EXHIBIT 3
SUMMARY OF POSSIBLE SALES TAX EXPOSURE
As discussed in the Summary of the Plan in the Disclosure
Statement (Section III.C: "Summary of Classification and Treatment of Claims and
Equity Interests Under the Plan"), the Plan reflects a compromise and settlement
under Section 9019 of the Bankruptcy Code, and the findings of the Bankruptcy
Court in the Confirmation Order, that no Priority Tax Claims shall be Allowed
with respect to any failure to file state and local sales and use tax returns in
the names of the correct entities, and all applicable state and local tax
returns (or portions thereof) filed by the Debtors and their Subsidiaries prior
to the Effective Date shall be deemed to have been filed on behalf of all
Debtors and Subsidiaries required to file such returns.
In addition, certain transactions or activities prior to the
Petition Date potentially could be viewed by a state as giving rise to possible
sales tax exposure for the Debtors and their Subsidiaries. To date, the Debtors
are unaware of any state that has taken this position and the Bar Date in these
Chapter 11 Cases has long since passed. In addition, discussions with a number
of states with respect to some of these possible exposure since the Petition
Date concerning these issues suggest that it is unlikely that those states would
take such a position. The information set forth below is solely being provided
by the Debtors to enable creditors (including various state and local
jurisdictions) to assess for themselves whether one or more of the transactions
involving the Debtors triggered or may have resulted in additional tax exposure
beyond that listed in the Schedules, set forth in any proofs of claim filed in
these chapter 11 cases, or otherwise forecasted to be paid pursuant to the
continuation of past practices. Nothing herein constitutes an admission or
acknowledgment by any of the Debtors as to any factual or legal issue relative
to any tax or potential tax owed by the Debtors.
I. Factual Background
Thirteen of the Debtors, commonly referred to as "operating entities"
(the "OEs")(1) own and lease tangible personal property ("TPP") that is located
in various states. The lessees in these transactions are independent third
parties.
In an effort to obtain more favorable financing, the OEs typically
transferred the lease agreements to various related affiliates.(2) The transfers
of the lease agreements to the related affiliates were effectuated via two or
more transactions, as follows:
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(1) American Capital Resources, Inc., Boulder Capital Group,
Inc., BSB-UCP, Inc. f/k/a The Myerson Companies, Inc., HLC Financial, Inc.,
Jacom Computer Services, Inc., KLC-UCP, Inc. f/k/a K.L.C., Inc. (a/k/a
Keystone), Merrimac Financial Associates, Inc., MFC-UCP, Inc. f/k/a Matrix
Funding Corporation, SFC-UCP, Inc., f/k/a Saddleback Financial Corporation, SFC
Capital Group Corporation, The Walden Asset Group, Inc., VRL-UCP, Inc. f/k/a
Varilease Corporation, and Varilease Capital Corporation.
(2) The lease agreements transferred include true or operating
leases and financing or capital leases, which will be described in more detail
below. In the case of true or operating leases, the intangible rights to the
receipt of the lease streams and the legal ownership, but not physical
possession, of the underlying TPP were transferred. In the case of financing or
capital leases, only the intangible rights to the receipt of the lease streams
were transferred.
1. First, the OEs transferred the lease agreements to UniCapital Funding
Corporation ("Funding"), a 100% owned subsidiary of UniCapital
Corporation.
2. Second, Funding immediately transferred the lease agreements to a
subsidiary (i.e., special purpose entity or "SPE") via capital
contributions that were exempt for federal income tax purposes.
(Various subsidiary SPEs exist.)
3. In some instances, the SPEs later transferred the lease agreements back
to Funding, either in connection with a refinancing or due to the such
lease agreements' lack of eligibility for financing under the SPEs'
financing arrangements
4. The lease agreements transferred back to Funding were either retained
by Funding, sold to an unrelated third party or contributed to another
subsidiary SPE in connection with a refinancing.
