State tax audits often come in waves. When a revenue department notices one business that has been overlooked, the business’s competitors often find auditors knocking at the barn door.  In Indiana, one of the areas of recent focus has been so-called claiming races.

Claiming races are a method of determining the price of a horse, with the successful buyer (claimant) taking title to the horse when it leaves the starting gate.  Claiming races also allow racetracks to offer more pari-mutuel races (filling the schedule with top-quality races is near impossible) and allow horse owners to prove the mettle of horses that might not otherwise be competitive.  If the horse wins the race, the original owner takes the purse, not the claimant.

Several months ago, the Indiana Department of Revenue began issuing letters of finding in cases where claimants had failed to pay the tax on the claiming transactions.  As improbable as it sounds, the issue became significant enough that the Indiana General Assembly included an “Amnesty Program for Unpaid Use Tax on Claimed Race Horses” in this session’s biennial budget.  Taxpayers with unpaid tax liability for claiming transactions occurring before June 1, 2012, can have interest, penalties, and costs abated in return for paying the unpaid taxes.  It should be noted that the Department’s first letters of finding came in September 2012.

Over time, the arguments against imposition of the tax became more developed and more interesting, though taxpayers have yet to have a protest sustained.  In May, taxpayers put forth two novel arguments that attempted to stir up the Department’s thinking.

A Horse is a Horse, of Course… Unless it’s a Farm Implement

In earlier cases, taxpayers had unsuccessfully argued that the agricultural exemption applied to the purchases.  The taxpayer in Letter of Findings 04-20130076, however, tried to make hay of a different argument for the exemption.

The taxpayer did not contest that he acquired horses in claiming transactions, and did not contest that such transactions are generally taxable.  Instead, the taxpayer argued that he acquired the claimed horses as part of his corn and soybean farming operations, and that they were, in fact, integral and essential parts of those operations.  The horses produced a “profuse amount of manure,” which the taxpayer used to fertilize his crops.  The fertilizer had to be “harvested several times a week to spread on the land.”  The horses were not primarily used for racing, in the taxpayer’s opinion, because they were stabled at his farm most of the time, and only left the farm to be raced.

The Department did not share the taxpayer’s opinion.  The horses’ biological byproduct, while important to the taxpayer’s agricultural production process, did not make the horses directly used in direct production of food or food ingredients.  The property in question (the horses, not their byproduct) must have an immediate effect on the food being produced.  Because the horses could not meet that test, the Department rejected the taxpayer’s argument.

The Department Beats a Dead Horse

Sales tax is imposed on the transfer of tangible personal property.  The taxpayer in Letter of Findings 04-20120541, who purchased a horse in a claiming transaction, argued that the nature of claiming transactions mean that there is no tangible personal property, and therefore no tax.

The taxpayer rested his case on Racing Commission regulations which explained that in claiming races, the successful claimant “become[s] the owner of the horse whether it be alive or dead, sound or unsound, or injured at any time during the race or after.”  The taxpayer emphasized that this means that he is responsible for the purchase price even if the horse dies.  Therefore, the horse was not tangible personal property, but nontaxable intangible personal property.

Although the regulations did provide that claiming races have a level of uncertainty, the Department disagreed that the (presumably still living) horse was intangible property.  “[E]ven a dead horse is capable of being ‘seen, weighed, measured, felt, or touched’ and thus is still tangible personal property as defined under Ind. Code § 6-2.5-1-27.”  Sales tax was therefore owed, and the Department put the taxpayer’s argument out to pasture.