Chesapeake Industrial Leasing Co. v. Comptroller of the Treasury

CHASANOW, Judge. In 1947, the Maryland General Assembly first enacted the Retail Sales Tax Act, the present form of which is now codified at Maryland Code (1988, 1992 Cum.Supp.), Tax-General Article, §§ 11-101 et seq. Under this original Act, leases of tangible personal property were not subject to sales tax. In 1955, however, the General Assembly amended the Act to include a lease of tangible personal property within the statutory definition of a “sale,” thereby subjecting it to sales tax.

See Chapter 332 of the Acts of 1955 (now codified at Md.Code (1988, 1992 Cum.Supp.), Tax-General Art., § 11—101(f)(1)); Comptroller v. Pittsburgh-Des Moines Steel Co., 231 Md. 132, 145-46 , 189 A.2d 107, 114-15 , cert. denied, 375 U.S. 821 , 84 S.Ct. 58 , 11 L.Ed.2d 55 (1963). The instant case concerns the lease of such personal property in the form of office and other business equipment. While there is no doubt that such leases ⁴³¹ are subject to sales tax, our task is to resolve two subsidiary-issues: (1) the effect, if any, of the assignment of the lease on the lessor’s statutory obligation to collect and remit sales tax, and; (2) the effect on the lessor’s sales tax obligation, if any, of the lessees’ failure to make lease payments as the lease requires. I. The appellant, Chesapeake Industrial Leasing Company, Inc. (Chesapeake), is a Maryland corporation in the business of leasing office and industrial equipment.

During the period at issue in this case, Chesapeake was the lessor in numerous lease transactions that generally came about in the following way: (1) a business in need of equipment (a Customer) contacted Chesapeake to obtain the equipment through a lease, either because the business could not or did not want to purchase the equipment outright; (2) Chesapeake determined whether the potential Customer was creditworthy and whether a financial institution would purchase an assignment of a lease with the Customer; (3) if the financial institution agreed to purchase the lease, Chesapeake executed a lease with the Customer providing for a predetermined number of monthly lease payments, each payment comprising a rent component and a sales tax component; (4) Chesapeake ordered the equipment from a supplier, who delivered it to the Customer; (5) Upon the Customer’s acceptance of the equipment, Chesapeake paid the supplier and took title to the equipment; 1 ⁴³² (6) Chesapeake assigned the lease to the financial institution and the financial institution paid Chesapeake for the assignment; (7) In some cases, Chesapeake agreed to “service” the lease for the financial institution by receiving the lease payments and forwarding the rent component to the financial institution and the tax component to the Comptroller. In a few other cases, the Customer paid the financial institution directly. In the transactions at issue in this case, Chesapeake’s leases with Customers were assigned to Baltimore Federal Financial (BFF). Some assignments were recourse transactions accomplished via a “Security Agreement and Assignment of Lease,” in which Chesapeake guaranteed payment of rent to BFF without requiring BFF to proceed against a defaulting lessee.

Other leases were assigned via an “Assignment of Lease Without Recourse,” under which the bank had no recourse against Chesapeake, as its assignor, if the lessee defaulted. On September 20,1988, the appellee, the Comptroller of the Treasury, Sales and Use Tax Division (Comptroller), issued a Notice of Assessment to Chesapeake for sales tax Chesapeake allegedly failed to remit on both recourse and non-recourse leases it had executed under the arrangement described above. Pursuant to that notice, the Comptroller levied an assessment in the amount of $21,417.18, plus interest and penalties. Chesapeake met informally with the Comptroller’s office to request an abatement of the taxes in question.

Shortly thereafter, the Comptroller denied the request. Chesapeake timely requested a formal hearing on its claim, at which it contended that because the lessees on the leases in question had failed to make their rent and sales tax payments, it was not required to remit sales taxes. Chesapeake asserted it was only required to remit sales tax on its leases on a cash basis, i.e., as it received monthly payments of rent and sales tax. Therefore, Chesapeake argued, when the lessees did not pay sales tax to Chesapeake, Chesapeake was not required to remit sales tax to the State.

The Comptroller countered that a lessor must remit tax payments on an accrual basis, i.e., ⁴³³ when each lease payment is due, without regard to whether the lessee’s payment is actually received. The hearing officer accepted the Comptroller’s view and affirmed the assessment, interest, and penalties. Chesapeake appealed to the Maryland Tax Court. The Tax Court found that Chesapeake was liable for the full amount assessed but was also entitled under the Comptroller’s regulations to an offset of $8,444.99 for the recourse lease receivables Chesapeake had previously written off on its federal tax returns as uncollectible bad debt. 2 The Tax Court found that Chesapeake was not entitled to an offset with respect to the remaining lease receivables because those leases had been assigned without recourse and therefore Chesapeake incurred no bad debt liability for them as a result of the lessees’ default.

Chesapeake appealed to the Circuit Court for Baltimore County, where Judge Alfred Brennan affirmed the Tax Court’s decision. Chesapeake appealed to the Court of Special Appeals, but this Court issued a writ of certiorari on its own motion before the intermediate appellate court could consider the case.

