How to Avoid California Tax Burdens When Purchasing an Aircraft: Interstate and Foreign Commerce Exemption
By Procopio Senior Associate Jessica L. Lazur
“In this world nothing can be said to be certain, except death and taxes.” No disrespect to Mr. Franklin, but California aircraft owners are fortunate that the assessment of sales and use taxes on the purchases of aircraft by state residents is anything but certain. Anyone in the market for an aircraft should be aware of certain exemptions from the California sale and use tax, in particular one specific exemption, the interstate and foreign commerce exemption. If the requirements of any such exemption are met, the new aircraft owner can, legally, avoid paying sales and use tax in California on the aircraft purchase.
Sales and Use Tax Exemptions
In general, sales tax applies to sales of aircraft that occur in California and use tax applies to the sales of aircraft outside of California when they are purchased for use or storage in California. However, if the aircraft is purchased for and used in interstate or foreign commerce prior to entry into California and continuously after entry, the use tax does not apply. In addition to the interstate and foreign commerce exemption, if the aircraft is leased to an aircraft charter company, or a ‘common carrier,’ California regulations also provide for an exemption to the sales and use tax. While the requirements of the common carrier exemption are beyond the scope of this article, if as an aircraft owner you intend to charter your aircraft, it is worth a lengthy conversation with your management company or aviation attorney prior to purchase to determine whether your intended usage of the aircraft could qualify for this exemption.
Interstate and Foreign Commerce Exemption Requirements
The most basic requirement of the interstate and foreign commerce exemption is that delivery of the aircraft physically take place outside California. The aircraft must be located in a different state when the bill of sale is filed with the Federal Aviation Administration and title (and funds) changes hands from seller to buyer. Ensuring delivery outside of California also ensures that California sales tax is not assessable on the purchase of the aircraft. Buyer beware, however, as the vast majority of states impose a sales tax on aircraft purchases. Thus, even if California sales tax does not apply, it is important to confirm if the state where delivery will occur has a sales tax that could be assessed.
Following delivery of the aircraft, the new owner must ensure the aircraft is functionally used in interstate commerce outside of California prior to its first entry into California following the purchase. This means that the aircraft must be flown to another location other than California (another state or country) and must carry business passengers for a business purpose.
The final requirement is that more than half of all flight time traveled by the aircraft during the six months immediately following the aircraft’s entry into California are in interstate commerce. More than 50% of the aircraft hours in this six-month test period must be outside of California for a business, not a personal, purpose and, again, with a business official onboard. It is critical to remember, however, if the first two requirements discussed above are not met, it does not matter what the usage after entry into California looks like. The aircraft could be used 100% of the time in interstate and foreign commerce after entry into California but if it was not functionally used in interstate commerce outside of California prior to entry into California, the requirements of the exemption will not be met and the California use tax will be assessable.
Avoiding the payment of state taxes doesn’t seem so hard, does it? If the aircraft is truly being used for interstate business purposes, it shouldn’t be. Take delivery outside of California, fly the aircraft to another state for a business meeting with a business passenger onboard and, following entry into California, ensure that at least 50% of the hours are travelled in interstate commerce with a business official onboard.
What can be difficult for aircraft owners is ensuring all required documentation is properly maintained and presented to the California Department of Tax and Fee Administration (the successor to the Board of Equalization or BOE) in order to prove that the requirements have been met. Particularly difficult can be proving to a regulator that there was in fact a legitimate business purpose for each interstate commerce flight. This is where an experienced aviation attorney can be invaluable (or at least worth somewhere between 7-8% of the aircraft’s value, the going sales and use tax rate in California depending on the owner’s county of residence). While the requirements are fairly straightforward, there is nuance in their application and a mistake can be costly. However, if as a California aircraft purchaser you are able to document compliance with the foregoing requirements, you too may prove Benjamin Franklin wrong and legally avoid paying the California sales and use tax.
Jessica L. Lazur is a senior associate in Procopio’s Aviation and Marine practice group. She has represented dozens of purchasers of aircraft in qualifying for exemptions from the California sales and use tax. She represents purchasers and sellers in aircraft acquisition transactions.