Nov 23, 2015
From KPMG TaxWatch
The Tennessee Court of Appeals recently held that lease transactions between related parties qualified as “bona fide sales” eligible for the “sale for resale” exemption. The taxpayer, an out-of-state LLC, was owned by an individual and his wife. The majority individual/owner was a member in a Tennessee LLC. The out-of-state LLC was established so it could purchase and own an airplane. The plane was leased to the Tennessee LLC for business purposes, as well as to the individual/owner for occasional personal use. The reasons for purchasing the plane through the taxpayer LLC were as follows. First, the individual/owner’s co-member in the Tennessee LLC refused to allow the Tennessee LLC to purchase the plane directly. Second, purchasing the plane through an LLC limited the individual/owner’s personal liability—and that of his wife. Finally, the tax savings associated with purchasing the plane using a sale-for-resale exemption factored into the decision. As planned, the taxpayer LLC leased the plane to the Tennessee LLC and the individual/owner for rates that all parties agreed were commercially reasonable. After an audit, the Department rejected the taxpayer’s contention that the plane was purchased for resale and assessed use tax. The matter eventually came before the appeals court after the trial court ruled in the taxpayer’s favor.
Under Tennessee law, tangible personal property purchased for subsequent lease to a customer qualifies as a sale for resale. Specifically, the definition of resale is "a subsequent, bona fide sale of the property, services, or taxable item by the purchaser.” Notably, the sale must be “bona fide,” a requirement that was added to the resale exemption statute in 2008. This case marked the first time the Tennessee Court of Appeals has addressed this requirement.
The Department argued that the leases were not bona fide sales because they were not objectively reasonable and were motivated chiefly by tax avoidance. In the Department’s view, the leases should be disregarded resulting in the taxpayer owing use tax on its use of the plane in Tennessee. The court began by considering the meaning of the phrase “bona fide sale,” eventually determining that a "bona fide sale" of tangible personal property meant the lease or rental of the property in good faith and for valuable consideration. The court determined that each of these conditions were met. The individual/owner had a legitimate business purposes for leasing the plane to himself and the Tennessee LLC. Further, there was no dispute that valuable consideration was paid. The court disagreed with the Department’s contention the lease could not be bona fide simply because tax savings was one of the purposes for the transaction. Further, the court disagreed with the Department’s contention that the lease could not be bona fide because the individual/owner never intended to operate the taxpayer LLC at a profit. This contention, the court noted, was based on the Department asserting the federal economic substance doctrine, which no Tennessee court has ever applied. Finally, the court declined the Department’s invitation to pierce the corporate veil of the taxpayer LLC and disregard its status as a separate entity. The court noted that it may only do so if a taxpayer corporation has been found liable, and no such finding was made in this case. Please contact Justin Stringfield at 615-248-5510, with questions on Niuklee LLC v. Dep’t of Revenue.
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The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.