Some lease agreements were sold directly by the OEs to unrelated third parties,
in which case transactions 1 through 4 above would not apply.
The lease agreements with the third party lessees remained
substantially unchanged throughout these transactions. Thus, the existing third
party lessees retained possession and control of the TPP at all times under
their original lease agreements.
The OEs originated both financing or capital leases ("financing
leases") and true or operating leases ("TLAs"). Although different states define
these terms differently, generally a financing lease is a lease in which the
lessee is the legal and economic owner of the property. As such, the lessee
claims all tax deductions (i.e., tax depreciation) and has the majority of the
rights and risks associated with the underlying property . For Generally
Accepted Accounting Principles ("GAAP") purposes yet another definition of these
terms applies. A GAAP financing lease should be accounted for by the lessee as
the acquisition of the asset and the incidence of an obligation. As a result,
the lessee's balance sheet should reflect the asset and the associated
obligation. The lessor should not reflect the TPP that is the subject of the
financing lease on its balance sheet for GAAP purposes. In summary, a
transaction of this type shall be characterized as a "purchase or capital lease"
by the lessee and as a sale or financing (e.g., a sale-type, direct financing,
or leveraged lease) by the lessor.
A TLA under state tax law is generally a lease in which the lessor is
the legal and economic owner of the property. As such, the lessor claims all tax
deductions (i.e., tax depreciation) and has the majority of the rights and risks
associated with the underlying equipment. The lessee should not reflect the TPP
that is the subject of a GAAP TLA on its balance sheet, other than in footnotes.
Instead, the lessee should periodically expense the lease payments. At the end
of the lease term, the lessee generally may (a) opt to purchase the property,
(b) renew the lease on a month-to-month basis, or (c) return the leased property
to the lessor.
The OEs have been registered in the appropriate states for sales and
use tax purposes and have historically paid sales tax on the taxable TLAs and
financing leases. Sales tax has been remitted by the OEs either at the time of
the TLAs' or financing leases' originations or at the time each payment is
received (i.e., under the cash basis method).
The OEs have continued to remit any applicable taxes on the leases they
have originated, even in circumstances where Funding or the SPEs currently own
such leases.(3) The SPEs are not registered in any state for sales and use tax
purposes. Funding is registered in some states for sales tax purposes, but its
returns generally reflect a zero tax liability. In addition, if applicable,
sales or use tax due on the sale of TPP at the conclusion of a lease is remitted
by the OE, even in circumstances where Funding or SPE is the current owner of
the lease. In summary, even though Funding and the SPEs do not directly file
and/or remit sales taxes to the states, the sales tax due on the TLAs and
financing leases currently owned by them has been reported and remitted to the
state by the OEs (i.e., the state registered entities). The Plan provides that
these past practices will be continued following the Effective Date of the Plan.
Since the Petition Date, the OEs, Funding and the SPEs have not
initiated any new leases. In addition, it is not the Debtors' present intention
to initiate any new leasing activity. All leases were initiated by the OEs,
prior to the date of the filing of these Chapter 11 Cases.
II. Possible Sales Tax Exposure
A. Sales Tax Imposed on the Transfers of TLAs ("Double Tax")
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In general, states may seek to impose sales tax on TLAs under one of
the following methodologies:
1. Lessee Pay - The lessee pays tax to the lessor with each lease payment.
2. Lessor Pay - The lessor pays tax when the TPP is purchased or at the
initiation of the lease.
3. Option - The lessor may opt to apply either the "lessee pay" or "lessor
pay" methodologies.
In lessor pay states or option states where the lessor pays the tax
"upfront" (i.e., at the time of the lessor's purchase of the TPP or the TLA's
initiation), the lessor is considered the consumer of the TPP, and the lease
payments are not subject to tax. When the lessor is deemed the consumer of the
TPP, the resale exemption typically does not apply to leased assets transferred
between leasing companies. As a result, the subsequent
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(3) The OEs may also continue to service leases (i.e., collect
and remit sales tax) on behalf of unrelated third parties that have acquired the
lease agreements from the OEs or Funding.
transfers of the TPP between the OEs, Funding, the SPEs and the unrelated third
parties may be subject to another sales tax, unless another exemption or credit
applies.
