Change in IRS Position Creates Additional Tax Exposure for Aircraft Management Companies and Aircraft Owners
Earlier this year, the Internal Revenue Service issued a Chief Counsel Advice (CCA 2012-10026) that addresses the taxability of aircraft management fees as amounts “paid for the taxable transportation of persons” that are subject to the 7.5% Federal Transportation Excise Tax imposed by §4261 of the Internal Revenue Code (the “FET”). The CCA’s analysis suggests that the IRS will insist that aircraft management companies collect FET on management fees and other amounts paid by owners under most garden-variety aircraft management arrangements. This is an unwelcome surprise, not only for management companies (which had assumed -- for decades -- that no such obligation existed), but also for their aircraft owner clients. In light of the CCA, management companies and owners may want to consider reviewing and re-casting their aircraft management arrangements – before the issue comes up on audit.
The CCA focusses on what were hitherto considered very customary arrangements between aircraft owners and aircraft management companies. In the scenarios addressed in the CCA, an aircraft owner hires a management company to manage aircraft operations, perform maintenance, and ensure regulatory compliance. The management company also provides qualified pilots, who are employees of the management company. The owner pays a monthly management fee and an hourly fee for each hour of flight time. In addition, the aircraft owner reimburses the management company for the costs of employing the pilots and any crew and for pilot training. In one of the scenarios, the management company is allowed to charter the aircraft to third parties under Part 135 of the Federal Aviation Regulations when the owner is not using it, and the management company and owner share the charter revenue.
The CCA concludes that the amounts paid by the aircraft owner to the management company under the described scenarios, including management fees and a variety of costs separately reimbursed by the aircraft owner, are subject to the FET. Because such payments are subject to the FET, the management company has the obligation to collect the FET from the aircraft owner and remit the collected tax to the IRS. Should the management company fail to do so, the FET can be collected from the management company directly by the IRS.
The CCA’s analysis focused on identifying, as between the aircraft owner and the management company, who had “possession, command and control of the aircraft.” If the management company had possession, command and control of the aircraft, it would be treated as having provided transportation services subject to the FET, and would be required to collect FET on amounts paid by the owner for such services. From that point, however, the CCA’s analysis took two unsettling turns -- in the view of the business aircraft community. First, the CCA suggests that the key factor in identifying who possesses, commands and controls the aircraft is control over the pilots, and, per the CCA, the entity that employs the pilots controls the pilots. In the scenarios described in the CCA, because the management company employed the pilots and carried them on its payroll, the management company had possession, command, and control of the aircraft for FET purposes. According to the CCA, not relevant to the determination of whether taxable transportation services were being provided were: (1) that the owner had the ability to schedule and direct the flights, (2) that the management company did not own the aircraft, and (3) whether the aircraft was operated under Part 135 or Part 91 of the Federal Aviation Regulations.
The second unsettling thing about the CCA was the scope of the payments subject to FET. These included not just management fees, but also the separate reimbursement by the owner of various management company costs that are determined to be a precondition of receiving air transportation services from the management company. The CCA specifically mentions costs attributable to employing the pilots and other crew members, and costs of training – but other costs (such as insurance – if separately reimbursable) could fall within this category.
The collection of FET on management services is not just a management company issue. Even though the obligation to collect the FET falls on the management company, the aircraft owner is the party liable for the tax. In this way, the FET is administered by the IRS in a similar manner to payroll taxes, which are imposed on the employee but collected and remitted by the employer. If the IRS discovers through an audit of the management company that the tax has not been collected or paid, the IRS can audit and ultimately assess the tax against the aircraft owner, plus any interest that has accrued from the date the FET should have been paid. Additionally, the management company may seek to collect the FET from the aircraft owner after being contacted by the IRS, or provide the IRS with the name and contact information of the aircraft owner to avoid FET liability. The aircraft owner can also be audited independently of the management company.
An FET audit of either a management company or an aircraft owner differs from an income tax audit. Unlike income tax, neither the management company nor the aircraft owner is able to judicially contest the imposition of the FET prior to assessment in the United States Tax Court. The only way for either party to judicially contest the tax is after assessment, by paying the tax and suing for a refund in the United States District Court or the United States Court of Federal Claims. However, like other IRS audits, both the aircraft owner and the management company can dispute the audit’s conclusion that the FET is owed before the IRS’s Office of Appeals, which operates independently from the audit division.
At this point, it is unclear whether the IRS will be imposing the FET on these management company arrangements solely on a prospective basis, or if it will be imposing the FET for periods prior to the date the CCA was issued. What is clear is that the IRS is staking out a new position on the imposition of the FET, and is aggressively pursuing that position. If they have not already done so, aircraft management companies and their owner clients should assess their options.