31 January 2017 Ohio Board of Tax Appeals applies sham transaction rule in sales and use tax case The Ohio Board of Tax Appeals (BTA) issued a decision in Pi in the Sky, LLC v. Testa,1 ruling that a company's purchase of an aircraft is subject to Ohio's use tax because it does not qualify for the resale exemption. The decision is notable as it represents the first time the BTA has applied the general sham transaction provisions of Ohio Rev. Code Section 5703.56(B), which authorizes the Tax Commissioner to disregard sham transactions (i.e., "a transaction or series of transactions without economic substance because there is no business purpose or expectation of profit other than obtaining tax benefits.")2 Pi in the Sky, LLC (Pi in the Sky) is a single member limited liability company (SMLLC) owned by a salon and day spa business (operating company) that was based in Ohio and had no business locations outside the state. Pi in the Sky was formed to purchase an aircraft for lease to the operating company. The aircraft was purchased without paying any Ohio sales/use tax, Pi in the Sky claiming the purchase was exempt from tax under the resale exemption. The operating company's president and sole owner (who was also a licensed pilot) was the borrower on the loan for the purchase of the aircraft. The operating company and Pi in the Sky entered into a non-exclusive aircraft lease agreement with the president of the operating company signing for both Pi in the Sky and the operating company. All flights logged on the aircraft for a two-year period were taken by the operating company and by no other third-parties. Some of the flights were to the operating company president's out-of-state home. The Ohio Department of Taxation (Department) concluded that the lease agreement was a sham transaction and, as such, determined Pi in the Sky's liability based upon its purchase price for the aircraft. The Department did not believe that the taxpayer had engaged in a legitimate business since the president of the operating company signed the agreement on behalf of both the operating company and Pi in the Sky. The Department viewed the two entities as one and the same. Other indicia of a sham transaction cited by the Department included the facts that: (a) Pi in the Sky's address also was the president's home address; (b) Pi in the Sky had no business location; and (c) Pi in the Sky did not advertise the availability of the aircraft for lease to third parties. The BTA, citing its decision in Barth Co. v. Tracy,3 noted that courts are reluctant to disregard the corporate form and have only done so where used as a "cloak for fraud or illegality or where the sole owner exercised such excessive control over the corporation that it no longer has a separate existence." In the Barth case, the owner of a luxury yacht leased it to other entities including third parties. It charged the same rates to third parties as to affiliated companies, maintained separate books and records, did not share the profits earned from leasing the yacht and reported the yacht for federal income tax and regulatory purposes. In contrast to Barth, the BTA concluded that the lease, in the instant case, lacked both factual and economic substance. Relying on the facts cited by the Department, the BTA concluded there was no evidence to support Pi in the Sky's contention that the separate entities and lease arrangement should be respected. In addition to upholding the Department's assessment, the BTA also rejected Pi in the Sky's arguments for abatement of penalty. It is unknown at this time whether Pi in the Sky will appeal the decision. This case presented a number of irregularities that were seized upon by the Department. These facts included: (1) personal use of the aircraft by an individual who was also a licensed pilot; (2) no demonstrated use for the hair salon and day spa business; and (3) a lease arrangement that was not at arm's length. The BTA's decision is nonetheless troubling in that it also cited: (1) the lack of marketing to unrelated parties; (2) the fact that there was only one lessee; and (3) a lease from a SMLLC to its single member, as factors in finding that the arrangement was a sham transaction. These latter facts are fairly standard in some corporate captive leasing arrangements and raise a concern as to whether such arrangements would be respected by the Department. At the 2017 Ohio Tax Conference, a Department official commented on the case and said that it was not the Department's intention to seek out sham transactions. The decision, however, creates uncertainty in this area. Businesses that have entered into, or are considering entering into, similar arrangements should ensure that lease transactions are at arm's length and that organizational formalities are observed.
Document ID: 2017-0203 | |||||
