Rev. Rul. 60-122

Advice has been requested as to the proper treatment, for Federal income tax purposes, of the transactions described below.

The taxpayer, corporation A , entered into two contracts designated respectively, `Lease for Business Equipment' and `Long-term Rental Contract' for two articles of office equipment to be used in its business.

Under the contract titled `Lease for Business Equipment,' corporation B furnished an item of equipment to corporation A for a period of 36 months for a consideration of 16 x dollars per month. The contract provided that this arrangement might be renewed for three years, in one-year renewals, for 16 x dollars per year. This results in the use of the equipment for 72 months by paying these 39 equal payments. At the end of such three-year renewal period (72 months), the item of equipment must be returned to corporation B . The equipment has a useful life of substantially longer than 72 months and if purchased outright would cost 500 x dollars.

Under the `Long-term Rental Contract,' corporation C furnished an item of equipment to corporation A for an initial period of 36 months for a total consideration of 462 x dollars. The contract provided for indefinite renewal, after the 36-month period, in one-year periods at 30 x dollars per year which includes what would ordinarily constitute a maintenance charge of 22 x dollars per year. The price of such item, if purchased outright, would be 370 x dollars.

Since, during the `renewal period,' only a nominal amount is paid for the use of the equipment, it is reasonable to assume that, in each case, the lease will be renewed in accordance with the agreement.

Revenue Ruling 55-540, C.B. 1955-2, 39, provides the guides to be used in determining, for Federal income tax purposes, whether a particular contractual arrangement constitutes a purchase or a lease. Section 4.06 of such ruling provides, in part, as follows:

.06 of the sum of the specified `rentals' over a relatively short part of the expected useful life of the equipment approximates the price at which the equipment could have been acquired by purchase at the time of entering into the agreement, * * * and the lessee may continue to use the equipment for an additional period or periods approximating its remaining estimated useful life for relatively nominal or token payments, it may be assumed that the parties have entered into a sale contract, even though a passage of title is not expressly provided in the agreement. * * *

The facts of the instant case indicate that under the contract designated `Lease for Business Equipment,' the taxpayer may obtain the use of the equipment for a period of 72 months, there being no evidence that the renewal options will not be exercised. Inasmuch as the equipment must be returned to corporation B at the end of this time, although the estimated useful life of it is substantially longer, it is held that this transaction constitutes a lease. However, inasmuch as the taxpayer may use the equipment for 72 months by making 39 payments, a portion of the total payments in the first 36 months constitute advance or prepaid rental applicable to the second 36-month period. Therefore, the taxpayer's allowable monthly rental deduction, under section 162 of the Internal Revenue Code of 1954, is limited to 1/72 nd of the total payments over the 72-month period (16 x dollars times 36 divided by 72). See Revenue Ruling 55-540, supra .

Under the contract designated `Long-term Rental Contract,' the taxpayer, during the first 36 months, will pay an amount which exceeds the outright purchase price of the equipment. Further, the taxpayer may have the use of such equipment for the entire period of its useful life inasmuch as there is no condition under which it will revert to corporation C so long as the contract is renewed each year for the sum of 30 x dollars. There is no indication that the renewal options will not be exercised. This sum includes maintenance service which would otherwise cost 22 x dollars per year. It is held that this transaction constitutes a purchase of equipment, expenditures for which may be recovered over its useful life through appropriate deductions for depreciation. See Revenue Ruling 55-541, C.B. 1955-2, 19.