Sam Brotman, JD, LLM, MBA December 30, 2020 20 min read

California Use Tax Planning for Aircraft

As with most other tangible property, the purchase and use of aircraft within California is subject to sales and use tax, respectively.

However, aligned with the constitutional provisions against burdening interstate commerce, certain aircraft uses and purchases may be tax exempt.

Under RTC 1620(b)(5)(C)(3), aircraft that is flown, for more than half of its flight time, for commercial purposes in interstate or foreign commerce for the six months following its entrance into the state will not be subject to use tax. 

In a 2020 case brought before the Office of Tax Appeals, the appellant Snowflake Factory LLC argued that the exemption of RTC 1620(b)(5)(C)(3) applied to its use of aircraft which was purchased within the state.

The panel rejected this argument, stating that the provisions of this section are limited to aircraft that are purchased from out of state and in this case, the aircraft was purchased in Fresno, California. Thus, through the interpretation of the provisions of RTC 1620(b)(5) and the Office of Tax Appeals decision in the Snowflake Factory case, this provision only applies to purchases of aircraft made out-of-state. 

In addition to the requirement that the aircraft be purchased out-of-state, the aircraft must also have been first functionally used outside the state of California in order for the exemption of RTC 1620(b)(5)(C)(3) to be applicable.

The phrase “functionally use” is defined in RTC 1620 as “use for the purposes for which the property was designed.”

In a 2002 opinion, the Board of Equalization noted that “[v]ehicles, vessels and aircraft are not necessarily functionally used simply because they are driven or piloted.” 2002 CAL. TAX LEXIS 784. Additionally, in the same opinion, the Board remarked that aircraft designed for personal use and aircraft designed for commercial use are distinguishable from one another. Id.

As demonstrated, it is essential that any aircraft purchaser hoping to benefit from the use tax exemption must retain documentation to prove the location of purchase, the location of use and storage, the location of first functional use, and the hours and purpose for which the aircraft was flown.

Is Your Aircraft Use Included in Interstate Commerce?

To determine whether your use of the aircraft would constitute interstate or foreign commerce, the RTC offers various examples of the types of activities that would qualify. Listed among them are examples that multistate retailers or wholesalers may potentially encounter:

  1. “Example 9. Property is transported by a commercial vehicle, vessel, aircraft, or locomotive from another state or country to California or from California to another state or country. While engaged in this transportation, the commercial vehicle, vessel, aircraft, or locomotive also transports property from one point in California to another.
  2. Example 10. A commercial vehicle, vessel, aircraft, or locomotive is dispatched from one location in California to another location in California to pick up property and transport it to another state or country.”

Further guidance is provided in several of the Annotations for Regulation 1620. Of relevance are the Annotation 325.0003.2000 (Aircraft Used Exclusively in Interstate Commerce) and Annotation 325.1724 (Ferry Flights), both of which describe scenarios in which aircraft may travel from one location in the state to another within the state and still qualify the trip as one of interstate travel.  

Annotation 325.0003.2000 mentions that if an aircraft travels between two California locations for maintenance only, assuming it travels continuously in interstate commerce both in and out of state, those maintenance trips will simply be considered “incidental” to the aircraft’s interstate use.

Annotation 325.1724 clarifies that even if a California-originating interstate flight makes a stop within the state to pick up passengers, the in-state leg of the flight will still be counted as part of the entire interstate trip. The key point to keep in mind when there are stops within the state is that the purpose of the flight must be interstate in nature. 

These exemptions illuminate the importance of documenting the reasoning behind any in-state flights for taxpayers hoping to receive a use tax exemption on their aircraft use.

The taxpayer needs to show that the intent of all legs of the flight, taken together, was to travel out of California. A stopover in San Francisco for a meeting would not meet this intent test. A stop only to refuel would, however, show such an interstate travel intent.

We recommend that flights originating in California and continuing through stops within California be supported by a flight plan that ends outside of California, and that only insubstantial delays be allowed within California.

Those flights originating outside of California will qualify as interstate flights for purposes of the exemption. However, flights or parts wholly within California need to be scrutinized to determine whether or not those legs are solely continuations of the flight from outside of California.

A stop within California to pick up an additional passenger for the flight from San Francisco to Los Angeles would not be solely a continuation of the interstate flight.

It is also important to note that any in-state use of the aircraft for purposes of training a pilot(s) who will be flying the particular aircraft in question will not count against a taxpayer applying for the use tax exemption. See 325.0002 (Aircraft—In-State Pilot Training). With respect to this provision, the Annotation specifically mentions that training must be for use of the specific aircraft and not simply the type of aircraft so this distinction is crucial to keep in mind. Id

As in most tax-related matters, careful and complete documentation is necessary to support any claim of exemption from the tax.

When we work on these matters, we ask that the taxpayer furnish copies of all of the purchase documents: the contract, application for registration, FAA bill of sale, notarized delivery receipt showing acceptance outside of California, and evidence of insurance.

We also request copies of the pilot’s log entries for the period to show where the aircraft was during the test period. A notation reflecting the business purpose as well as other parties who were involved will help meet the “business purpose” portion of the test. The auditor may wish to contact these third parties to verify the meetings.

