Arkansas holds that aircraft owner has responsibility for collecting sales tax on sale made through broker. In November of 2017, an Arkansas aircraft owner sold an airplane to a purchaser through a third-party broker. Ark. Code Ann. § 2652505 requires sellers of airplanes to register for a sales tax permit and to collect and remit tax on the sale. However, the aircraft owner did not do so here. The purchaser, who was registered for the state sales tax, did not pay sales or use tax on the purchase and did not provide any exemption certificate to the broker or aircraft owner. After receiving information from the Federal Aviation Administration (“FAA”) regarding the sale, the Arkansas Department of Finance and Administration (“DFA”) opened an audit that resulted in an assessment issued to the aircraft owner. The aircraft owner protested the assessment but the Administrative Hearings Division upheld the entire assessment.
In the protest, the aircraft owner claimed that the broker, who was engaged in the business of selling airplanes, should have properly collected the sale tax on the sale that it performed on the owner’s behalf. However, the Hearings Division disagreed, holding that Ark. Code Ann. § 2652505 makes the seller of an airplane strictly responsible for collecting and remitting sales tax. Thus, the aircraft owner’s use of a third-party broker did not relieve the owner from his tax obligations. Ark. Admin. Hearing Dec., Dkt. No 19024 (Sept. 10, 2018).
Reed Smith takeaway:
- This decision is an important reminder that when selling an aircraft, the purchase agreement should clearly state which party is ultimately responsible for any sales or use taxes arising from the sale. It is often the case that the sales and use tax burden is placed on the purchaser, who agrees to indemnify the seller for any sales or use tax the seller may incur on the aircraft sale. We also note that Ark. Code Ann. § 2652505(a), as interpreted in the above decision, appears to broadly require anyone selling an aircraft in Arkansas to register as a retailer/dealer in the state. It is not clear if this registration requirement extends to aircraft owners not engaged in selling aircraft or sellers availing themselves of the state’s “flyaway” exemption (Ark. Code Ann. § 2652451(a)). If so, this decision could have a chilling effect on aircraft sold in the state. Sellers (or purchasers) who find themselves in a similar situation as the aircraft owner in the above hearing decision should also make an effort to determine if the counterparty to the transactions has already been audited or assessed tax on the aircraft sale in order to avoid double taxation. Many states include guidance in the audit manual on how to avoid double taxation in similar situations.
Arkansas issues taxpayer friendly opinion on the flyaway and substantial completion exemptions. On October 23, 2018, the DFA issued an opinion regarding the applicability of the state’s sales tax exemptions for transfers of aircraft that are subsequently flown out of Arkansas for use outside the states. In this instance, the aircraft purchaser was a resident of a foreign country. The aircraft in question had a certified maximum takeoff weight of more than 9,500 lbs. and was delivered in “green condition” (which generally means that the aircraft does not have internal furnishings or exterior paint) at a location in Arkansas, where final completion of the aircraft was to occur. The completion activities in Arkansas included: structure installation, avionics/electrical fabrication and installation, upholstery fabrication, cabinet fabrication and finishing, exterior paint, interior installation and flight tests. Once the aircraft was completed, the buyer accepted the aircraft in Arkansas and subsequently flew it out of Arkansas for use and to be based outside the state. The aircraft was not expected to return to Arkansas, except for occasional maintenance.
The DFA concluded that the transaction was exempt under both the flyaway exemption and the state’s exemption for aircraft substantially completed in Arkansas. The flyaway
exemption (Ark. Code Ann. § 2652451) exempts the sale of an aircraft with a certified maximum takeoff weight of more than 9,500 lbs. that will be based outside Arkansas, as long as possession of the aircraft is taken in Arkansas for the sole purpose of removing the aircraft from the state under its own power or for temporary maintenance (and is removed upon completion of the maintenance). The substantial-completion exemption1 (Ark. Code Ann. § 2652505(c)) exempts the sale of new aircraft substantially completed within Arkansas when sold to a purchaser for exclusive use outside the state, notwithstanding that possession may be taken in the state for the sole purpose of removing the aircraft from the state under its own power. In addition to ruling that the flyaway exemption applied, the DFA concluded that the completion activities described above constituted “substantial” within the meaning of the exemption and thus, the sale of the aircraft would also be exempt under Ark. Code Ann. § 2652505(c). Ark. Opin. No. 20181005 (Oct. 23, 2018).
