by Jordan S. Wigdor
Regardless of the size or complexity of a commercial lease transaction, the state of Florida requires sales tax to be paid on certain lease-related charges. This article is designed to serve as a refresher on the issues surrounding the taxability of various charges associated with commercial leases. In addition, this article makes recommendations on how to draft certain lease provisions relating to the payment of sales tax.
Florida imposes a sales tax of six percent on the “total rent” charged under a lease.1 In specific situations, counties are authorized to levy an additional discretionary sales surtax on the charges subject to sales tax.2 Particular payments made by a tenant may be classified as rental consideration and subject to sales tax, including not only base rent, but additional rent and common area maintenance charges as well.3
F.S. §212.031 addresses sales tax on leases and generally provides that the rental or lease of real property is subject to sales tax. Florida’s Department of Revenue (DOR) interprets the provisions of §212.031 in Florida Administrative Code Rule 12A-1.070, which sets forth in greater detail the rules relating to the taxing of specific lease charges and lease-related items.
The legislative intent underlying §212.031, as specifically stated in the statute, is that anyone engaging in the business of renting, leasing, letting, or granting a license for the use of real property is exercising a taxable privilege, unless such property is specifically exempt from tax.4 Sales tax of six percent is imposed on the “total rent or license fee” charged for the real property and includes payments made for the privilege to use or occupy real property for any purpose.5
While §212.031 provides the law for sales tax on leases of real property, Rule 12A-1.070 implements and administers §212.031 and defines the taxability of certain lease charges. Rule 12A-1.070 covers a broad spectrum of lease-related charges, many of which are potentially subject to tax, including insurance premiums and ad valorem taxes. The DOR generally considers any payment required to be paid as a condition of occupancy under a commercial lease to be taxable as rent.6
Although §212.031 and Rule 12A-1.070 have not received a significant amount of attention in the Florida courts, the issues surrounding commercial leases and sales tax have been addressed by the DOR in the form of various technical assistance advisements.7 The determinations rendered by the DOR further interpret and clarify the provisions of §212.031 and Rule 12A-1.070.
Generally speaking, all payments made by a tenant for the right to occupy or use leased premises are taxable as rent.8 These include charges paid by a tenant in the nature of typical pass-through operating expenses associated with a landlord owning, operating, and maintaining real property. Commonly referred to as common area maintenance charges (CAM), CAM is paid by tenants to landlords for the privilege or right to use or occupy leased premises and is taxable.9 There is no “standard” set of charges that are deemed to constitute CAM; simply, if CAM charges are required to be paid under a lease, they are taxable.
The cost of utilities servicing the common areas of a property are generally considered a component of CAM. As stated above, CAM charges are subject to sales tax.10 In addition to utility charges for common areas, sales tax is typically due on utilities paid for leased premises.11 Where commercial premises are served by a master meter and the proportionate share of the utility costs are passed through to a tenant, the utility costs are generally considered a taxable element for renting the real property.12 However, despite the general rule requiring sales tax to be paid, in certain instances, as set forth below, utility charges are exempt from sales tax.
First, no sales tax is due if 1) the landlord pays sales tax on the purchase of utilities; 2) the landlord’s invoice to tenant for CAM separately states the utility charges; and 3) the landlord’s charge to tenant for utilities is equal or less than the amount billed by the utility provider to the landlord.13 This exemption prevents payment of double sales tax on utilities, i.e., a landlord paying sales tax on the purchase of utilities from the utility company and again when remitting the same taxes to the state following reimbursement by the tenant.14
In addition, when utility charges for leased premises are paid directly to the utility provider by a tenant, sales tax is not due.15 In this instance, because the benefit of utilities goes to the tenant rather than to the landlord, payment for separately metered utilities is not considered rental consideration under a commercial lease, and no sales tax is due under §212.031.16
Another lease charge often included in CAM is real estate taxes for the property where the premises are located. Ad valorem taxes paid by a tenant qualify as rent and are taxable.17 It is irrelevant whether the property taxes are paid by a tenant, either directly to the landlord as part of CAM, as a reimbursement to the landlord, or directly to the relevant tax collector.18 In these situations, substance prevails over form, and payment of ad valorem taxes is classified as consideration for a tenant occupying the premises.19
Other Lease-related Items
In addition to specific charges under a commercial lease, there are other lease-related items which may be subject to sales tax. Leases typically require a tenant to maintain insurance for leased premises. The relevant insurance policy often names the tenant as the insured party with the landlord as an additional insured. Although payments made on behalf of a commercial property owner by a tenant benefitting the owner are generally classified as taxable rental consideration, insurance is treated differently. The insurance premium paid by a tenant for its own protection is not treated as rental consideration, even though a landlord may be listed as an additional insured and protected by the coverage.20 To be considered taxable rental consideration, some portion of tenant’s insurance premium must secure the protection of the landlord and be separately stated or itemized on tenant’s premium statements.21 In addition, if an insurance policy jointly insures the landlord and the tenant and provides particular coverage protecting solely the landlord, the premiums related to the landlord’s coverage are deemed rental consideration and taxable.22
Although not technically a lease charge, tenants often have the right to sublet or assign leased premises. When assigning or subletting premises, a tenant is generally required to collect and remit sales tax on the amount of rental consideration paid by a subtenant or assignee.23 However, to eliminate paying sales tax on two separate leasehold interests for the same space, the DOR promulgated specific rules for addressing the assignment and sublet of leases, allowing lease parties to pay sales tax only once. The rules pertaining to assigning and subletting differ based on whether the transaction involves all or only a portion of the leased space.
