When affiliated companies share aircraft
It’s no secret that the FAA and IRS approaches to business aviation differ in important ways. This cleavage is especially evident in their respective treatment of related or affiliated groups of companies.
For the FAA—and its parent, the U.S. Department of Transportation—the issue is whether chargebacks for transportation among related companies should be permitted without a commercial certificate. For the IRS, meanwhile, the issue is whether such chargebacks represent taxable income. (Similar questions arise for states, which must determine whether chartering an aircraft to a related company counts as a commercial flight for sales-tax purposes.) In each case, the answers highlight the agencies’ views about what constitutes commercial aviation.
Jets often sit uneasily in complex corporate structures. An entity in the corporate structure has to own or lease the airplane and an entity in the group has to operate it. (In theory, ownership and operation can each be shared among two or more companies in the group, though that rarely occurs.) Once the aircraft is situated in the corporate structure, it’s not unusual for other companies to want to use it and for the cost to be allocated to the using company.
The challenges begin with the concept of related or affiliated companies. The Internal Revenue Code definition of an “affiliated group” involves a relatively clear 80 percent voting-and-value test—the same test employed for filing consolidated tax returns. In 2006, the DOT published a rule allowing a company to receive reimbursements for transportation provided in a U.S.-registered foreign civil aircraft to a “subsidiary or parent or subsidiary of its parent.” The DOT regulation says that aircraft’s operator “must hold majority ownership in, be majority owned by, or have a common parent with” the company to which it provides transportation. While not a model of clarity, this standard is crystal clear compared with FAA positions on the subject.
In a mind-bendingly complicated regulation, the FAA permits a company to charge for transporting a company’s employees and property “on an airplane operated by that company, or the parent or subsidiary of the company or a subsidiary of the parent.” Nowhere does the agency define these terms, though glimmers of insight shine dimly from FAA interpretations. The “parent,” for example, must be a company, not an individual, though why this should make a difference is unclear. More generally, a 1985 FAA Chief Counsel interpretation observed that “the agency’s long-established interpretation of the parent-subsidiary provision…is that it should be strictly construed to apply only to corporate complexes of the parent-subsidiary scheme,” whatever that is.
To further elucidate this cryptic standard, the agency rejected the suggestion that ownership of approximately 25 percent of the voting stock of a public company should be sufficient to render that company a “subsidiary.” The FAA noted that such an interpretation “would subject the agency to endless inquiries and disputes over whether control exists.” Thus, it claimed that “voting stock ownership percentages as low as 5 percent, or even lower, might constitute control, depending on whose viewpoint or standard would be used,” a concept not likely to forestall future inquiries and disputes.
Another problem plaguing both the FAA and DOT approaches to the affiliated group is the inclusion of indirect subsidiaries. If a direct subsidiary of the parent operates the aircraft, the agencies say, the subsidiary can charge the parent for flights. The subsidiary should also be able to charge its own subsidiary for flights.
But what about another direct subsidiary of the parent and its subsidiaries, which are in effect brother/sister companies of the subsidiary operating the aircraft? In interpreting the law, the FAA, literal-minded as always, seems to think that a subsidiary could charge another direct subsidiary of their common parent company for flights, but not subsidiaries of the subsidiary.
At first blush, it’s hard to see why the FAA would have a problem with this. But remember: since the FAA fails to define the ownership percentage required to be a member of the affiliated group, it may be worried (though I’m not aware the FAA has ever said this) that as you go down the chain of companies, the beneficial ownership percentage could become unacceptably attenuated. A parent that owns 50 percent of SubA would own only 25 percent of a 50 percent-owned subsidiary of SubA, and so on.
However the agencies define the affiliated group, how do they treat it? The IRS imposes a “transportation excise tax” on flights provided by one party to another. For the last 15 years, the tax has been 7.5 percent
of the amount paid for the transportation. Essentially, this is a tax on commercial aviation, where a party having what the IRS calls “possession, command and control of the aircraft” charges another party for transportation.
There is an exemption, however, when the charges are for transportation provided by one company in an affiliated group to another. Initially, the IRS position was that the exemption didn’t apply if the aircraft was also used to provide transportation for hire to parties outside the affiliated group. So, if a wholly owned subsidiary provided transportation to its parent company, but chartered the aircraft on one occasion to an unrelated company, the IRS taxed all chargebacks for the intercompany flights as well.
The transportation excise tax isn’t exactly well known to begin with, and the IRS’s counterintuitive position caught many accountants and finance departments unawares; back taxes, interest and penalties piled up in the meantime. With the help of the National Business Aviation Association, however, the law was changed in 1996 so that the IRS assessed the tax on a flight-by-flight basis. NBAA efforts also helped lead the DOT to permit, as noted earlier, intercompany chargebacks under some circumstances for transportation provided in a U.S.-registered foreign civil aircraft.
Thus, the IRS has a relatively clear definition of what constitutes an affiliated group of companies. The FAA does not. As noted earlier, the issue for the FAA is when to allow intercompany chargebacks for use of the aircraft by other members of an affiliated group. For complex corporate structures and companies with many-tiered subsidiaries, the answer will remain shrouded in mystery until the agency issues clearer rules.
Jeff Wieand is a senior vice president at Boston JetSearch and a member of the National Business Aviation Association’s Tax Committee.