Colorado rules that aircraft parts and manufacturing equipment used in the manufacture of an R&D prototype aircraft are exempt from sales and use tax. In PLR 18003, the taxpayer, who was in the early stages of preparation for the manufacturing of commercial aircraft, requested, among other things, a ruling from the Colorado Department of Revenue as to whether the aircraft parts and manufacturing machinery it purchased to build a prototype aircraft were subject to sales or use tax. The taxpayer was in the research and development stage for its aircraft and had not yet begun manufacturing aircraft for sale. In order to flight test its prospective aircraft, the taxpayer had to build an operational prototype. After testing the prototype, the taxpayer expected to sell the prototype aircraft or, if it could not find a buyer, use the prototype for marketing purposes. The taxpayer asked for a ruling as to whether: (1) the aircraft parts to be affixed to the prototype aircraft were exempt from sales and use tax under the state’s manufacturing or aircraft parts exemptions; and (2) the manufacturing equipment used to build the prototype was exempt under the state’s manufacturing machinery exemption.
The Department concluded that the general manufacturing exemption would not apply to the aircraft parts, because the aircraft parts were not purchased primarily for sale (a requirement of the exemption) but for flight testing and marketing. However, the Department did find that the aircraft parts were exempt under the state’s exemption for aircraft parts permanently affixed or attached as component parts of an aircraft. Col. Priv. Ltr. Rul. PLR18003 (May 23, 2018).
Reed Smith takeaways:
- The aircraft parts exemption applies to all aircraft, not just those used in interstate commerce. In its ruling, the Department added a footnote that the aircraft-parts
exemption is not limited to aircraft used in interstate commerce. Generally, under Colorado law, the purchase of an aircraft may be exempt if it is used in interstate commerce. However, the Department considered whether this interstate commerce should also be read-into the aircraft parts exemption and declined to do so.
- Manufacturing machinery and equipment is exempt. The taxpayer in the ruling also requested a ruling on the taxability of machinery and equipment used to manufacture the prototype. The Department concluded that the exemption for manufacturing machinery applies regardless of whether the manufactured item is sold by the manufacturer. Aircraft and parts manufacturers should review their purchases of manufacturing equipment to ensure they are using the exemption to the fullest extent allowed, and to the extent they are not, they should consider filing refund claims.
New statutory provision provides refund opportunity for tax paid on aviation fuel. Effective July 1, 2019, air carriers conducting scheduled operations or all-cargo operations authorized under FAA Part 121, Part 129, or Part 135 are entitled to receive a refund of 1.42 cents per gallon with respect to all purchases of aviation fuel. Fla. Stat. § 206.9826.
Idaho clarifies the treatment of aircraft repair services performed under warranty agreements. In August, the Idaho State Tax Commission proposed revisions to its sales and use tax regulations to clarify and illustrate that aircraft parts installed on an aircraft owned by a nonresident individual or business are exempt if the installation of the parts is covered by a warranty agreement. A business is considered a nonresident of Idaho if it is not formed under the laws of the state, is not required to be registered to do business with the Idaho Secretary of State, does not have significant contacts with Idaho, and does not have consistent operations in the state. The revised regulation was adopted January 2, 2019. Idaho State Tax Comm’n, Proposed Regs. Sections 35.01.02.037, 35.01.02.049, 35.01.02.068, Idaho Admin. Bull. Vol. 188 (Aug. 1, 2018); Idaho State Tax Comm’n, Regs. Sections 35.01.02.037, 35.01.02.049, Idaho Admin. Bull. Vol. 191 (Jan. 2, 2019).
Illinois Court upholds use tax assessment on transfer of aircraft to living trust; taxpayer must pay tax twice. The Circuit Court of Cook County upheld a use tax assessment by the Illinois Department of Revenue (“IDOR”) on an individual’s transfer of an aircraft to a living trust. The individual originally purchased the aircraft, a recreational single-seat glider plane, in 2008 and paid sales tax at the time of purchase. In 2014, he engaged in estate planning whereby title to the aircraft was transferred to a newly created living trust. As a result of this transfer, he filed a new bill of sale with the FAA. IDOR, which routinely receives information from the FAA regarding aircraft registered to an Illinois address, saw the bill of sale and assessed aircraft use tax against the trust for use of the aircraft in Illinois.