When a tenant sublets or assigns its interest in only a portion of the leased premises, a tenant receives a credit for any sales tax paid by a subtenant or assignee for the subleased or assigned premises.24 To calculate the appropriate sales tax credit, the square footage of the premises or some other basis acceptable to the DOR is used.25 The following example provided in Rule 12A-1.070(8) illustrates how the process works:
Tenant leases 200 square feet of floor space for $400 and pays Landlord $24 rental tax. Tenant subleases 100 square feet, or one half, of the space to Subtenant for $300 and collects $18 tax which he remits to the [DOR], less a credit of $12 for tax that [tenant] paid to [his] landlord on the space that he subleased to Subtenant. (One half of $400 is $200 and 6 percent of this amount is $12.)26
If a tenant sublets or assigns its interest in the entire leased premises, or retains only an incidental portion thereof, a tenant may forgo paying any sales tax to the landlord under the master lease provided the tenant 1) registers as a dealer with the DOR; 2) collects and remits to the DOR all sales tax due on the tenant’s sublease of the leased premises; and 3) pays any sales tax due on any retained portion of the leased premises directly to the DOR.27 If all sales tax under the sublease is paid by the tenant directly to the DOR, the tenant does not have to pay the landlord the sales tax due under the master lease.28 Following this method allows the tenant to avoid calculating the relevant sales tax credit.
A tenant may have the right to terminate or cancel a lease prior to the expiration of the lease term, provided a specified amount of money is paid to the landlord. In determining whether these “lease termination payments” are subject to sales tax, the DOR reviews how these payments are recorded in the books and records of the landlord and the tenant.29 Generally speaking, charges to tenants by landlords to cancel or terminate a lease are presumed taxable if either the landlord or the tenant records such charges as rental income or rental expense, respectively, in its books and records.30 However, the form of recordation is not dispositive of the issue. The presumption can be overcome by the provision of sufficient documentation by either the landlord or the tenant that the payment was other than for the use of the real property.31 On the other hand, if the payment is not recorded as rental income or rental expense, but found to be for the rental of the property, then such payment is taxable.32
In addition to the foregoing matters, certain other issues involving sales tax and commercial leases warrant a brief discussion. Tenant payments made in connection with improvements to leased premises may be subject to sales tax regardless of whether they are minor improvements or significant capital improvements. To determine the taxability of such payments, the relevant inquiry is whether the payments are part of the total consideration paid by the tenant for the right to occupy the property.33 Also, a common misconception exists that rental payments made under commercial leases between related entities are not subject to sales tax. In the past, in certain situations, leases between related parties were exempt from sales tax, for example, when a parent corporation leased space to its subsidiary. However, under current law, rental payments between related entities are now subject to sales tax.34
Responsibility for Payment of Sales Tax
The party responsible for the payment of Florida sales tax is usually set forth in a lease. However, leases are often silent on this point. In these cases, there may be a question as to the party ultimately liable if sales tax is not paid.
This issue was addressed by the Florida Supreme Court in Schnurmacher Holding, Inc. v. Noriega, 542 So. 2d 1327 (Fla. 1989). In Schnurmacher, the court held that the plain language of §212.031, together with the public policy of the state, requires the tenant to pay the sales tax on a lease that is silent on the issue.35 By holding the tenant as the party responsible to pay the tax, the court expressly rejected the holding in Oven v. Dawirs, 419 So. 2d 1186 (Fla. 1st DCA 1982). The Oven court, basing its decision on the strict language of §212.031(3), held the landlord responsible for payment of sales tax because anyone in the business of leasing real property is exercising a taxable privilege.36 In Schnurmacher, the court found the First District’s holding erroneous and reaffirmed the decision of its lower court that §212.031(3) merely serves to designate the landlord as the agent for collecting and remitting the taxes to the DOR.37 Accordingly, absent a specific lease provision to the contrary, tenants must pay the sales tax, and landlords are, in turn, obligated to collect and remit the sales tax to the state.