II

In this Court, Chesapeake makes several arguments. Acknowledging that the “vendor” is statutorily liable for collect ⁴³⁴ ing and remitting sales tax, Chesapeake first contends that it is no longer the vendor because BFF assumed this role upon assignment of the lease. Alternatively, Chesapeake contends that even if it remained the vendor, its statutory obligation to remit sales tax ceased when the lessees failed to make their lease payments. Failing that, Chesapeake believes it is entitled to an offset for those uncollectible lease receivables written off by its assignee, BFF, in addition to those written off by Chesapeake itself.

We address each of these contentions in turn, after addressing two preliminary matters. First, we note that while the Retail Sales Tax Act was recodified in 1988, appearing now as Md.Code (1988, 1992 Cum.Supp.), Tax-General Art., §§ 11-101 to 11-712, the provisions in effect during the time of this assessment were those of Md.Code (1957, 1980 Repl.Vol.), Art. 81, §§ 324 to 371. Therefore, we apply the provisions of Article 81 to this case. Because we would not reach a different result under the recodified provisions, however, we make reference to the recodified provisions throughout our opinion where appropriate.

Second, we make clear that we are treating the taxable transactions in question solely as leases for sales tax purposes, not as installment sales or as financing transactions. The parties have not suggested an alternative treatment, and we proceed on that basis. Our analysis treats the transaction as two distinct events, a lease (the taxable transaction) and a subsequent and separate assignment of the lease. We now turn to the substance of Chesapeake’s arguments.

A. Under Article 81, as under the present law, the identity of the “vendor” for sales tax purposes is critical. The statute imposes personal liability on the vendor for failure to collect sales tax from purchasers of. tangible personal property and pay it over to the Comptroller. Md.Code (1957, 1980 ⁴³⁵ Repl.Vol.), Art. 81, §§ 327 & 328. 3 In the context of the Retail Sales Tax Act, a vendor is defined as “any person selling property or rendering services” subject to sales tax. Art. 81, § 324(b). 4 As for the meaning of “selling,” a “sale” is “any transaction whereby title or possession, or both, of tangible personal property is or is to be transferred by any means whatsoever for a consideration including rental, [or] lease.... ” § 324(d) (emphasis added). 5 Chesapeake admits that, for the period between the Customer’s acceptance of the equipment and the assignment of the lease to BFF, it was the “vendor” under the statute, but contends that the assignment transferred the “vendor” status to BFF and thereby relieved Chesapeake of its obligations.

We disagree. The principal reason for our disagreement with Chesapeake’s position is that Chesapeake misunderstands the source of the vendor’s sales tax obligations. Chesapeake points to the assignments of the leases to BFF and argues that “there is no language in the Assignments burdening Chesapeake with continuing Sales Tax liability” where a customer defaults after an assignment. While this statement correctly describes the BFF assignments, it fails to take into account the true source of the vendor’s obligation to collect and remit taxes.

This obligation is clearly and directly imposed by statute. Under Article 81, § 328, “[t]he vendor ... shall be personally liable for the tax collected or required to be collected____” 6 We have previously said that this statute imposes “an absolute obligation on a vendor to collect and pay over to the Comptroller the money collected from the purchaser if it is available or the proper amount of his own money if it is not.” Rockower ⁴³⁶ Bros. v. Comptroller, 240 Md. 379, 392 , 214 A.2d 581, 588 (1965) (rejecting vendor’s suggestion that statute made it only an involuntary trustee whose liability is limited to the exercise of due care). This absolute legal duty of the vendor to collect and remit taxes cannot be assigned via a contract between the vendor and a third party because the purpose of the statute—insuring that the State will receive sales tax revenues by imposing absolute, personal liability upon the vendor—would be defeated if vendors could relieve themselves of personal liability by contracting it away. This is not to say that a vendor cannot delegate to a third party the duty of collecting and remitting sales taxes on its behalf, and seek indemnification should the third party fail to fulfill this obligation, but such a contractual arrangement does not alter the vendor’s statutorily-imposed obligation to the State.

As between the State and the vendor, the vendor remains liable to collect and remit the sales tax. Finally, as an equitable matter, we note that when Chesapeake purchased the office equipment from its suppliers, it avoided paying taxes otherwise due by furnishing the suppliers with a resale certificate. Under the statute and regulations then applicable, the duty of a vendor to collect the sales and use tax from a buyer was waived if the buyer provided the vendor with a signed resale certificate. See Art. 81, § 333 and former COMAR 03.06.01.40.A. 7 The certificate permitted Chesapeake to avoid paying sales tax at the time of its purchase by certifying that the property was bought for the purpose of resale and that sales tax would be paid when it resold the property.

