Welcome to Reed Smith’s semiannual update on state and local tax developments affecting the aviation industry. In this update, we will focus on some noteworthy sales and use tax law changes, cases, rulings, and guidance from the first half of 2019, as well as Massachusetts corporate excise tax guidance on the treatment of like-kind exchanges after federal tax reform.1 For a copy of our early 2019 update, visit www.reedsmith.com.
Illinois Office of Administrative Hearings upholds aircraft use tax assessment against Nevada LLC. The taxpayer, a Nevada LLC, was owned by individuals who also owned an aircraft repair company in Illinois. The taxpayer purchased an aircraft in California in 2008 and then delivered the aircraft to the affiliated repair company in Illinois for refurbishment. The taxpayer purchased the aircraft with the intent of repairing the aircraft and reselling it for a profit. After substantial repairs, the aircraft became airworthy in June 2010, and was ready for resale. Between August 2011 and May 2013, the aircraft engaged in 18 flights, 15 of which either originated or ended in Illinois. These flights were for demonstration purposes to market the aircraft to prospective buyers. The aircraft was eventually sold to a Texas buyer in December 2013. The aircraft was based in Illinois during refurbishment and while being held for resale.
The Illinois Department of Revenue (the “Department”) assessed aircraft use tax, interest, and penalties against the taxpayer because of its use of the aircraft in Illinois. The taxpayer challenged the aircraft use tax assessment on five separate grounds:
- the “temporary storage” exception;
- the purchase for resale exemption;
- the aircraft was not “used” in Illinois;
- the aircraft did not have substantial nexus with Illinois; and
- the aircraft’s use fell within the “Safe Harbor Rule” under the interim and demonstration use exemptions for retailers.
The Office of Administrative Hearings (the “OAH”) upheld the Department’s aircraft use tax assessment. In reaching its conclusion, the OAH held that the temporary storage exemption under 35 ILCS 105/3-55(e) did not apply, because the taxpayer kept the aircraft in Illinois for more than five years, which was too long to qualify as “temporary storage”. In addition, even if the repair period was considered temporary, the OAH found that the aircraft was not used solely outside the state after the repair period ended, because the taxpayer used the aircraft to conduct demonstration flights originating or ending in Illinois following the repairs. The OAH also found that the resale exemption did not apply because the taxpayer was not registered as a retailer.
The OAH further found that the taxpayer used the aircraft in Illinois in a taxable manner, because it exercised incidents of ownership over the aircraft in the state by bringing the aircraft into Illinois for repairs and for demonstration purposes, and was not a registered retailer. According to the OAH, had the taxpayer been a qualified retailer, then the repairs and demonstration flights, by themselves, would not have constituted taxable “uses” in the state. Finally, the OAH found that the Safe Harbor Rule under the interim and demonstration use exemptions found at 86 Ill. Admin. Code § 150.306(a)(1)(B) did not apply, because the rule is limited to registered retailers, and, for aircraft, the interim and demonstration use exemptions are expressly limited to 18 months. Illinois Department of Revenue, Administrative Hearing UT 18-05, October 27, 2017 (published April 17, 2019).
Reed Smith takeaway: The OAH appears to have taken a very narrow view of Illinois’ purchase for resale exemption. Whether the taxpayer was registered as an Illinois retailer or not, it appears the aircraft was acquired for the sole purpose of resale, and was never used for purposes other than reselling the aircraft. Being a registered retailer is not a strict requirement in Illinois in order to qualify for the state’s resale exemption. Thus, it seems this case could have been decided differently, at least as to the resale exemption. Notwithstanding the resale exemption, the fact that the taxpayer held the aircraft for more than 18 months after it became airworthy was likely fatal for the taxpayer under the state’s provision that an aircraft used for demonstration purposes for more than 18 months is subject to use tax on the aircraft’s purchase price. This conclusion, however, depends on how the 18 months is determined. For instance, does the 18 month clock start running with the first time the aircraft is used for demonstration purposes, or at some other time? The law in Illinois is not clear on this point. Plus, it seems counterintuitive to the legislative intent to exempt purchases for resale that an aircraft, acquired for resale and operated only for demonstration flights to prospective buyers, should be subject to Illinois use tax, just because it takes the seller more than 18 months to find a willing and able buyer.
Louisiana enacts a sales and use tax exemption for the use of aircraft for demonstration flights. On June 4, Louisiana Governor John Bel Edwards signed H.B. 209 into law, which includes exemptions for new vehicles (including new aircraft) withdrawn from stock or kept in inventory by a factory-authorized new vehicle dealer and used for demonstration purposes. (The bill also includes an exemption for used automobiles and trucks utilized for demonstration purposes, but the exemption for used vehicles does not extend to used aircraft.) The new law took effect on July 1, 2019. H.B. 209 (enacted June 4, 2019).
