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By John B. Hoover, Esq.
Dow Lohnes PLLC Attorneys At Law, Washington, DC
The IRS Office of Chief Counsel has issued Chief Counsel Advice 201210026 (3/9/12) (the "CCA") apparently taking the position that when a business aircraft is managed by an aircraft management company under a typical management arrangement, the aircraft management company is providing air transportation service to the aircraft owner subject to the Federal Transportation Excise Tax (FET). This new position by the IRS is difficult to reconcile with existing law, and, if it is applied in IRS audits, it will impose a heavy and inequitable tax burden on aircraft management companies.
In general, FET is imposed at the rate of 7.5% of the "amount paid" for domestic air transportation service, and it is collected by the provider from the customer in a manner similar to a sales tax. For an aircraft management company to provide taxable transportation service, the company must provide both the aircraft and the pilot services. Only providing the aircraft would be a dry lease, and only providing the pilot services would be personal services. Neither, standing alone, would be subject to FET.
In a typical aircraft management arrangement, the management company provides the pilot services but it does not actually provide the aircraft. The owner of the aircraft already has the aircraft. To reach the conclusion that the aircraft management company provides taxable transportation service, it is necessary to determine that the management company obtains the aircraft from the owner (a constructive lease) and then uses the aircraft to provide transportation service to the owner.
The CCA states that the management company obtains possession, command and control of the aircraft because the management company "exercises virtually all decision making with regard to the operation and maintenance of the aircraft," and "[t]he operational authority that the Owner exercises over the aircraft is limited to selecting flight destinations." The IRS appears to be saying that the party that performs the day-to-day management of the aircraft will be deemed to have possession, command and control of the aircraft. However, this logic does not seem consistent with existing law.
The only court to directly address this issue concluded that a privately owned aircraft management company did not provide transportation service to its owner based on "the objective attributes of a lease, notably the right to possess, use, and control the aircraft." See Petit Jean Air Service, Inc. v. U.S., 33 AFTR2d 1526 (E.D. Ark. 1974), appeal not recommended, AOD 1975-33 (2/7/74). Likewise, in another context, the IRS has ruled that a management company hired to perform day-to-day management services for a hospital under a five year contract does not "control" the hospital for tax purposes, when the owner retained ultimate authority over the assets and activities of the hospital and the management company did not have the right to operate the hospital for its own benefit. Rev. Rul. 98-15, 1998-1 C.B. 715. In ordinary aircraft management company arrangements, the management company provides day-to-day aircraft management services and has no right to operate the aircraft for its own benefit (with respect to owner flights), while the aircraft owner retains ultimate authority over the aircraft.
Unfortunately, IRS auditors may follow the CCA, which would impose a particularly heavy and inequitable burden on aircraft management companies. Most aircraft management companies have not been collecting FET from the aircraft owners in reliance on long-standing precedent in Rev. Rul. 58-215, 1958-1 C.B. 439. If a management company has failed to collect FET on taxable transportation, §4263(c) empowers the IRS to require the management company to pay the uncollected FET for prior periods out of the management company's own pocket. It would be extremely inequitable for the IRS to require management companies to pay this extraordinary amount of FET out of their own pockets with respect to prior periods, when the management companies had no reasonable notice of this aggressive change in the IRS' position. (Since a CCA may not be cited as precedent, management companies arguably still do not have such notice.)
The CCA distinguishes Rev. Rul. 58-215 and indicates that FET will not apply in the case of a management company that acts as "agent" for the aircraft owner if the owner has "exclusive control" over the management company's personnel. However, since the IRS has privately ruled that FET applied to aircraft management services provided under an agreement that designated the management company as the agent of the owner, simply recasting a management company agreement as an agency agreement may not be sufficient to avoid FET. PLR 9404007 (10/20/93).
Accordingly, this CCA seems likely to generate tax disputes with respect to aircraft management services provided in prior as well as future years. In view of the heavy and inequitable burden of imposing the CCA's position on aircraft management companies, as well as the weak legal support for the position announced in the CCA, the IRS should at a minimum announce that it will refrain from imposing FET on aircraft management services provided in past years. Furthermore, it would greatly enhance administration of the FET, if the IRS would work with industry representatives to develop clear guidance on this issue that is more consistent with applicable law.
For more information, in the Tax Management Portfolios, see Glicklich and Miller, 945 T.M., U.S. Taxation of International Shipping and Air Transport Activities.
© 2012 John B. Hoover, Esq.
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