The individual challenged the assessment on the grounds that nothing had changed—that is, he continued to have full control and possession of the aircraft as he had before the transfer. The only difference was that he did so now as trustee of the living trust instead of individually. Thus, he argued in his motion for summary judgment, that the transfer lacked economic substance and could not be taxed. IDOR argued that it was entitled to summary judgment because the trust was a separate and distinct entity and therefore the transfer was taxable, despite the taxpayer’s prior payment on the original purchase. In a case of first impression, the Court agreed with IDOR. The Court reasoned that the economic substance test advocated by the taxpayer would be difficult to administer on a case-by-case basis and would result in less predictability for taxpayers. Therefore, the Court granted summary judgment for the IDOR and held that the Illinois Aircraft Use Tax statute “creates a tax liability any time an aircraft owner files an FAA bill of sale registering as an aircraft owner with the FAA”, even if, like here, the transfer would result in the taxpayer paying tax twice. Shakman v. Ill. Dept. of Rev., Cook Cty Cir. Ct. Dkt. No. 2017 L 050873 (Oct. 5, 2018).
Maine updates instructional bulletin on sales and use tax exception for aircraft trade-ins. In Maine, the general rule for sales tax purposes is that the entire transaction price, including any credit for trade in property, is subject to the sales tax. For example, if a retailer sells a laundry machine for $500, and the customer pays $400 in cash and trades in their old laundry machine for a $100 credit, the tax is imposed on the entire $500 transaction. However, as confirmed in the updated bulletin, there is a special rule that applies to aircraft that are traded-in. If you are trading in an aircraft, the sales and use tax is only imposed on the difference between the sale price of the purchased aircraft and the trade-in value/credit of the previously owned aircraft. Maine Instructional Bulletin No. 39 (Nov. 19, 2018).
Nebraska publishes new information guide for common and contract carriers. In August, the Nebraska Department of Revenue published a new information guide that explains that the purchase, lease, or rental of aircraft used “predominantly” as a common or contract carrier vehicle is exempt from sales and use tax. The exemption also covers repair and replacement parts for such qualified aircraft. The guide defines “predominant use” to mean “the [aircraft] is used more than 50% of the time in transporting persons or property for hire.” The guide offers additional information on calculating predominant use and proper exemption certificate procedures, and provides examples of purchases that do and do not qualify for the “common carrier” exemption. Neb. Common or Contract Carrier Info. Guide (Aug. 2018).
Reed Smith takeaway:
- The information guide provides examples of methods to calculate the percentage of use but does not require any particular method. Thus, taxpayers should have flexibility on the method they use to reasonably approximate use of an aircraft – i.e., mileage, hours, takeoffs and landings, etc. Taxpayers should consider all reasonable options to determine the method that is most favorable.
New Jersey bill introduced to eliminate tax exemption on aviation fuel for certain airlines
. In August, New Jersey Senate President Stephen Sweeney (D) introduced Senate Bill 2892, which would limit the current tax exemption for aviation fuel. Currently, aviation fuel is exempt from tax, except for the “burnout” portion of fuel used in takeoffs and landings. The proposed bill would narrow the exemption and impose tax on receipts from the sale of aviation fuel used by or delivered to a “qualifying airline.” The bill would define “qualifying airline” as any person or business authorized by the FAA to operate as an air carrier and which has more than 8 million enplaned passengers per year in New Jersey or any regional carrier operating an aircraft of 99 seats or fewer under contract with such a person or business. The revenue generated from imposing the tax on airlines would be appropriated first to fund the completion of the Port Authority Trans-Hudson train extension to the Newark Liberty International Airport and then to the Air Safety Fund. The bill was passed by the Senate in September and is currently pending in the Assembly. New Jersey Senate Bill 2892 (introduced Aug. 27, 2018)
Reed Smith takeaway:
- So far, this bill has garnered a lot of attention from industry members. At public hearings and through written submissions, practitioners and taxpayers have questioned the constitutionality of the bill. As this bill continues to move forward in the Assembly, it will be one to watch in 2019.