Some people may not fully comprehend the seriousness of the failure to remit sales tax to the state. Landlords who collect sales tax from tenants, but who knowingly fail to remit such sales tax to the DOR, may be held criminally liable for committing up to a first degree felony.38
Despite the holding in Schnurmacher, clearly defining the party responsible for payment of sales tax is good practice and should eliminate potential issues. Carefully drafting commercial leases can also potentially minimize the sales tax due for certain lease charges, particularly charges for utilities and lease termination payments.
The simplest way to handle payment of utility charges and minimize sales tax is to require the tenant to maintain the utilities account in its own name and pay the utility charges directly to the utility provider. However, if the cost to install the separate meter to measure the tenant’s utility consumption is cost prohibitive, or if the relevant utility charges relate to the common areas of the property, the lease should require separate billing and reimbursement in order to meet the requirements of Rule 12A-1.070(4)(e).
To help minimize sales tax on lease termination payments, attorneys should advise their clients that reporting such payments as rental income and rental expense, respectively, may result in these payments being subject to sales tax. Also, the lease should clearly label and describe lease termination payments. It may also be beneficial to prohibit the landlord and the tenant from recording lease termination payments as rental income and rental expense, respectively, in their books and records.
Florida has an established set of rules for landlords and tenants to follow for commercial leases and sales tax. This article reviews these rules and the issues involving the taxability of certain commercial lease charges and provides practitioners with certain lease drafting recommendations to help their clients minimize the sales tax due on certain lease payments.
1 Fla. Stat. §212.031(1)(c) (2009).
2 Fla. Stat. §212.054 (2009).
3 Fla. Admin. Code R. 12A-1.070 (2009).
4 Fla. Stat. §212.031(1)(a) (2009) (There are certain enumerated exceptions to the general rule that sales tax is due on leases of real property; such exceptions are found in subsections 1-13 of §212.031(1)(a).).
5 Fla. Stat. §212.031(1)(c) (2009) (Additional tax may be due if the county in which the property is located employs a discretionary sales tax. Not all Florida counties impose such tax. By way of example, as of the date of this article, the following surtax rates are imposed in these Florida counties: Brevard County – None; Palm Beach County – 0.5 percent; Hillsborough County – 1.0 percent; Monroe County – 1.5 percent.).
6 Lexis FL Tax P.I. 1,092 (2009).
7 Florida issues involving sales tax and commercial leases are generally handled by regulatory agencies, such as the DOR. Taxpayers initially raise such issues with the DOR and request the DOR to issue a technical assistance advisement concerning such issue. Thereafter, taxpayers have the right to appeal the DOR’s decision.
8 Lexis FL Tax P.I. 1,092 (2009).
9 Fla. Admin. Code R. 12A-1.070(4)(d) (2009).
11 Fla. Admin. Code R. 12A-1.070(4)(e) (2009).
12 State of Florida, Department of Revenue, Technical Assistance Advisement 89(A)-024.
13 Fla. Stat. §212.031(7) (2009) and Rule 12A-1.070(4)(e). To satisfy the first requirement, bills from the utility provider showing a charge of sales tax and proof that the corresponding payment was made by the landlord for the relevant period must be produced. The second requirement is satisfied if utility charges were separately stated on landlord’s invoice to the tenant for its share of CAM or the landlord provides to the tenant year-end reconciliation statements specifically breaking out the portion resulting from utility costs incurred by the landlord. The final requirement is self-explanatory. Any mark-up in the price of the utilities charged by the landlord to the tenant will result in such excess amount considered as rent subject to tax. In determining a mark-up of utility costs, the DOR will take into account any administrative fee charged by the landlord on the pass-through. If the DOR concludes there has been a mark-up, sales tax will be due, not only on the residual amount, but on any administrative fee charged by the landlord as well. See State of Florida, Department of Revenue, Technical Assistance Advisement 06(A)-044.
14 See Omni International of Miami, Ltd. v. Department of Banking and Finance and Department of Revenue, 444 So. 2d 540 (Fla. 3d D.C.A. 1984).
