Orange County Accountant

Sacramento, CA – Aero-tax Compliance Experts, LLC (ACE) is California?s newest connection for anyone seeking professional and expert management for their aircraft, vessel and vehicle sales and use tax issues, including legal tax exemptions, refunds, appeals conferences and hearings.

Often it is believed that simply purchasing an aircraft outside of California eliminates the sales and use tax liability.  There is a half truth here; properly purchasing an aircraft outside of California does eliminate the sales tax obligation, however, it does not eliminate the use tax. 

Many people do not know how, or where to begin when going through the California sales and use tax exemption process.  The simple answer is that you must take delivery of the aircraft outside of California.  However, there is more detail behind the simple answer.  For example, the contract of sale (purchase agreement) must specifically reference the location where the aircraft will be delivered to the purchaser outside the state.  

As standard practice, we advise that the delivery occur in Oregon.  Oregon is the closest, non-sales tax state in proximity to California that will not have a jurisdictional claim for sales or use taxes simply because the sale occurs there.  Therefore, Oregon is often times the most convenient location.  However, it may not be convenient in every situation.  There are a total of five non-sales tax states:  Oregon, Alaska, Montana, New Hampshire, and Delaware.  Many other states have guidelines for non-resident purchasers taking delivery within their state without fearing tax repercussions.  Be sure you know the rules.

To properly evidence the delivery outside of California, you must maintain a clear separation between the seller and the buyer.  To accomplish this, the seller will be solely responsible for transporting the aircraft to the out of state delivery location, and the buyer will be solely responsible for getting to the delivery location independent of the aircraft they are purchasing.  It is recommended that the buyer travel via commercial airlines to generate and obtain confirmation of the travel to the out of state delivery location.  In addition, the buyer must not exercise any right or control over the property until after it is delivered (test flights are ok, but insuring the property prior to delivery could pose a problem). 

Once the seller and buyer have converged upon the delivery location, it is now time to execute the paperwork.  They will execute the FAA Bill of Sale, FAA Registration, any delivery receipts prepared by the seller and a proper delivery document for California sales and use tax purposes.  This is referred to by many in the industry as a “6247 statement.”  Beware, some tax representatives will charge you for this form.  This form when properly and completely executed and notarized will evidence the out of state delivery.  The insurance on the property can become effective as of this day.

Upon completion of the delivery, it is recommended that you immediately purchase fuel for the aircraft, using a credit card.  Doing so will generate a receipt that will contain the date, location, tail number, and the buyers signature.  Keep copies of all your documentation; you will need it to support your exemption.

The out of state delivery is only a small part of the exemption process.  There are many factors which come into play when the Board of Equalization is determining where the “place of sale” was.  They will look at the contract of sale, insurance binder, evidence of delivery, evidence how the parties converged upon the delivery location, FAA Bill of Sale, FAA Registration, and other pertinent information to develop their conclusion as to where the delivery occurred.  If there are conflicting dates, locations, or details, they may conclude that the delivery occurred somewhere other than where you intended, and classify your delivery as “ceremonial.”  This means your delivery may jeopardize the availability of the sales and use tax exemption from the onset.

The article written last month titled “Proper Delivery Outside of California Begins the “Use Tax” Exemption Process” explained the importance of, and how to, properly take delivery of an aircraft outside the state, which is the first step in the California sales and use tax exemption process.  If you didn’t get a chance to read that article you can contact Aero-tax Compliance Experts, LLC (ACE) for a copy or visit www.aero-tax.com.

Many aircraft owners and potential owners have contacted us for an explanation on California’s “first functional use” requirement.   We have learned that there is a lot of mis-information and confusion on this issue.  Our attempt is to clarify some of the confusion that exists and eliminate the mis-information with the “first functional use” requirement for the California use tax exemption process.

