NAFA member, Christopher B. Younger, GKG Law Business Aviation Principal, discusses Federal Excise Tax Exemption for Owner Flights.
New IRS Proposed Regulations
History & Current Status Under Newly-Issued Proposed Regulations
The Internal Revenue Service (IRS) recently issued a Notice of Proposed Rulemaking containing proposed regulations regarding “Excise Taxes; Transportation of Persons by Air; Transportation of Property by Air; Aircraft Management Services” (Proposed Regulations). The Proposed Regulations address the application of federal air transportation excise taxes (FET) to payments made to aircraft management companies by aircraft owners for the costs of flights on the owners’ aircraft. The Proposed Regulations, if finalized, will provide additional guidance regarding a provision of the Tax Cuts & Jobs Act of 2017 (TCJA), which provides that certain payments by an aircraft owner to an aircraft management company are not subject to FET (TCJA FET Exemption).
This article provides an overview of how the IRS has applied FET to payments made by aircraft owners to aircraft management companies in the past. Following this overview, the article analyzes the requirements for the application of the TCJA FET Exemption as further clarified in the Proposed Regulations.
FET and Part 91 Managed Aircraft
FET is comprised of three elements: a percentage tax (currently 7.5% of the amounts paid); a head tax on domestic flight segments (currently $4.30 per passenger per flight segment); and a head tax on international transportation (currently $18.90 per passenger, except for flights beginning or ending in Alaska or Hawaii where the rate is $9.50 and applies only to departures).
FET applies to “taxable transportation” that consists of the provision of air transportation by one person to another person for compensation. This generally includes FAR Part 121 (airline) and FAR Part 135 (charter) flights, but generally does not include FAR Part 91 operations. However, there are certain instances where FAR Part 91 operations are treated as “taxable transportation.”
For example, based on prior IRS guidance, a person must have “possession, command, and control” of an aircraft to be considered the provider of taxable transportation for purposes of imposing FET on payments made to such person for such transportation. Consequently, a key issue in prior IRS FET audits of aircraft management companies was whether the aircraft owner or the aircraft management company had possession, command, and control of the aircraft.
In April 2008, the IRS published a revised version of its Air Transportation Excise Tax Audit Techniques Guide (the Guide). The Guide was a resource to IRS auditors conducting FET audits and provided IRS interpretations of existing law regarding FET application in specific situations.
The IRS published the Guide to provide its agents with a compilation of the laws, regulations, judicial opinions and IRS rulings applicable to federal air transportation excise tax. However, specific examples in the Guide were not reflective of “real world” scenarios. The IRS subsequently withdrew the Guide from publication, though it seems that IRS agents continue to rely on it when conducting FET audits.
Chapter 5 of the Guide provided that “possession, command, and control” of an aircraft is determined by analyzing:
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who chooses and pays for the pilots;
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who provides maintenance on the aircraft;
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who controls the scheduling of the aircraft; and,
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who pays for the insurance and other expenses of the aircraft.
In March 2012, the IRS published Chief Counsel Memorandum 201210026 (CCM), in which it concluded that control of an aircraft’s pilots was the primary factor in determining which party has possession, command, and control of an aircraft for purposes of imposing FET on payments relating to that aircraft’s operation. Under the facts described in the CCM, the IRS concluded that when an aircraft management company had primary control of the aircraft’s pilots, virtually all fees and reimbursements paid by the owner of an aircraft to its aircraft management company were subject to FET.
The IRS’s conclusion in the CCM was not new. However, the CCM provided a more aggressive interpretation of over 50 years of prior published guidance regarding the determination of which party had possession, command, and control of an aircraft. Based on the guidance provided in the CCM, many IRS agents asserted in FET audits of aircraft management companies that FET applied to all payments made by an aircraft owner to its management company since the owner had transferred “possession, command, and control” of its aircraft to the management company.
Further adding to the confusion, some IRS agents asserted that, despite the owner’s continued maintenance of operational control of the aircraft for its flights under FAR Part 91, “possession, command, and control” of an aircraft shifted to the management company at all times if the aircraft was on that company’s charter certificate and the contract between the aircraft owner and the management company provided that the owner’s right to unfettered use of its aircraft could be restricted because of a previously scheduled charter.
New Law and Proposed Regulations
TCJA added the TCJA FET Exemption, which is effective for payments made by an aircraft owner to a management company after December 22, 2017 that are related to maintenance and support of the owner’s aircraft or to flights by the owner on the owner’s aircraft including amounts paid for:
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assisting an aircraft owner with administrative and support services, such as scheduling, flight planning, and weather forecasting;
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obtaining insurance for a managed aircraft;
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maintenance, storage and fueling of aircraft;
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hiring, training, and provision of pilots and crew;
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establishing and complying with safety standards; and
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other services necessary to support flights operated by an aircraft owner.
An aircraft lessee is treated as an aircraft owner for purposes of the TCJA FET Exemption unless the aircraft is leased under a disqualified lease. A “disqualified lease” is a lease from a person providing aircraft management services with respect to the aircraft (or from a related person to the person providing the services) if the lease is for a term of 31 days or less.
The TCJA FET Exemption applies on a pro rata basis if only a portion of the payment is attributable to aircraft management services. FET must be collected on the portion of payments attributable to flights on aircraft not owned by the aircraft owner.
Subsequently, on July 31, 2020, the IRS published the Proposed Regulations. If finalized, the Proposed Regulations would further clarify the scope of the TCJA FET Exemption. Some key takeaways include clarification that:
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the “Possession, Command, and Control Test” is not relevant to the application of the TCJA FET Exemption.
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choice-of-flight rules (i.e. FAR Part 91 or Part 135) do not affect the application of the TCJA FET Exemption.
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whether an aircraft owner permits its aircraft to be used for for-hire flights (i.e. third-party charter) does not affect the application of the TCJA FET Exemption to amounts paid by the aircraft owner for aircraft management services.
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the method or manner by which an aircraft owner is billed for aircraft management services (e.g. monthly fees, hourly fees for each hour of flight time, billed at cost plus a mark-up, etc.) does not affect whether the TCJA FET Exemption applies to amounts paid for those services.
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payments by certain closely related parties shall not be considered as though made by the aircraft owner for purposes of applying the TCJA FET Exemption.
The above takeaways address some of the business aviation industry’s most frequently asked questions regarding the application of the TCJA FET Exemption. Nonetheless, open issues remain that are either not addressed in the Proposed Regulations or that are addressed only in part or incorrectly.
The National Air Transportation Association (NATA) and the National Business Aviation Association (NBAA) have jointly prepared and submitted comments to the IRS regarding the most important of these open issues and their recommendations regarding how the IRS should resolve them. That publication is available for download at https://www.nata.aero/pressrelease/ nata-nbaa-seek-clarity-on-excise-tax-exemption-indetailed-comments-to-irs. At this point, the IRS is reviewing all comments and will likely move toward finalizing the Proposed Regulations taking the comments into account (although it is not known with certainty if or when the IRS will issue the final regulations).
Conclusion
The basic issue of whether FET applies to payments by an aircraft owner to an aircraft management company seems to have been resolved with the enactment of the TCJA FET Exemption. The Proposed Regulations provide much needed additional guidance regarding the scope of the TCJA FET Exemption and its application in the context of specific fact patterns. However, important, but unresolved, issues remain, including those described in the NATA/NBAA comments regarding the Proposed Regulations, which the IRS will hopefully address as it moves toward finalization of those Proposed Regulations.
This article was originally published in Aviation Business Journal's Fall 2020 issue.
