The Ohio Supreme Court (Court) recently issued two decisions on sales and use taxes. One decision, Great Lakes Bar Control, Inc.,¹ upheld that the reversal of an Ohio Department of Taxation (Department) assessment on certain services by the Board of Tax Appeal (BTA). Another decision, Pi In The Sky, L.L.C.,² upheld an assessment of tax on a limited liability company's purchase of an aircraft that was leased to the LLC's sole member. This Alert discusses each of these decisions.

Great Lakes Bar Control

The taxpayer provided services related to beer-dispensing systems. One of its services involved a beer-line maintenance service that removed build-up of unwanted sediment. The sediment included bacteria and yeast that could clog lines and taps and adversely affect the taste of the beer. This service involved a technician's inspection of the system and, if needed, the injection of compressed gas into the system to remove the sediment. If warranted, the technician also would flush the entire system with an acid or potassium rinse to prevent the growth of bacteria.

The Department assessed tax on these services, asserting that they were building maintenance and janitorial services taxable under Ohio Revised Code (ORC) Section 5739.01(B)(3)(j). ORC Section 5739.01(II) defines building maintenance and janitorial services as "cleaning the interior or exterior of a building and any tangible personal property located therein." The taxpayer appealed the assessment. The BTA reversed the assessment; while the taxpayer's service was primarily a maintenance service, the BTA noted, any cleaning was incidental to that maintenance and not taxable. The Department appealed the BTA's decision.

In upholding the BTA's reversal of the assessment, the Court observed that taxability depended on the meaning of the term "cleaning" as used in the statute. The term "cleaning" is not defined in the statute, so the term should be given its plain and ordinary meaning. The Court further observed that evaluating the context in which a word is written is essential to a fair reading of the statute. Instead of limiting analysis to a "hyperliteral meaning of each word," the Court said that the ordinary meaning of the word should be considered as it is used within the surrounding statutory text. The Court concluded that the beer-line maintenance services did not fit within the common usage of "cleaning." The Court noted that janitorial services are generally understood to encompass activities such as washing floors and windows, removing trash, vacuuming, dusting, etc. and that "no one would take the ordinary meaning of janitorial cleaning to include inspecting and flushing beer lines." To do otherwise, would open a "swath of obviously nonjanitorial 'cleanings'" within the scope of taxability, noting examples such as a service cleaning computer hard drives or scrubbing database errors as well as cleaning fish. A dissenting opinion would have reversed the BTA on the grounds that the beer-line service is cleaning within the scope of taxability and expressed a concern that the majority opinion would "brew confusion" with its application of the statute.

Pi In The Sky

The taxpayer was a single-member limited liability company (LLC) created to solely hold an aircraft for lease to its single individual member. The LLC purchased the aircraft without paying tax, claiming the resale exemption. The LLC then entered into a lease agreement with its single member, the president of a salon and day spa business with operations in the Cincinnati, Ohio area. The single member also was a licensed pilot. The single member signed the lease agreement on behalf of both parties. The lease agreement granted the single member nonexclusive use of the aircraft and required her to provide for the aircraft's operation, maintenance and storage. The lease prescribed a rental rate of $80 per flight hour.

Under ORC Section 5739.01(E), the resale exemption applies when "the purpose of the consumer is to resell the thing transferred … , by a person engaging in business … ." It was the "engaging in business" requirement in the statute that was the crux of the debate in this case.

The Department assessed use tax against the LLC. The Department concluded that the LLC was not engaged in business within the meaning of the resale exemption because its only lessee was the single member and it never marketed or advertised the aircraft for lease to others. Moreover, the Department singled out the fact that the LLC's address was the single member's residential address, which it believed evidenced an intent not to attract lessees. The Department also found the lease terms uncharacteristic of an arm's-length transaction, given the terms of the lease and the low rental rate, which was insufficient to service the loan payment on the aircraft. The Department also cited the lessee's conduct in using the aircraft. Flight logs indicated several flights to an airport near the lessee's lakefront home in Michigan and many flights where the lessee was the only passenger. Given that the salon and day spa locations were all in the Cincinnati area, the Department questioned the business need for the aircraft. For these reasons, the Department concluded that the arrangement was a sham transaction under ORC Section 5703.56(A)(1) and denied the resale exemption.

The taxpayer appealed the assessment to the BTA, but waived a hearing. By waiving the hearing, the taxpayer lost its opportunity to present testimony or other evidence to dispute the assessment. The BTA heard the case on the statutory record certified by the Department. The BTA affirmed the assessment, reasoning that the LLC did not purchase the aircraft for the purpose of leasing it to others as part of a business enterprise.

The Court affirmed the BTA's decision, noting that lease agreement lacked substance given the facts cited by the Department in assessing the tax. The lease did not confer a defined term of use to the lessee, but conferred responsibility for virtually every cost to the lessee and was not at an arm's-length price. The Court also found persuasive the fact that the LLC had no business location aside from the single member/lessee's residence and that many of the logged flights were to the single-member/lessee's summer home in Michigan (where no business locations existed). Given the "peculiarities" of the arrangement, the Court concluded that the LLC did not purchase the aircraft as part of a business enterprise and that it was not "engaged in business" as required by and within the meaning of the statute.

The Court also considered procedural issues related to the taxpayer's waiver of the hearing and subsequent attempt to present additional evidence in its merit brief to the BTA. The Court said that, by waiving the hearing, the BTA was confronted with a situation in which the taxpayer sought to rely on information not admitted into evidence at a hearing or by stipulation of the parties. The Court held that the BTA acted reasonably in confining itself to the statutory transcript certified by the Department and not considering the additional evidence.

Implications

The Great Lakes Bar Control decision suggests that the definition of taxable building maintenance and janitorial services may not be as broad as applied by the Department in audit situations. It has been observed that the Department has asserted taxability in a wide variety of situations in which cleaning may have been more incidental to non-taxable maintenance services. Taxpayers should consider whether assessments of tax made on such purchases might be eligible for a refund claim. The Ohio statute of limitations on claiming refunds is four years from the payment of tax.

The Court's decision in Pi In The Sky may be read as turning on the "peculiarities" of the specific facts and the taxpayer's prosecution of its appeal rather than a broad indictment of captive leasing arrangements. Nonetheless, Pi In The Sky provides a cautionary tale that such arrangements should be entered for a business purpose and have requisite economic substance, including leasing arrangements that are at arm's length.

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ENDNOTES

¹ Great Lakes Bar Control, Inc. v. Testa, Slip Opinion No 2018-Ohio-5207 (Ohio S.Ct. Dec. 27, 2018).

² Pi In The Sky, L.L.C. v. Testa, Slip Opinion No 2018-Ohio-4812 (Ohio S.Ct. Dec. 7, 2018).