Part of a 2011 lawsuit that NetJets filed against the U.S. government has been resolved in the fractional-share company’s favor. NetJets filed the lawsuit seeking “refund and abatement of excise taxes, interest and penalties totaling $642,706,119.89, which the Internal Revenue Service (‘IRS’) has illegally assessed against them under section 4261 of the Internal Revenue Code,” according to the document.
Under a set of decisions handed down by the Federal District Court in Columbus, Ohio, on January 26, the court “invalidated the more than $500 million of assessments, penalties and interest the IRS was attempting to collect from NetJets,” according to a company statement. “While the court ruled that a 1997 decision in which NetJets was a party precluded it from recovering excise taxes already paid, the court went on to hold that the IRS acted unlawfully in applying the tax to two of the fees NetJets collects that were not subject to the 1997 decision. NetJets is pleased by the court’s decision but will review whether to appeal the portion precluding NetJets from recovering excise taxes already paid.”
This decision was part of a series of cross motions involving NetJets Aviation, NetJets Large Aircraft, NetJets International (referred to collectively by the court as “NetJets”) and NetJets subsidiary Executive Jet Management (EJM). “This case deals with NetJets issues,” explained Scott O’Brien, NBAA senior manager of finance and tax policy.
Since the period to which the case refers, the federal excise tax (FET) issue for fractional-share operations has been resolved: in the FAA reauthorization in 2012, Congress imposed a 14.1-cents-per-gallon fuel surtax on fractional operations. “That’s satisfying their tax obligations,” O’Brien said, “and there’s no question [now] about whether they might owe the 7.5-percent FET.”
The FET is the so-called “ticket tax” assessed on airline tickets and fees paid by charter clients; the IRS has long held that the FET should apply to fractional operations and to management fees paid by aircraft owners to management companies, even when no charter is involved.
Before the 2012 reauthorization NetJets did have to contend with the IRS’s desire to assess the FET. In the lawsuit filed originally by the fractional company, it sought a refund of approximately $220 million in FET collected by the IRS, which was remitted for occupied hourly fees that NetJets billed to its fractional-share owners, according to John Hoover, senior counsel in the tax practice at Washington, D.C. law firm Cooley. The IRS not only felt that the $220 million was appropriate but also wanted another $340 million worth of FET that it believed NetJets should have collected based on the monthly management fees and fuel surcharge fees that its clients paid, he explained.
In its latest decision, the court refused NetJets’s request for a refund of the $220 million because this issue had already been decided in a previous case involving EJM. According to Hoover, “the court refused to reconsider the question of whether the NetJets fractional program constitutes taxable transportation.” But because of a 1992 IRS Technical Advice Memorandum (TAM), he added, “the court also held that NetJets did not owe FET on the monthly management fees or the fuel surcharges.” Although the TAM did not explicitly state that NetJets shouldn’t collect FET on monthly management or fuel surcharge fees, during an audit the agency had agreed to that position. According to Hoover, the court asserted that this agreement makes that position part of the TAM and that since the IRS had never revoked that TAM it remained applicable.
The IRS could appeal the court’s decision, Hoover noted, if it wants to try to collect the $340 million that it believed should have been assessed as FET against management and fuel surcharge fees, but lacking any appeal NetJets will not have to pay.
EJM and IRS
The other part of the case remains active, because the court denied summary judgment requests from both EJM and the U.S. government. “It was a draw for EJM; neither party prevailed,” said Keith Swirsky, president of GKG Law in Washington, D.C. The IRS assessed the FET on fees charged to owners of aircraft managed by EJM, but only on aircraft that were also flown on charters by EJM’s Part 135 operation. In other words, the IRS believes in this particular situation that FET should be assessed on management and other fees paid by owners, even when they are flying on their own aircraft, but only for aircraft that are also in EJM’s charter program. Nothing in the judge’s denials addressed pure Part 91 management customers, whose aircraft are managed and not flown on charters. The IRS still wants to assess the FET on fees paid by pure Part 91 owners whose aircraft are managed, even when flying on their own aircraft.
“Possession, command and control is still the central concept,” Swirsky explained. The court believes that the many IRS revenue rulings that have been issued since the 1950s “show that deference is due to the ‘possession, command and control test’.” The question is “who performs the services that allow the aircraft to be operational, who provides the crew and if services provided by the management company are different from the services that the charter customer receives,” he said. “The court didn’t say that was an exhaustive list, but those are relevant factors. The court said that the fact that a customer owns the airplane is not dispositive.”
While this court action applies to NetJets and EJM and wasn’t intended to address the issue of whether pure-Part 91 management fees should be subject to the FET, that remains an important issue for business aviation. “The problem with this,” Swirsky said, “is it’s a mess. It leaves the traditional management industry in a continued state of unknown.” If further court decisions solidify the possession, command and control test as a means of determining FET applicability as well as other factors, he explained, “it’s going to be a difficult standard to interpret and enforce with some level of consistency on a contract-by-contract management company basis. It’s too subjective to enforce with any degree of consistency. As an industry we need clarity with an objective standard that everybody in the industry understands.”
“The judge basically punted the issue,” said NBAA’s O’Brien, “and was not able to decide on the summary judgment. I think this has limited value [as a precedent]. This is one’s judge’s view.”
Because the motions for summary judgment were denied, the EJM portion of this case remains active, explained Lon Sobel, an attorney and former law professor at Southwestern Law School in Los Angeles. The parties could appeal or the judge could set a trial date if there is no appeal, he said. The alternative would be for the IRS to compromise and settle its dispute with EJM and change the rules for FET applicability. This could make sense, he added, because a simple IRS rule change could resolve the FET issue with regard to managed aircraft.
“Congress has already taken the extra step of imposing a 14.1-cent fuel surcharge [for fractional operations] in lieu of FET,” Sobel pointed out. “Congress has already exempted operations that are much more like charter than the kind of operations that are currently the subject of controversy. It would be a tiny step [to add Part 91].”
There is also an effort under way by Ohio legislators to resubmit legislation to Congress, similar to a bill that was introduced last year. The bill would clarify that the FET is not due on Part 91 management fees or flights and thus would be another way to resolve this issue.
NBAA and the National Air Transportation Association have been working the Part 91 FET issue for years and met with the Treasury Department’s Office of Tax Policy and the IRS Office of the Chief Counsel late last year. IRS auditors have audited some management companies based on the IRS’s 2012 Chief Counsel Advice memo (CCA) and the IRS can still open an audit and conduct research and interviews, according to O’Brien. But when it comes to assessing actual penalties for unpaid FET, those are or will be placed on hold until the IRS determines whether FET should be assessed for management and other fees. “Our feeling, and they agreed, is that the IRS doesn’t have clear guidance as to when the tax is due,” he said. “It’s been a very hard issue for many years to figure this out. There are a lot of questions about what the test should be and a lack of understanding in the government of how management works. If you look at the Chief Counsel Advice and the IRS audit technique guide, they’re trying to put out guidance that’s clear, but it’s an area they’re not familiar with. It’s a challenge to help them understand.”
“The court left open the entire issue on Part 91 managed arrangements,” said Glenn Hediger, a certified public accountant at Aviation Financial Consulting, Fairfax, Va. “The IRS is still auditing pure Part 91 clients, pursuant to the CCA in 2012. Those audits are continuing and are still subject to final action by the IRS and work being done by NBAA to come to some sort of agreement. I think the next thing is to see what NetJets and the government decide to do with the decision.”
NBAA does recommend that companies dealing with the FET issue consult experts such as aviation tax attorneys and accountants.