It .seems disingenuous that Chesapeake could take advantage of this waiver, without which it would surely have been required to pay taxes to its equipment suppliers, and then later seek to avoid paying the tax at all. In light of the foregoing arguments, we believe that Chesapeake remained the vendor under the statute, even after the ⁴³⁷ assignment, and therefore hold that it also retained its liability to collect and remit sales tax. B. In the alternative, Chesapeake argues that, even if it remained the vendor after assignment of the leases, the lessees’ subsequent default relieved it of its obligation to remit sales taxes to the Comptroller. We review the relevant statutory and regulatory authority upon which Chesapeake bases this contention.

As we have noted, since 1955 a lease of tangible personal property has been considered a “sale” for sales tax purposes. Art. 81, § 324(d). 8 Former § 327 created the vendor’s legal liability to collect and remit sales tax payments on such “sales,” providing that “[t]he tax shall be paid by the purchaser to the vendor as trustee for and on account of the State, and the vendor shall be liable for the collection thereof for and on account of the State.” 9 Former § 329 then addressed the timing of the required collection: “The tax hereby imposed shall apply and be collected by the vendor from the purchaser at the time the sale is made regardless of the time when the purchase price is paid and delivered; unless the Comptroller shall provide by regulation in the case of credit or installment sales for the payment of the tax upon collection of the price or installments of the price or at some other time.” 10 The Comptroller amplified these provisions and promulgated several regulations, in accordance with its statutory authori ⁴³⁸ ty. 11 Among these regulations was former COMAR 03.06.01.-57, which provided, in pertinent part: “.57 Time of Collection. A. A sale is a transaction for the present or future transfer of title or possession of tangible personal property, or for the performance of certain services, for a consideration, and the tax imposed on sales at retail applies when the transaction is entered into, regardless of when the consideration is to be paid, the tangible personal property is to be delivered, or the services are to be performed. Except as provided by this regulation[ 12 ] the vendor shall collect the tax from the purchaser when the sale occurs.

A vendor shall collect the tax on rental or lease transactions in accordance with Regulation .73.” (Emphasis added). 13 Former Regulation .73 (COMAR 03.06.01.73) provided, in pertinent part: “.73 Lease of Tangible Personal Property. A. The transfer of possession, without regard to limitations upon the use, of tangible personal property for a consideration, by way of lease, rental, license to use, royalty or similar transaction, referred to in this regulation as a ‘lease’, is included within the statutory definitions of the terms ‘sale’ and ‘purchase’ and is thus subject to the tax in the absence of a specific exemption or exclusion. B. Each lease payment period is considered a separate lease, and thus a separate sale, for the purpose of determin ⁴³⁹ ing when the tax is to be collected or paid.” 14 For the most part, the parties do not disagree over the meaning and effect of the statutory and regulatory scheme. For example, they agree that the vendor must collect the tax at the time of the sale, except in cases of certain installment sales where the Comptroller may promulgate other regulations.

They also agree that a “sale” is generally defined as the moment when the transaction is entered into, without regard to when payment or delivery is made. They disagree, however, about the meaning and effect of COMAR 03.06.01.73, set out above, which the Comptroller promulgated specifically to address leases of tangible personal property. In particular, the parties differ on the meaning of section 03.06.01.73.B, which identifies each “lease payment period” as a separate sale and, therefore, as the trigger for collection and remission of tax under the Statute. Chesapeake’s first argument is that if the lessees ceased paying rent, the leases ended, meaning there were no more “lease payment periods” and consequently no more “sales” to which the sales tax could apply as per COMAR 03.06.01.73.B. We need not address today the effect of lease termination upon a vendor’s obligation to remit sales tax because there is no evidence that the leases in this case actually terminated.

Chesapeake’s lessees apparently remained in possession of the leased property, and so we presume the periodic payments remained due and the leases continued to exist. There is no indication that the leases were ever terminated or, alternatively, that they contained an automatic termination clause effective upon a lessee’s failure to pay. In fact, the leases gave the lessor several different remedies in the event of a lessee’s default, only one of which was the option of terminating the lease. Upon a lessee’s default the lessor could, for example, sue to “enforce performance by Lessee”—an acknowledgment, it would appear, that the lease did not necessarily terminate upon the mere occurrence of a lessee’s default.

Accordingly, ⁴⁴⁰ we reject Chesapeake’s initial argument that the “lease payment periods” marking the taxable “sale” ceased just because the lessees stopped making payments. Chesapeake next argues that, even if the leases did not end, the statutory and regulatory scheme only requires the vendor to remit sales tax on a cash basis, i.e., as tax payments are actually collected from the lessee. When the lessees failed to pay tax to Chesapeake, Chesapeake contends it was not required to remit tax to the Comptroller. In making this argument, Chesapeake necessarily construes the term “lease payment period” in COMAR 03.06.01.73.B (now COMAR 03.-06.01.28.B) to mean an actual lease payment.

The Comptroller responds that “lease payment period” refers to the period itself, not the actual payment, and that as long as the lease has not been terminated, “lease payment periods” continued for the scheduled life of the lease. The Comptroller therefore contends that the tax is collectible on an accrual basis, regardless of whether the rent is paid or the tax collected in a particular month. By this reasoning, the tax on a monthly rental would simply be due each month. We find ourselves