how the fixture would be classified for tax purposes, but on a duty owed by the alarm company to the public independent of the contract duty. That is my primary concern, not the tax treatment.