Ohio Supreme Court holds that purchase and subsequent lease of aircraft did not qualify for resale exemption. On December 7, 2018, the Ohio Supreme Court affirmed an assessment of use tax against an LLC that purchased an aircraft and subsequently leased the aircraft to its sole member. The LLC, Pi In The Sky LLC (“PITS”), was a single member LLC formed for the purpose of purchasing and leasing an aircraft to its sole member, Mitchell’s Salon and Day Spa, Inc. (“Mitchell’s”). Mitchell’s owns and operates several hair salons and spas in the greater Cincinnati area. Mitchell’s president is a licensed pilot. PITS purchased the aircraft from an Indiana-based vendor and did not pay sales or use tax at the time of purchase. The Ohio Department of Taxation (the “Department”) audited PITS and assessed use tax.
PITS appealed the assessment, arguing that the subsequent lease of the aircraft to Mitchell’s qualified the initial purchase of the aircraft as an exempt purchase for resale. The Department argued that the sales-for-resale exemption did not apply because PITS was not “engaged in business” as required by the resale exemption. Under Ohio law, the resale exemption in R.C.5739.01(E) applies when the purpose of a purchase is to resell the purchased item in the same form in which it was acquired, while that purchaser is engaging in business. According to the Department, PITS was not engaging in the business of leasing because:
- PITS had not reported a business location apart from the personal residence of Mitchell’s president;
- There was no evidence that leasing activity took place at the aircraft’s hangar;
- The aircraft was never used by a third-party lessee;
- There was no evidence that PITS ever marketed the aircraft for lease;
- Many of the flights were to or from a lake house owned by Mitchell’s’ president;
- The aircraft was purchased using personal funds of Mitchell’s’ president; and
- The lease agreement between PITS and Mitchell’s lacked economic substance, such as arm’s-length rental rates.
The Tax Commissioner and the Board of Tax Appeals upheld the Department’s assessment and the Ohio Supreme Court affirmed. The Ohio Supreme Court found that PITS had not carried its burden to show that it satisfied the requirements of the state’s sale-for-resale exemption. Because the Court determined that the aircraft did not qualify for the state’s resale exemption, it declined to address whether PITS engaged in a sham transaction. Pi In The Sky, LLC v. Testa, Ohio Supreme Court Docket No. 20170236 (Dec. 7, 2018).
Reed Smith takeaway:
- It appears from the facts of the decision that PITS and Mitchell’s entered into a typical nonexclusive, dry lease agreement for use of the aircraft. For instance, the lease with Mitchell’s had no defined lease term, with each lease period commencing with delivery of the aircraft and concluding with the return of the aircraft to the lessor. Additionally, PITS, as the lessor, had sole discretion to deny any flight-scheduling request made by Mitchell’s. However, the most troubling fact for the Court seem to be that the lease rate of $80 per flight hour was low when compared to the value of the aircraft ($1,217,460), making it difficult for PITS to generate sufficient revenue to pay the monthly payment on its acquisition loan. Based on the foregoing, in light of the Ohio Supreme Court’s decision, it may be prudent to revisit any nonexclusive dry lease agreements currently in place for aircraft based in Ohio to make sure the lease terms and rental rates are arm’slength.
Washington issues advisory to explain how manufacturers and sellers of aircraft components and materials qualify for the B&O tax rate for the aerospace industry. On June 28, 2018, the Washington Department of Revenue issued an excise tax advisory to explain how manufacturers or sellers of components and materials that are subsequently sold to and used by other manufacturers for the manufacturing of components and materials for installation into commercial aircraft may qualify for the preferential aerospace B&O tax rate. The preferential aerospace tax rate applies to manufacturers of commercial airplanes or components of commercial airplanes. The preferential rate also applies to retail or wholesale sales of commercial airplanes and components that are manufactured by the seller. A “commercial airplane” means an airplane certified by the FAA for transporting persons or property. The advisory explains that to qualify for the preferential rate it does not matter that the components, including materials, undergo additional steps in the manufacturing process (i.e., the parts are sold to another manufacturer who, in turn, uses the materials to manufacturer and sell a component to an airplane manufacturer), as long as the parts are FAA certified and are ultimately installed on a commercial aircraft. The advisory also describes ways that a taxpayer can document its FAA certifications to support the preferential aerospace B&O tax classification. Wash. Excise Tax Advisory ETA 3210.2018 (June 28, 2018).
1. Ark. Code Ann. § 2652505(c) also applies to all aircraft manufactured in Arkansas.
Client Alert 2019-017