“First functional use” is a critical component of the California use tax exemption process.  California Sales and Use Tax Regulation 1620 defines first functional use as “use for which the property was designed.”  An aircraft is defined in Law section 6274 as “any contrivance designed for powered navigation in the air except a rocket or missile.”  Logically, one would conclude that first functional use of an aircraft is flight because aircraft are designed to fly; right?  Not necessarily.  In my experience with the sales and use tax law, one can not rely upon logic. 

The California State Board of Equalization (BOE) has effectively confused the term “for which the property was designed” with “how big it is,” or “how is it configured.”  I’ll explain; in May of 2002 a staff member of the BOE’s tax counsel (writer) drafted a memorandum to another staff member explaining to them the writer’s interpretation of first functional use.  Somehow, the writer deduced a formula, or justification, to distinguish between aircraft designed for personal purposes and aircraft designed for commercial purposes.  Simply put, the writer concluded in the memorandum that an aircraft with 6 or fewer seats was an aircraft designed for personal purposes, and an aircraft with 7 or more seats was designed for commercial purposes. 

To confuse the issue even further, the writer decided that all jet aircraft were designed for commercial purposes, and “personal” aircraft could be “configured” for commercial purposes.  Additionally, the writer added that it was possible for someone to justify a large jet as a personal use aircraft.

Now that the writer made a distinction between personal and commercial aircraft, the writer defined the “first functional use” for each.  Aircraft that are designed for personal purposes were first functionally used when flown, and aircraft designed for commercial purposes were first functionally used when flown with a passenger or cargo onboard.

We have researched and reviewed several thousand legal opinions and rulings from the BOE on this issue.  The BOE had interpreted first functional use as flight, up until this memorandum was drafted and distributed throughout the agency.  After the distribution its effect was immediate, and in some cases a retroactive application of the new formula.  During our research, we developed the industries most successful approach to complete the first functional use requirements pursuant to the current standards, and have projected other items that may be required in the future. 

As a standard practice, Aero-tax advises that the purchaser bring someone, to the out of state delivery location, to act as a true passenger (not a pilot, co-pilot, flight crew, CFI, etc.) onboard a flight (or two) outside of California before proceeding with their specific exemption.  In addition, this flight must begin in one state, country, territory, etc. (not California), and end in a separate state, country, territory, etc. (not California).  For example, this flight may depart from the out of state delivery location (Oregon), to another state (not within California or Oregon).  Depending on the “design/size” of the aircraft and for those who are claiming the commercial interstate or foreign commerce exemption, they must conduct business at the location they travel to.  In addition, documentation must be obtained to support the business purpose (i.e., meeting notes, invoices, proposals, etc.) of the flight.

After the first functional use flight has been made, and prior to departing that location, fuel must be purchased, ideally using a credit card.  This will generate a fuel receipt that will contain documentary evidence that the aircraft was at this location on a specific date.  Additionally, a statement will be needed from the passenger onboard the aircraft during the “first functional use” flight.  Depending upon the type of exemption you are claiming the aircraft may or may not be allowed into California.   

If the foregoing process and documentation are properly completed and collected, the “first functional use” requirement should be adequately fulfilled.  The smallest variation could mean disaster for the tax exemption.

The “first functional use” is only one of the small, yet critical, parts of the California use tax exemption process.  There are many aspects which must be completed successfully and documented in order to secure the exemption.  ACE will guide the purchaser through the process and ensure the success by monitoring each aspect of the exemption requirements.

Unless otherwise expressly indicated, any advice contained herein was not written and is not intended to be used, and cannot be used, for the purpose of avoiding any sales or use tax, interest or penalty that may be imposed.  To be certain the exemption requirements are accurate for your specific situation, call one of our tax experts to discuss.

Other articles will be coming out periodically to explain other aspects of the California sales and use tax laws, regulations, legal decisions, exemptions, or other related matters.  If you have a specific sales and use tax topic that you would like discussed or explained please send us an email to joe@aero-tax.com.