Massachusetts issues guidance on the corporate excise tax treatment of like-kind exchanges of certain property following the federal Tax Cuts and Jobs Act. Prior to the enactment of the Tax Cuts and Jobs Act (“TCJA”), a taxpayer could defer recognition of gain or loss on the sale of business property if the taxpayer replaced the property with “like-kind” property as defined under section 1031 of the Internal Revenue Code. The TCJA amended section 1031 by eliminating like-kind exchange (“LKE”) deferral for exchanges of tangible personal property (that is, limiting LKE deferral to real property only). On May 9, 2019, the Massachusetts Department of Revenue issued a Technical Information Release affirming that, for Massachusetts corporate excise tax purposes, the pre-TCJA version of section 1031 will remain in effect, allowing taxpayers to continue to defer recognition on the sale of LKE of tangible business property, such as aircraft. Massachusetts Technical Information Release 18-14 (May 9, 2019).
North Carolina’s sales tax exemption for services performed on qualified aircraft is now effective. North Carolina Senate Bill No. 628, enacted by L. 2017, S628 (c. 204), provides for a sales and use tax exemption for repair, maintenance, installation services, and service contracts sales for “[a]n aircraft with a gross take-off weight of more than 2,000 pounds.” Although the bill passed in 2017, the effective date for the exemption was delayed until July 1, 2019. N.C. Gen. Stat. § 105-164.13(61a)m.
North Dakota attorney general issues opinion clarifying that payment of aircraft excise tax is a condition precedent to state licensing of an aircraft. The North Dakota Aeronautics Commission, which issues registration licenses to aircraft operating in North Dakota for more than 30 days in a year, sought clarification on the proper sequence for paying the North Dakota aircraft excise tax and issuing aircraft registration certificates. The North Dakota aircraft excise tax applies to every transaction involving an aircraft that must be registered in North Dakota, including all purchases and all subsequent leases to affiliates (if the initial purchase was exempt or excluded). In the case of a registered aircraft that was purchased and then leased, the Aeronautics Commission’s practice was to issue the registration certificate without first requiring payment of the excise tax, and then to collect the payment of the excise tax quarterly based on the rental value of the aircraft that was leased to the purchaser’s affiliate.
In its opinion, the attorney general determined that if an aircraft is purchased for use in North Dakota, the aircraft excise tax must be paid in full on the aircraft’s purchase price or lease or rental cost before the aircraft can be registered with the state. According to the attorney general, the Aeronautics Commission’s past practice of allowing aircraft owners to pay tax over time on the lease stream is not permissible under the state’s tax laws. Based on the attorney general opinion, it seems the aircraft excise tax can only be computed based upon the rental value of the lease, if the aircraft is not subject to registration in North Dakota at the time of purchase. North Dakota Attorney General Opinion 2019-L-01.
Texas comptroller abates use tax assessment on purchase of an aircraft for resale while upholding the assessment of use tax on second aircraft. On January 14, 2019, the Texas comptroller of public accounts issued a decision addressing the applicability of Texas use tax to two separate out-of-state aircraft purchases made by the same taxpayer.
Aircraft 1: The taxpayer purchased Aircraft 1 in Florida in October 2012 and flew it to Texas in November 2012 for renovations. Immediately after bringing Aircraft 1 into Texas, the taxpayer listed it for sale. After renovations were complete, Aircraft 1 did not fly again until April 2015, when routine maintenance was required. In October 2015, the taxpayer sold Aircraft 1.
The comptroller audited the taxpayer’s purchase of Aircraft 1 and assessed use tax, penalties, and interest because it found that the taxpayer had used Aircraft 1 during the time it was located in Texas. The comptroller principally based its determination on the fact that the taxpayer had taken depreciation deductions with respect to Aircraft 1 and had not amended its federal income tax returns to recapture those deductions. The comptroller asserted that taking a depreciation deduction constituted a taxable use under Texas law. In response, the taxpayer argued that it mistakenly treated Aircraft 1 as a depreciable asset. The administrative law judge (“ALJ”) concluded that there was ample evidence to support a finding that the taxpayer purchased Aircraft 1 for resale, and the fact that the taxpayer took depreciation deductions with respect to the aircraft was not determinative. The facts supporting the taxpayer’s resale claim were: (1) the taxpayer was in the business of selling aircraft, (2) the taxpayer immediately advertised Aircraft 1 for sale upon purchase, and (3) the taxpayer did not operate the aircraft while holding it for resale other than for routine maintenance.
