By John Alan Cohan, Attorney at Law
A relatively new
approach to air travel has introduced the business community to
fractional ownership programs. These programs enable individuals to
have partial ownership in one or more aircraft, and to share the
maintenance and management costs. Purchasers of shares are usually
affluent individuals or companies that wish to enjoy the
convenience of access to private aircraft without the cost and
responsibility of doing it alone. Similar to timeshare memberships,
the owners of each program “own” a portion of the fleet
with contractual rights to share and use all the aircraft in the
fleet. Legally speaking, the fractional owners are considered
tenants in common. In turn, the management company manages the
fleet by maintaining the aircraft, providing onboard services, and
manages contractual agreements among the parties. The owners
ordinarily are entitled to depreciate their ownership interest in
the aircraft.
The management company requires each owner to sign a series of
contracts that outline the owner’s responsibilities
concerning the operation of the aircraft and participation in the
program. A fractional owner must agree to share his portion of
flight time with others in the program in exchange for the
opportunity to use others’ portion of flight time when
necessary.
Taxpayers purchasing a fractional interest in an aircraft may be
subject to the imposition of sales or use tax. A use tax is the
counterpart to a sales tax, imposed on purchases of tangible
personal property made outside the state if the property purchased
is then used within the state. A state’s use tax can generate
significant revenue for the state. When a state experiences large
budget deficits, the Department of Revenue has a huge incentive to
keep a closer eye on purchases made outside the state to see if the
state’s use tax might apply.
A use tax is levied on
property purchased outside the state, where the property would have
been subject to the sales tax if purchased locally. This tax
eliminates the incentive to purchase from out-of-state merchants in
order to escape local sales taxes. With regards to fractional
interests, the basis of the use tax is that the interests are
tangible personal property, the transaction would have been subject
to local sales tax if it occurred in the state, and the fractional
owner exercises sufficient dominion and control over the aircraft
within the state to justify imposing the use tax.
There are “loopholes” to avoid use tax, but this
depends entirely on the individual state law and the facts in
question. A leading case in Missouri, Fall Creek Construction
Company v. Director of Revenue, has held that the purchase of a
fractional interest is a taxable purchase, while New York and Texas
have taken the opposite position. Most states will impose the use
tax on these interests. Often enough, owners of fractional
interests will not voluntarily pay the use tax, but if the
transaction comes to the attention of taxing authorities, an
assessment will be issued, usually with penalties and interest.
The Missouri court held that the fractional share was tangible
personal property, and therefore, the fractional owner was subject
to use tax under Missouri law. In order to analyze application of
the use tax, one must first examine the purchasing agreement
between the management company and the fractional owner to
ascertain the nature of the owner’s interest. Second, it is
important to know who is in “operational control” of
the aircraft. Third, if the aircraft is hangared outside of the
state there must be some reasonable nexus between the state and the
aircraft to hold the fractional owner liable for use taxes. For
instance, the fractional owner use the aircraft on some flights to
or from the state in question in order for there to be an adequate
nexus to impose the tax.
A counterargument to imposition of the use tax is that
fractional ownership interest does not constitute ownership of
tangible personal property but rather the right to use the aircraft
for a specified number of hours per year. The success or failure of
this argument will depend in part upon the contractual intent shown
in the documents pertaining to the transaction.
Another argument
against the tax in individual cases is that there is an
insufficient connection between the aircraft and the state to
justify the burden on interstate commerce. A further argument is
that the fractional owner did not exercise sufficient dominion or
control over the property to constitute “use” under the
use tax, or that the aircraft never was “used” in the
state. The taxing authority will generally argue that any use of
the aircraft in the state is sufficient to find “use”
under the statute.
A final argument that might be used to avoid the use tax is that
imposition of the tax impermissibly burdens interstate commerce.
The Supreme Court has recognized that a state has the power to tax
the use of property purchased outside the state, but not if the tax
impermissibly burdens interstate commerce. The case, Complete Auto
Transit, Inc. v. Brady, provides that a state tax on interstate
commerce will not be sustained unless the tax (1) has a substantial
nexus with the state; (2) is fairly apportioned; (3) does not
discriminate against interstate commerce; and (4) is fairly related
to the services provided by the state.
In addition to the use tax, some states seek to impose an
aircraft registration tax on aircraft owned by residents of the
state, and in some instances this tax will extend to ownership of
fractional interests.