What Is the Meaning of ‘Control’ in the Context of Use Tax? Part 1

For certain types of specialized equipment or property, the seller of the equipment may require the buyer to agree to certain terms and conditions concerning use of the property. For example, a seller of construction equipment may require the buyer to use the seller to service or replace the equipment.

Furthermore, a lessor of airplanes or commercial trucks may require the lessee to use certain routes or schedules, to use airports or truck stations, to store the airplanes or trucks, to maintain state-required registrations, to provide maintenance, or to otherwise exercise dominion over the use of the leased property. See, e.g., WPGP1 Inc. v. Mich. Dept. of Treas. (airplanes). Many of these sellers may be unaware that their standard terms and conditions could potentially trigger a use tax liability.

The thesis of this article is that while companies often think they are relinquishing control via a lease, gift, or distribution, they need to be careful not to retain some interest or control that could be used to say they are creating a taxable use. Courts in Michigan and elsewhere have examined this question and begun to develop a continuum of “control” that can be instructive to companies in evaluating their potential exposure. This article will examine how this issue has evolved in Michigan.

In an order of the Michigan Tax Tribunal granting summary disposition to the Michigan Department of Treasury, the taxpayer, Zimmer US Inc., in Zimmer US Inc. v Dept. of Treas., was denied a petition for a refund of approximately $870,000 in use tax.

Zimmer is an Indiana-based company that manufactures and markets orthopedic implants, such as prosthetic joints, that it provides to its customers, who are presumably the end consumers of the products. It also provides customers with the medical instruments that are used to install the implants, usually on an indefinite basis, at no extra charge. Subsequent to the sale, Zimmer retained ownership of the instruments, and its contracts required the customer to reimburse Zimmer for any loss, damage, or destruction of the instruments.

Zimmer argued “that the sole purpose of the requirement was to ensure that petitioner could replace the instruments.” Indeed, “petitioner did not sell the instruments” and “received no consideration for the equipment,” and while not explicitly mentioned in the opinion, its customers presumably had to eventually return the instruments. Zimmer sought a refund of use tax on the basis that it did not use the instruments in Michigan within the definition of “use” under the Michigan Use Tax Act (UTA). The court disagreed and held that Zimmer retained control over the instrument, which constituted a taxable use.

The UTA imposes a tax on the “privilege of using, storing, or consuming tangible personal property” in Michigan. Michigan Compiled Laws Section 205.93(1). Specifically, “use” means “the exercise of a right or power over tangible personal property incident to the ownership of that property including transfer of the property in a transaction where possession is given. Converting tangible personal property acquired for a use exempt from the tax levied under this act to a use not exempt from the tax levied under this act is a taxable use.” Mich. Comp. Laws Section 205.92(b).

In addition to the leasing or rental context, Michigan also analyzed a taxable use “incident to the ownership” of property in WPGP1 Inc. v. Mich. Dept. of Treas. The Michigan Court of Appeals held that a lessor of two airplanes that landed at Michigan airports 49 and 44 times, respectively, constituting less than 1.5% of each airplane’s total landings during a year, did not “use,” “store,” or “consume” those airplanes in Michigan within the UTA because it did not control the planes.

Furthermore, merely registering the airplane with the Federal Aviation Administration using a Michigan office where the plaintiff did not actually have a Michigan office was a fact that, “standing alone, cannot support a finding that plaintiff ‘used’ the airplanes in Michigan under the UTA.” Compare with Kellogg Co. v. Mich. Dept. of Treas. (holding use tax was properly imposed where the plaintiff registered two airplanes in Michigan and kept them in a Michigan hangar).

In NACG Leasing v. Mich. Dept. of Treas., the taxpayer had purchased an aircraft from one company and immediately executed in Michigan a five-year lease of the aircraft to another company that already had possession of the aircraft. The Michigan Supreme Court determined that “the act of ceding control of an aircraft can, itself, be an exercise of a right incident to ownership,” and held that the act of executing the lease in Michigan was a “use” for Michigan use tax purposes, “regardless of whether [the taxpayer] ever had physical possession of the aircraft.”

According to the NACG Leasing court, “[i]t is a basic precept of property law that a property owner has the right to the use and enjoyment of his or her personalty. A corollary to this right is the property owner’s right to allow others to use his or her property in exchange for consideration [e.g., executing a lease].” According to the NACG Leasing court, the lower court had relied on the WPGP1 court and the court in Czars Inc. v. Mich. Dept. of Treas. for the opposite conclusion that executing a lease was exercise of right or power over property incident to ownership of that property. Those two cases had distinguished between partial and total relinquishment of control of an aircraft for purposes of assessing the use tax.

In Czars Inc., the petitioner allowed a sister corporation, Grand Aire, to use the petitioner’s airplane in the absence of a formal lease agreement. The majority held:

“Petitioner concedes that there is no lease or other documentary evidence showing that it totally or permanently relinquished control of the aircraft to Grand Aire in Arizona. In addition to allowing Grand Aire in Arizona to fly the plane to Michigan . . . petitioner also permitted Grand Aire in Michigan to modify the plane extensively, to obtain FAA approval to fly the plane, and to make use of the plane in Grand Aire’s cargo transport business. Under these circumstances, petitioner failed to rebut the presumption that it exercised rights and powers of ownership . . . in Michigan and, therefore, is liable for use tax.”

While these courts have construed use tax statutes as containing a requirement of “control” as an essential element of a taxable use, some view that “the cases sustaining use taxes on advertising materials shipped on behalf of advertisers from outside the state directly to in-state residents by third parties on the theory that the advertisers enjoy the economic use of the property in the state make it clear that actual control of property is not an essential element of a taxable use in many states.”

In Part 2, the authors examine the sliding scale of “lasting control” and scenarios exhibiting varying degrees of “control.”

This column doesn’t necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.

Author Information

Taylor A. F. Wolff is a Senior Associate in State and Local Tax in the New York Office at KPMG LLP. Spurgeon Green IV is an Associate in State and Local Tax in the New York Office at KPMG. Robert E. Weyman is a Principal in State and Local Tax in the New York Office at KPMG LLP.

The information in this article is not intended to be “written advice concerning one or more Federal tax matters” subject to the requirements of Section 10.37(a)(2) of Treasury Department Circular 230. 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. This article represents the views of the author(s) only, and does not necessarily represent the views or professional advice of KPMG LLP.

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