Aircraft 2: The taxpayer purchased Aircraft 2 in September of 2011 through a finance lease (installment sale) with a seller-lessor. Under the terms of the finance lease, the taxpayer would make periodic payments to the seller-lessor until the full purchase price was paid. Upon making the last payment, title to the aircraft would be transferred to the taxpayer. During the period when title was held by the seller-lessor, the seller-lessor and an affiliate of the taxpayer (Affiliate) entered into a charter management agreement whereby Aircraft 2 was dry-leased by the seller-lessor to Affiliate. After the taxpayer made the final installment payment and title transferred, the taxpayer and Affiliate entered into a new charter management agreement, whereby the Affiliate would operate Aircraft 2 under 14 C.F.R. Part 135 (“Part 135”) as an on-demand charter operator carrying passengers or property for hire. Under the agreement, the taxpayer reimbursed Affiliate for all costs of financing, equipping, and certifying Aircraft 2 for charter operations, and the taxpayer bore all costs of scheduled maintenance. The taxpayer also paid Affiliate a monthly charter management fee.
The comptroller audited the taxpayer’s purchase of Aircraft 2 and assessed tax, penalty, and interest. The taxpayer challenged the assessment claiming an exemption under Texas Tax Code § 151.328(a)(1), which exempts sales to certificated or licensed carriers of persons or property. In the alternative, the taxpayer claimed the resale exemption. Taxpayer argued that it qualified for the certificated carrier exemption because it entered into a management agreement with a related entity that was a certified and licensed carrier under Part 135. However, the ALJ dismissed that argument, finding that the statute and prior comptroller decisions make clear that the purchaser must meet the definition of a carrier to qualify for exemption. Here, because the taxpayer/purchaser was not, itself, a licensed Part 135 carrier, the common carrier exemption could not be claimed by the taxpayer.
The ALJ also dismissed the taxpayer’s resale argument, finding that the charter management agreement the taxpayer entered into with its Affiliate had all the markings of a service agreement and no indications of a lease. In fact, all consideration under the agreement flowed from the taxpayer to the Affiliate to manage and service the aircraft with no consideration (that is, lease payments) flowing to the taxpayer. Therefore, the comptroller’s assessment of tax on Aircraft 2 was upheld. Texas Comptroller’s Decision No. 115,331 (January 14, 2019).
Texas comptroller issues private letter ruling on the sales and use tax treatment of an aircraft purchased through a finance arrangement and used predominantly outside Texas. In this ruling, the taxpayer sought clarification on the taxable nature of an aircraft financing arrangement (that is, a conditional sale). The taxpayer entered into an aircraft purchase agreement with the aircraft’s manufacturer, but later assigned its purchase rights in the aircraft to a financing company (Lessor). The taxpayer and the Lessor entered into a separate agreement whereby the Lessor agreed to grant exclusive use and operational control of the aircraft to the taxpayer. In exchange, the taxpayer agreed to make monthly payments to the Lessor for 10 years, and then a lump-sum purchase payment at the end of the 10-year lease period. The delivery of the aircraft would take place outside of Texas and, according to the taxpayer, the aircraft would be used predominantly (more than 50 percent of the time) outside of Texas in the first year following completion.
Based on the facts presented, the comptroller found that the aircraft would qualify for the state’s out-of-state use exemption under Texas Tax Code § 163.005 because more than 50 percent of the aircraft’s departures for one year would take place outside of Texas. The comptroller also noted that the agreement between the taxpayer and Lessor constituted a financing arrangement and not a true lease. Thus, none of the “lease” payments made to the Lessor would be subject to Texas sales and use tax, so long as the taxpayer satisfies the state’s purchase for out-of-state use test, as intended. Texas Letter Ruling No. 201812005L(December 18, 2018).
West Virginia State Tax Department adopts regulations under the sales and use tax exemption for services performed on aircraft operated under a fractional ownership program. On April 9, 2019, the State Tax Department adopted rules describing the administrative and procedural requirements to qualify for the newly enacted sales and use tax exemption for purchases of services or tangible personal property sold for the repair, remodeling, and maintenance of an aircraft operated under a fractional ownership program. In addition to the exemption for the services, the rules identified specific categories of tangible personal property that are exempt from tax when used in the performance of repair, remodeling, and maintenance services on qualifying aircraft, including machinery, tools, or equipment physically incorporated into finished fractional program aircraft, engines and components, or aircraft used exclusively in a designated exempt service. The rules became effective as of April 9, 2019, and remain effective until April 9, 2024. West Virginia State Tax Department, Regulations Sections 110-15K-1 et seq. (April 9, 2019).