A federal excise tax of 7.5% (plus a small, per-head fee) applies to amounts paid for transportation by air if the trip begins and ends within the United States, or in Canada or Mexico within 225 miles of the US border. Because aircraft operations require specialized skill and knowledge, it is not uncommon for aircraft owners and lessees who operate aircraft to retain the services of experts to assist them in safely and appropriately using their aircraft. The task of interviewing, hiring, and supervising an aircraft pilot or mechanic may be quite challenging for the human resources department of a company lacking in aircraft expertise. As a result, companies that own aircraft routinely hire independent management companies to fly, maintain, and otherwise care for their aircraft. These arrangements give rise to a question whether the amounts paid to aircraft management companies are being paid for transportation (and are therefore subject to the excise tax) or are being paid for some other service (for example pilot services on the operator’s own aircraft).
In a ruling issued March 9, 2012, the IRS significantly expanded its guidance on when fees will be deemed taxable. Under this new guidance the excise tax will broadly apply to management company arrangements where aircraft are operated purely under Part 91 for the use of an aircraft operator. This memorandum discusses the March 9 ruling in the context of prior established law, and then proceeds to discuss what aircraft operators can do to minimize their exposure.
IRS Broadening of Excise Tax
For over fifty years, the aviation industry has relied on IRS Revenue Ruling 58-215 (1958) (the “Revenue Ruling”) for the conclusion that aircraft management arrangements where aircraft operators retain management companies for services in support of that operator’s own Part 91 operations will be broadly exempted from the excise tax. However, in IRS Chief Counsel Advice 201210026 (March 9, 2012) (the “Counsel Advice”), the IRS, while not explicitly rejecting the Revenue Ruling, narrows it and suggests that it will not exclude from tax a broad array of Part 91 management arrangements.
Both the Revenue Ruling and the Counsel Advice are structured so as to first posit a factual scenario and then evaluate whether the excise tax will apply. The facts specified in each are so closely similar that a magnifying glass may be needed to distinguish between them, although the IRS has concluded that they receive opposite tax treatment.
The Revenue Ruling
In order to understand how nearly identical the Revenue Ruling facts are to those of the Counsel Advice, it is necessary to extensively recite the arrangements under consideration in each case. In the Revenue Ruling the situation evaluated involved a company owning an aircraft and hiring an aircraft manager in an arrangement pursuant to which:
- The manager services, maintains, and overhauls the aircraft for a specified amount paid by the owner.
- The owner pays the manager a certain sum per flight hour for fuel, oil, and hydraulic fluid.
- The owner pays for the aircraft insurance, with the manager listed as additional insured.
- The owner reimburses the manager for landing fees, but the manager provides weather and flight information at no cost.
- The manager indemnifies the owner for losses arising out of the hangaring, maintenance, and servicing of the aircraft.
- The manager selects and provides crew to operate the aircraft, at a base selected by the owner. The owner has the power to reject the crew, in which case the manager will select and provide a new crew, subject to the owner’s approval.
- The crew are employed by the manager, which also provides their workmen’s compensation and employees’ liability insurance, but the owner pays the manager for the crew salaries based on an established pay scale.
- The crew have authority over operational safety but are otherwise under the owner’s “control” (as discussed below, it is unclear what “control” means).
Based on these facts, the Revenue Ruling concludes that excise tax does not apply to the owner’s payments to the manager, and highlights the following key factors in its decision (a) the owner owns the aircraft, (b) the owner has “control” (again, the meaning of which is uncertain) over the crew, (c) the owner pays the aircraft operating expenses, (d) the owner maintains the liability and risk insurance, and (e) the manager operates the aircraft as the owner’s “agent” (more below on the meaning of this term).
The Counsel Advice
The Counsel Advice evaluates a situation where a company owns an aircraft and hires an aircraft manager in an arrangement pursuant to which:
- The owner pays the manager a monthly fee, plus a per-flight-hour fee, plus certain reimbursements of expenses, and, at times, a fuel surcharge.
- The manager provides crew to operate the aircraft, and the owner has the power to reject the crew, in which case the manager will provide a new crew, subject to the owner’s approval.
- The crew have authority over operational safety, but the owner chooses where the plane will go.
- The crew are employed by the manager, which also pays their benefits and handles their income tax reporting, but the owner reimburses the manager for the cost of employing the crew.
- Manager ensures that the crew is properly trained, and owner reimburses the training costs.
- Manager maintains and cleans the aircraft and ensure that all FAA maintenance and recordkeeping requirements are met.
- Manager provides scheduling, flight planning and weather services.
- Manager selects and maintains the insurance policy, which names the owner as the insured party.
- Manager does not indemnify owner for losses resulting from aircraft operations.