15 State of Florida, Department of Revenue, Technical Assistance Advisement 89(A)-024; see also Omni International of Miami, Ltd. v. Department of Banking and Finance and Department of Revenue, 444 So. 2d 540 (Fla. 3d D.C.A. 1984); State of Florida, Department of Revenue, Technical Assistance Advisement 85(A)-012.
16 State of Florida, Department of Revenue, Technical Assistance Advisement 89(A)-024.
17 Fla. Admin. Code R. 12A-1.070(4)(c) (2009).
18 State of Florida, Department of Revenue, Technical Assistance Advisement 94(A)-052.
19 Seaboard Coast Line Railroad Company v. Askew, No. 72-15 (Fla. 2d Cir. Ct. 1972) (unreported).
20 Fla. Admin. Code R. 12A-1.070(12) (2009).
21 Because they are less likely to be manipulated in any manner, premium statements prepared by the relevant insurance company provide the most accurate itemization of insurance premiums attributable to landlord coverage. See State of Florida, Attorney General Opinion, AGO 97-055 n.4.
22 This situation may arise when a policy names the landlord and the tenant as co-insureds and provides multiple and distinct types of coverage, a portion of which protects only the landlord. In this case, the itemized portion of the insurance premium serving to protect only the landlord will be treated as taxable rent, while any portion protecting the tenant, or the parties jointly, is nontaxable. See State of Florida, Department of Revenue, Technical Assistance Advisement 07A-042; State of Florida, Attorney General Opinion, AGO 97-055.
23 See Fla. Admin. Code R. 12A-1.070(7)(a) (2009) (emphasis added) (“Where a tenant or person occupying, using, or entitled to use any real property which is subject to tax sublets or assigns and collects rentals or license fees on a taxable portion of the leased or licensed premises, such tenant or other person shall be required to register as a dealer….”).
24 Fla. Admin. Code R. 12A-1.070(8) (2009).
27 Fla. Admin. Code R. 12A-1.070(9) (2009).
28 Id. (emphasis added) (“If the tenant or licensee elects not to pay the tax to his landlord, or other person granting the right to occupy or use such real property, he should extend to his landlord or such other person a resale certificate.”).
29 Fla. Admin. Code R. 12A-1.070(4)(g) (2009).
30 Fla. Stat. §212.031(8) (2009); Fla. Admin. Code R. 12A-1.070(4)(g)(2) (2009).
31 Fla. Stat. §212.031(8) (2009); Fla. Admin. Code R. 12A-1.070(4)(g)(3) (2009).
32 Fla. Admin. Code R. 12A-1.070(4)(g)(4) (2009).
33 State of Florida, Department of Revenue, Technical Assistance Advisement 89(A)-064. Neither §212.031 nor Rule 12A-1.070 address the taxability of payments made in connection with an improvement allowance. Because no firm test has been established by Florida’s courts or its regulatory agencies, an analysis of the lease is necessary. Lease items examined include: 1) whether the lease treats the payments as additional rent to be paid as part of monthly rent consideration; 2) whether completion of the improvements is a condition precedent for occupying the premises; 3) which party becomes the owner of the improvements following termination or expiration of the lease; and 4) whether the cost of the improvements was used to establish the base rent payable under the lease. In the case of a long-term lease or build-to-suit lease where a landlord agrees to accept tenant’s construction of certain improvements in lieu of rent, the tenant’s payment for the capital improvements represents “rent in kind,” equitable to actual consideration paid for the right to occupy the premises. See State of Florida, Department of Revenue, Technical Assistance Advisement 89(A)-064; Department of Revenue, State of Florida v. Seminole Clubs, Inc., 745 So. 2d 473 (Fla. 5th D.C.A. 1999).
34 Fla. Admin. Code R. 12A-1.070(19) (2009).
35 Schnurmacher, 542 So. 2d at 1329.
36 Oven, 419 So. 2d at1187.
37 Noriega v. Schnurmacher Holding, Inc., 528 So. 2d 28, 30 (Fla. 3d D.C.A. 1988).
38 Fla. Stat. §212.12(2)(c), (d), and (e) (2009). The degree of felony depends on a variety of factors including, but not limited to, the amount of unreported or uncollected taxes and the number of prior offenses of unreported or uncollected taxes.
Jordan S. Wigdor is an associate in the real estate department of Proskauer Rose, LLP, in Boca Raton. He focuses on real estate acquisitions and sales, as well as leasing and financing of commercial properties. He received his J.D. from the Benjamin N. Cardozo School of Law.
This column is submitted on behalf of the Tax Section, Frances D. McCoid Sheehy, chair, and Michael D. Miller and Benjamin Jablow, editors.