Surprise - Intercompany Real Property Rentals Are Subject To Florida Sales Tax - Even Without Paying Rent
For businesses that own their own buildings, the most common way of protecting the business from the liabilities of the operations is to place the land and buildings into a separate legal entity from the operations. This is a very standard, effective way of doing business in almost every state in the US. Usually rental agreements are put in place between the operating entity (Lessee) and the real estate entity (Lessor) with rent either equal to the mortgage payments, taxes, and insurance for the building or to some percentage of revenues of the operating entity. Occasionally, no rental agreement is put in place and the operating entity simply pays the mortgage, insurance, and taxes for the real estate entity. In most states, this does not create any significant tax problems. However, as anyone with a little bit of multi-state tax knowledge will tell you, what is true in most states is not true in every state.
Florida is one of the very few places in the country where commercial rental agreements are subject to sales tax at a state rate of 6% plus a local option rate of up to an additional 1% (Arizona & New York City also charge commerical rental taxes). Even most tax professionals are surprised to find out that sales tax is imposed on commercial rents when the lessor and lessee are commonly owned. The most surpising fact is that unlike the Federal income tax realm, Florida considers disregarded entities as seperate legal entities for Florida Sales and Use Tax purposes. This has the effect of blindsiding many businesses, surprisingly some of which are wholly owned and operated in Florida. However, the most common victim surprised by this tax scheme is the business that migrates into Florida from other states that do not impose a sales tax on commercial rentals. These out of state companies simply recreate the same corporate structure and rental agreements as they had been using in other states with dire tax consequences.
Even if no rental agreements are put into place and rents are never paid, if the operating entity pays the mortgage, insurance, or taxes for the real estate entity, then Florida takes the position that these amounts are the equivalent to rent and impose the sales tax on the payments made by the operating entity on behalf of the real estate entity. This too catches many, many companies off guard because when competent counsel does only a cursory reading of the relevant statutes – they could easily assume that if no rental agreements are in place and nothing is labeled "rent," then no sales tax would be due. The Florida Department of Revenue has been very successfully imposing sales taxes on the indirect payment of rent when the obligations of the real estate entity are paid directly by the operating entity. (See the US Cardio Vascular Inc vs FL DOR case below)
I cannot tell you the number of times our firm has received a phone call from a company that has just been through a Florida Tax Audit and they want help dealing with a very substantial tax assessment specifically due to sales taxes on intercompany rental situations. Florida trains even the greenest of auditors to look for signs of intercompany rental transactions and it is very rare that issue will escape detection. Because most Florida tax audits cover periods of 3 years, the imposition of up to a 7% tax, plus up to 50% penalty and interest can add up to a staggering amount. It is really disheartening because the entire tax amount on purely intercompany transactions could have been avoided with a little planning and advice from a trained Florida tax advisor.
If you or your client are going through an audit and are facing these issues, then there are ways to negotiate down the assessment if you have local, experienced counsel. Depending on your fact pattern, there may even be ways to argue some of the amounts paid should not be considered rent (such as the arguing part of payments should be considered interest instead of 100% rent). Any position we might be able to argue for you is very fact specific and a free consultation may reveal ways to lower the tax assessment. However, there are many situations in which proper planning can eliminate or significantly reduce a whole owned group of company's sate tax liabilities on related party leases.
If you or your client realizes that this situation applies to your company and you have Florida sales tax exposure on intercompany rental income, then there are ways to minimize the impact of the past transactions and to substantially lessen or possibly eliminate the sales tax on rents issue going forward. For example, a rental agreement for $1,000 annually would only be subject to approximately $70 of sales tax. You would still need to get the funds from the operating entity to the real estate entity to pay expense, but there are ways to do that safely too if proper planning is put in place and followed to a T (for example - profit distributions to a common parent).
If you are caught on audit treating the payments as "rent" on both your books and your federal income tax returns, then there is an alternative arguement that takes a little more time to make. The argument is that you made a mistake calling the payments rent. You have to amend your federal income tax returns and books to even begin making this arguement and this audit defense strategy may have other non-sales tax consequinces. Finally, this position is not guaranteed to win because it is very fact dependant, but it is an argument that we have made successfully multiple times in the past.
If no sales tax returns have been filed, then there is the possibility for the Florida Department of Revenue to claim taxes due for many years into the past. If the dollar amounts are substantial enough, then voluntary disclosure agreements can greatly reduce the overall impact of the taxes, penalties, and interest due – as well as the number of years open to the statute of limitations.
If you have any questions about this article, then please don't hesitate to contact me for a FREE CONSULTATION at JamesSutton@FloridaSalesTax.com or call me directly at 813-367-2134 at our Tampa office.
Sections 212.02(12), 212.031 Florida Statutes
Rule 12A-1.070 Florida Administrative Code
US Cardio Vascular Inc vs Florida Department of Revenue, Case No 1D07-3811 (1st DCA, Sept. 23, 2008)
Solano vs Florida Department of Revenue, DOAH Case No 03-4272 (March 17, 2004)
Florida Department of Revenue Guide: Sales and Use Tax on Commercial Property Rental
Technical Assistance Advisement 11A-020 – June 21, 2011
Technical Assistance Advisement 09A-048 – September 29, 2009 (Intercompany Rental Implied)
Techncial Assistance Advisement 04M-002 - November 16, 2004 (Capital Lease vs Rental Lease)
© 2011 All rights reserved - James H Sutton Jr