Some states have special provisions enabling the acquiring leasing
company to avoid potential "double tax" on the transfer of TPP, where tax was
paid "upfront" by the original lessor. For example, in certain situations and in
certain states, sales tax prepaid by a predecessor corporation is deemed to have
been paid by the surviving corporation in a reorganization, and no additional
tax is due on the transferred TLA. Other provisions and exemptions may apply in
the states that require or permit the lessor to pay the tax upfront. As these
rules are often not clear cut in application to the transactions entered into by
the Debtors and SPEs, some level of tax exposure may exist with respect to the
transferred TLAs in some states. That having been said, no proof of claim has
been filed by any entity asserting that a tax based upon this type of
transaction is due. In no instance has the result of an audit of any of the
Debtors by a state or local taxing authority revealed that any so-called
"double-tax" is due.
B. Tax Acceleration Due to Use of the Cash Basis Method and Transfers
("Tax Acceleration")
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In certain states, for certain types of lease transactions and
for certain transfers, sales tax may be payable at the origination of a
transaction, over time on an accrual basis or over time on a cash basis. It is
expected that in those circumstances where the Debtors are incorrectly using the
cash basis method to report and remit sales tax, the states will ultimately
receive the total tax due from the Debtors as it is remitted over the duration
of the lease.(4) The issue becomes one of timing and collection risk from the
underlying lessees.
Listed below are the situations that may arguably create tax
acceleration exposure for the Debtors in a particular state:
Tax Acceleration Caused by Pre-existing Reporting Issues
1. Sales/Financing Leases - All Tax Due at Time of Sale (Acceleration to
Lease Origination)
2. TLAs - Cash vs. Accrual Reporting Item (Acceleration to the Present
Time)
3. TLAs - All Tax Due at Time of Lease (Acceleration to TLA's Origination)
Tax Acceleration Caused by Transfer of Leased Assets and/or Lease Stream
1. Sales/Financing Leases - Cash (Installment) Basis State Where Tax is
Due Because of the Transfer (Acceleration to Time of Transfer)
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(4) Some tax base differences may exist, especially in regard to
financing leases, where the aggregate tax base on which tax is remitted each
month exceeds the tax base on which the states' sales tax is imposed.
2. TLAs - Rent Strip Where Tax is Due Because of the Transfer
(Acceleration to Time of Transfer)
Each of these types of tax acceleration is described briefly below:
1. Tax Acceleration Caused by Pre-existing Reporting Issues
Sales/Financing Leases - All Tax Due at Time of Sale (Acceleration to
Lease Origination)
An "accrual state" is a state that does not permit the cash basis for
remitting sales tax on sales or financing leases, but instead requires the tax
to be remitted when the sale occurs, regardless of when the payments are
actually collected from the customer. In certain circumstances, the Debtors have
utilized the cash basis method (i.e., although tax was not remitted at the
sale's origination, portions of the tax have been remitted on a monthly basis).
When this occurs, acceleration exposure may arguably exist in those affected
states for the balance of tax due on the remaining payments that will be
received in the future. Historically, the Debtors have remitted such amounts as
collected and it is the intention of the Plan proponents that this practice
continue following the Effective Date.
TLAs - Cash vs. Accrual Reporting Item (Acceleration to the Present
Time)
As noted above, an "accrual state" may not permit the cash basis for
remitting sales tax but instead may require the tax to be remitted when the sale
occurs, regardless of when the payments are actually collected from the
customer. In regard to TLAs, in certain states, the sale is deemed to occur as
each monthly payment is accrued. Therefore, the tax is due to the state at the
time of the income's accrual, regardless of when the lease payment is actually
received from the lessee. The Debtors have utilized the cash basis method for
remittance of tax on TLAs in states that required the accrual method. When this
occurs, acceleration exposure may exist for one month's sales tax liability.