If possible, we prefer to have contemporaneous third-party documentation of the meeting or activity in question so there will be no question about the commercial nature of the visit. For example, an email or fax mentioning the upcoming or just completed meeting between the participants would be helpful.

We would like to see copies of trip sheets/pilots’ logs sheets several times a month so I can carefully monitor the aircraft’s usage for purposes of the exemption. Beginning and ending Hobbs meter readings need to be recorded by the pilot for every leg traveled during the test period.

That way, the auditor will be assured that all of the trips were recorded in the log book. Once the test period has expired, it will be impossible to correct any shortfall in interstate usage. A copy of the aircraft maintenance log is also necessary, for the same reason.

In addition, we may need to provide the auditor with copies of the paid bills related to each interstate flight. Out of state tie downs, gas, oil and supplies purchases, dinner bills, motel room, and any other bills associated with out-of-state travel will be useful. This third-party documentation assures the auditor that the trips really occurred.

Once the test period has been successfully completed, we will prepare a California sales and use tax return claiming the interstate commerce exemption from the tax and submit it to the State along with a complete package of supporting documentation. If we’ve both done our parts, the case should be approved for exemption without further difficulty.

Exemptions on Vessels

Like aircraft, vessels (the term for a ship or boat) brought into California from out of state will qualify for use tax exemption when they are first functionally used outside of California and are used outside of the state for 12 months before they are brought into the state.

Otherwise, vessels brought into California before the 12 month period has passed will be subject to use tax unless the vessel is used or stored outside of the State for more than half of the six months after it first entered the State. See RTC 1620(b)(5).

When it comes to aircraft or vessels designed for personal use, the first instance in which it enters California has served as the date of first functional use. 1992 CAL. TAX LEXIS 140. On the other hand, if designed for commercial purposes, the date of first functional use will be the first instance in which the vehicle, aircraft or boat is used for that commercial purpose. 

The CDTFA recommends that documentary evidence showing that the vessel was not purchased for use in California must be retained for 8 years. Among the evidence listed are mooring and service/fuel receipts, bank statements, documents showing the location of delivery and the location of the first functional use. See Publication 52 Vehicles and Vessels: Use Tax, 7.

In the past, the Board of Equalization has held that, absent proof of first functional use, a vessel that was in the state for more than half of the six month period following its entrance into the state subjected it to use tax. 1996 CAL. TAX LEXIS 1019. Meticulous record-keeping is necessary for all business and tax-related matters, but especially when requesting tax exemptions, as such requests will be highly scrutinized. 

The regulations surrounding the circumstances in which a vessel may be brought into California within the 12 months of purchase without jeopardizing its use tax exemption qualification have changed a few times through the past few decades.

However, as of 2010, vessels may be brought into the state of California within 12 months of purchasing for the sole purpose of repair, retrofit and modification. See Publication 52 Vehicles and Vessels: Use Tax, 8.

Additionally, any repairs, retrofits or modifications done must be performed by a repair facility that is county or city (or both) licensed or by a repair facility located in a county with no licensing requirement. Id. Repairs need not be made in the facility itself if they are done by a repairer employed by a licensed repair facility. Id

With respect to vessels used in leases, the lessee’s use of the vessel counts towards the timeframes used to determine whether use tax is owed.

In one case, the Board of Equalization held that a cruise company’s agreement to lease a vessel to the shipbuilder that created the vessel for 91 days demonstrated that the vessel was not purchased for use in California. 1991 CAL. TAX LEXIS 511.

Demonstrating that a particular vessel was purchased for use outside of California, as evidenced by the amount of time the vessel was used or held outside of California, is one way to qualify for use tax exemption.

The CDTFA notes that vessels that are principally used for “transporting passengers or property for hire for interstate or foreign commerce”, for deep-sea fishing outside California, or for “transporting people or property for hire to certain vessel or off-shore drilling platforms” all are exempt from use tax. See Publication 40, Tax-Exempt Watercraft.

In regards to deep-sea fishing, yearly earnings of less than $20,000 from a vessel will form the presumption that that particular vessel is not being used for commercial purposes.

However, this presumption is rebuttable by documentary evidence such as tax returns, profits and loss statements, licenses and boat registrations, twelve months worth of documentation regarding the fish caught and their locations, among other pieces of evidence. In regards to vessels used out of the State, it is not necessary for 100% of the use to be in interstate or foreign commerce for a vessel to qualify for the exemption.

Rather, a use of more than 50% in interstate or foreign commerce suffices. See Publication 40, Watercraft Industry, 1.

Any business looking to register their vessel in California without having to remit use tax must fill out CDTFA-106, Vehicle/Vessel Use Tax Clearance Request. For businesses applying for an exemption for vessels used in interstate commerce, the first step is to visit the CDTFA’s Online Services page and to submit a request under the File a Return or Claim an Exemption for a Vehicle, Vessel, Aircraft, or Mobile Home option. The CFTDA will request documentary evidence at the end of the test period to verify that the exemption criteria has been met. 

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law

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