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.

FMI: johnalancohan@aol.com