Additional acceleration exposure may arguably exist if customer's accounts are
delinquent; such additional exposure would be based on the number of months that
the payments are delinquent.
TLAs - All Tax Due at Time of Lease (Acceleration to TLA's Origination)
As discussed previously, certain states require sales tax to be paid on
TLAs at the time of the lease's origination, rather than with each lease payment
(known as "upfront states"). In certain circumstances, the Debtors have
collected and remitted the sales tax with each lease payment, even though the
tax may have been due to the state at the time of the TLA's origination (i.e.,
although tax was not remitted at the TLA's origination, portions of the tax have
been remitted on a monthly basis for the duration of the lease). When this
occurs, acceleration exposure may exist for the balance of tax due on the
remaining lease payments that will be received in the future.
2. Tax Acceleration Caused by Transfer of Leased Assets
and/or Lease Stream
Sales/Financing Leases - Cash (Installment) Basis State Where Tax is
Due Because of the Transfer (Acceleration to Time of Transfer)
A "cash basis or installment method state" permits the cash basis or
installment method for remitting sales tax on sales or financing leases, whereby
the tax may be remitted to the state as it is actually collected from the
customer. Some cash basis states may treat the subsequent transfer or assignment
of a financing lease as an accelerated receipt of the remaining installment
payments and impose tax on such accelerated receipt. In certain circumstances,
the OEs have transferred the financing leases (or sold the remaining
receivables) to Funding or an unaffiliated third party. If this were to have
occurred in certain states that permit the cash basis method, acceleration
exposure could exist for a portion of the tax due. Depending on the state at
issue, the acceleration exposure would be based on the remaining lease payments
that would have been received in the future or on the actual amount of proceeds
received on the sale.
TLAs - Rent Strip Where Tax is Due Because of the Transfer
(Acceleration to Time of Transfer)
The Debtors have also engaged in "rent strips," whereby a third party
purchases the lease income while the OE retains title to the property. In
certain states, rent strips of TLAs to a third party may be subject to tax
acceleration exposure. When the lease receipts are factored or assigned by the
lessor, who retains ownership of the property, sales tax may be due by the
transferor on all lease amounts not yet reported.
III. Discussion
The Debtors believe that the notice of the Bar Date sent to the states
in these Chapter 11 Cases precludes the assertion of the sales tax claims
described above. Alternatively, to the extent sales tax claims are Allowed as
Priority Tax Claims, the Plan provides for them to be funded through Lessee Tax
Payments as such payments are received, pursuant to Section 7.12 of the Plan, or
for them to be paid over six (6) years pursuant to Sections 4.02 and 7.12 of the
Plan.
With respect to the potential sales tax exposure (i.e., "double tax")
that may exist on the transfer of TLAs in the "upfront" states, the Debtors
believe that the various transfers of the intangible rights to the lease streams
from its lease agreements with third party lessees, and the related transfer of
legal ownership (but not physical possession) of the underlying TPP, are not
subject to additional and extraordinary charges for sales and use tax purposes.
The Debtors believe that the transfers comply with the underlying sales and use
tax principles administered in the states and should qualify for an exemption
and/or exclusion due to the nature of the transactions.
With respect to the "tax acceleration" exposure, the Debtors believe
that the Bar Date Notice should preclude the assertion of these claims.
Moreover, the Plan provides
for all sales taxes to be paid to the states as Lessee Tax Payments are
received, and for any "acceleration" claims that are Allowed as Priority Tax
Claims to be paid over six (6) years.
In addition, the Debtors believe that any penalties related to sales
tax claims are subject to subordination pursuant to the Plan, as Class 7 penalty
claims.