Both the Revenue Ruling and the Counsel Advice deal with pure Part 91 management arrangements where, for all relevant purposes, the aircraft is used exclusively by the aircraft owner. Nonetheless, the Counsel Advice finds the manager to be selling taxable transportation, while the Revenue Ruling finds the opposite. The Counsel Advice, in seeking to distinguish the agreement under its review from the Revenue Ruling, focuses on two mixed questions of fact and law. A mixed fact-and-law question is a determination that, although often stated as a simple fact, is instead a determination that a particular set of facts satisfies an abstract category of legal significance. The two factors identified by the Counsel Advice in reaching the opposite conclusion to the Revenue Ruling are that, unlike the Revenue Ruling, in the Counsel Advice case (1) the Owner does not have exclusive control over the aircraft personnel, and (2) manager does not operate the aircraft as an agent of the owner.
While the IRS’ conclusions as to these two questions are straightforward, the difference in the underlying facts that led to the disparate conclusions are anything but clear.
Conclusion 1: Exclusive control over personnel. Both the Revenue Ruling and the Counsel Advice describe the relationship between the owner and the crew. The descriptions are nearly identical. In both cases (a) the manager employs the crew, (b) the owner reimburses the manager for their salaries, (c) the manager selects the crew, subject to the authority of the owner to reject them and have them replaced, and (d) the crew has control over assuring safety of operations. In the Revenue Ruling case, it specifies that the crew will be permanently based at a location designated by the owner, while that description is absent in the case of the Counsel Advice. This seems to be a distinction without a difference. Aircraft operators typically first choose a location to base their aircraft and then select a management company suited to manage aircraft at that location. The Counsel Advice claims that the Revenue Ruling states that the crew “are permanently based with, and exclusively assigned to, the [owner’s] aircraft.” In fact, what the Revenue Ruling states is slightly different, that the crew “are under the corporation’s exclusive control, subject to the discretion of the [crew] as to safety of operation.” The Counsel Advice seems to view this as requiring that the crew service only the owner’s aircraft, and no other. A fair, contrary reading of the Revenue Ruling would read the “exclusive” language to suggest that, during the owner’s use of the plane, the crew is answering exclusively to the owner. In any case, it is not obvious why the fact that the crew may or may not at times service other aircraft impacts whether the operator/manager transaction involves the sale of air transportation.
Conclusion 2: Presence of an agency relationship. The Counsel Advice finds there to be no agency relationship between the owner and the manager, and that this is a pivotal factor in applying tax. It is unclear whether this conclusion as to agency is based on the facts and circumstances of the relationship between the parties, or based on whether a declaration is present in the management agreement stating certain services are being provided in an agency capacity. However, it is difficult to identify any facts and circumstances indicative of agency in the Revenue Ruling case, but not in the Counsel Advice one. If anything, the case against agency in the Revenue Ruling situation is stronger because there the manager indemnifies the owner against certain losses.
Strategies to Minimize the Impact of this Change
The Counsel Advice points the way to a few strategies that may be useful to protect against over-broad application of the excise tax. The first is to, where possible, include declarations in the management agreement of the two key factors that the Counsel Advice cited as distinguishing from the Revenue Ruling. These declarations would be:
- That the crew, while employed by the manager, are, except for safety of flight issues, under the exclusive control of the owner and exclusively dedicated the owner’s aircraft.
- That the owner can designate the base location and that the crew will be located there. This will typically be the base location known at the outset of the agreement. There is nothing in the Counsel Advice stating that the owner must have the authority to later change the base location, but the topic is not fully addressed.
- That the crew will be providing its services as an agent of the owner. This could have potential state liability issues in creating owner liability for acts of the crew.
A further step that could be beneficial would be to arrange for the owner to pay aircraft expenses directly to vendors, rather than to the management company, thus further demonstrating the owner’s control of, and involvement in, the aircraft maintenance and operations.
The Counsel Advice may initiate a new regime of excise tax enforcement related to management companies by the IRS. As a result, aircraft operators and management companies should revisit their arrangement in order to, where possible, avoid the application of tax to the relationship and, at a minimum, appropriately diminish the tax base. In making changes to such relationships, parties must be mindful of the complex landscape created by multiple interacting and conflicting layers of regulation, including the IRS, FAA, and state courts and regulatory agencies. Each of these must be considered in crafting the most appropriate agreement, and expert advice is critical to anyone embarking on such an effort.
November 1, 2012, rev.
Jonathan Levy, Esq.
Advocate Consulting Legal Group, PLLC
Advocate Consulting Legal Group, PLLC is a law firm whose practice is limited to serving the needs of aircraft owners and operators relating to issues of income tax, sales tax, federal aviation regulations, and other related organizational and operational issues.