Sales and Use Tax Developments

March 7, 2014
by  Steve Britt
Is “Pay to Play” still the rule in Texas?  As discussed in our November newsletter, the Austin Court of Appeals decision in Richmont Aviation, Inc. v. Combs held that the Plaintiff could move for an injunction and a declaratory judgment in district court without first paying the disputed amounts under protest or posting a bond of twice the amount as required by Tax Code Chapter 112.  The Court ruled this “pay to play” requirement was unconstitutional.  The Comptroller has appealed the ruling to the Texas Supreme Court, but if the decision stands, it may open the door for injunction and declaratory judgment lawsuits without the Tax Code’s onerous prepayment requirements.

In a related development last month, SD&M obtained an injunction in the case of EVO Inc. v. Combs even though tax had been neither been paid nor assessed on the relevant transactions.  The Comptroller had issued a letter ruling that EVO’s downhole video and diagnostic services were taxable.  Based in part on the Richmont case, SD&M contended that EVO was entitled to enjoin the Comptroller from collecting tax on the transactions because EVO would be irreparably harmed if it was forced to collect tax while its competitors did not.  The district court ruled for EVO.  The Comptroller’s deadline for appeal has not yet expired.

Update on the Comptroller’s “business purpose” policy.  For several years, the Comptroller has been applying a “business purpose” test to purchases of aircraft.  The implicated transactions usually involve multi-step transfers between related entities.  In 2006 and 2009, the Comptroller issued policy letters indicating that it reserved the right to disregard legal entities or look behind the form of a transaction to determine if there was a legitimate business purpose beyond the mere avoidance of tax.

The Comptroller’s Business Activity Research Team (BART) has been very aggressive in application of this policy to aircraft being used in Texas.  Basically, if BART identifies an aircraft operating in Texas upon which no sales or use tax was paid, it will assess tax and put the burden on the taxpayer to prove that there was a legitimate business purpose to the structure.  There are hundreds of such assessments being challenged in administrative hearings or district court lawsuits.

There have been numerous Comptroller decisions regarding the policy, most in the context of aircraft purchased for resale and then leased to related entities.  However, application of the policy has not been approved in every circumstance.  SD&M recently obtained a favorable Proposal for Decision from the State Office of Administrative Hearings rejecting the application of the policy to a non-lease transaction.

Business purpose cases are now appearing in the Texas court system.  In the recent district court case of Warren Transportation v. Combs, the business purpose theory was one of several grounds asserted by the Comptroller to oppose application of the resale exemption to the purchase of an aircraft for lease to a related entity.  The judge ruled for the Comptroller, but the ruling was not based on the business purpose theory.  The judge’s ruling did not approve or reject the policy.  The taxpayer is not appealing the ruling.

It is only a matter of time until the business purpose policy is considered in the Court of Appeals.  If the policy is affirmed, it is possible the Comptroller could begin to apply the policy to purchase of other types of property.  Texas could become a “substance over form” state and taxpayers could lose the right manage their tax liabilities based on the plain meaning of the Tax Code.  This aircraft litigation merits close attention because it could have much broader implications.

Commercial carrier exemption extended to some Part 91 aircraft.  Tax Code Section 151.328 exempts from sales tax aircraft “sold to a person using the aircraft as a certified or licensed carrier of persons or property”.  The Comptroller’s long-standing policy restricted this exemption to commercial air carriers certified under Parts 121, 125, or 135 of the FAA regulations.  In the recent case of Cirrus Exploration v. Combs, the Austin Court of Appeals ruled the exemption also applied to an aircraft operator holding a “Letter of Authorization” from the FAA to conduct commercial air tours under Part 91 of the FAA’s regulations.  This case is pending before the Texas Supreme Court.  If affirmed, the decision could extend the exemption to all commercial operators, not just those operated as common carriers.
The information in this article and any attached or referenced pages have been written or gathered for informational purposes only, are not legal advice, and may now be outdated. Persons receiving information from this article should not act upon the information without seeking professional legal counsel.

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