Background
The Texas Comptroller of Public Accounts recently issued a memorandum, 202507015M, providing detailed guidance on the treatment of sales-type leases under FAS 13 for franchise tax purposes.1 This guidance clarifies the classification of such leases as sales, their impact on the calculation of taxable margin, and their eligibility for the COGS deduction, in light of the Texas Supreme Court’s decision in Hegar v. Xerox Corp., 633 S.W.3d 298 (2021).
Classification of Sales-Type Leases as Sales
For purposes of the Texas franchise tax, the terms “sale,” “selling,” and “sold” include arrangements that qualify as sales-type leases under FAS 13. This classification is relevant for determining whether a taxable entity is primarily engaged in retail or wholesale trade, which may entitle the entity to the reduced franchise tax rate of 0.375% (as opposed to the standard 0.75%).
- Retail trade is defined by reference to Division G of the 1987 Standard Industrial Classification (SIC) Manual and generally involves selling merchandise for personal or household consumption.
- Wholesale trade is defined by Division F of the SIC and involves selling merchandise to retailers, contractors, or other business users.
Eligibility for the COGS Deduction
The memorandum confirms that tangible personal property transferred under a sales-type lease is considered “goods sold” for purposes of the COGS deduction under Texas Tax Code Section 171.1012. Only costs related to selling real or tangible personal property in the ordinary course of business are eligible for inclusion in the COGS deduction.
FAS 13 Criteria for Sales-Type Leases
A lease qualifies as a sales-type lease under FAS 13 if it satisfies at least one of the following criteria:
- The lease transfers ownership of the property to the lessee by the end of the lease term;
- The lease contains a bargain purchase option;
- The lease term equals 75% or more of the estimated economic life of the property (with certain exceptions); or
- The present value of the minimum lease payments equals or exceeds 90% of the fair value of the leased property (with certain exceptions).
Additionally, both of the following must be met:
- Collectibility of minimum lease payments is reasonably predictable; and
- No important uncertainties surround unreimbursable costs yet to be incurred by the lessor.
Implementation and Audit Considerations
Whether a lease constitutes a sales-type lease is a question of fact, requiring auditors to compare the lease terms to the FAS 13 requirements. The guidance applies to all open periods within the statute of limitations.
Implications for Taxpayers
Taxpayers engaged in leasing transactions should review their lease agreements to determine whether they qualify as sales-type leases under FAS 13. Proper classification may impact eligibility for the reduced franchise tax rate and the COGS deduction. Entities should ensure that their documentation supports the classification of leases and the calculation of related deductions.
The Comptroller’s guidance provides clarity and aligns Texas franchise tax treatment of sales-type leases with the ordinary meaning of “sale” as interpreted by the Texas Supreme Court. Taxpayers should assess the impact of this guidance on their Texas franchise tax reporting and compliance.
- FAS 13 is now incorporated into FASB Accounting Standards Codification, Topic 842.
Client Alert 2025-219
