What Is the Meaning of ‘Control’ in the Context of Use Tax? Part 2

Sellers of certain types of specialized equipment or property may require the buyer to agree to certain terms and conditions concerning use of the property. These terms and conditions could be construed as sufficient control to constitute a taxable use by the seller. Courts will also look to the duration and degree of control to determine whether there was a taxable use.

The Sliding Scale of ‘Lasting Control’ in Zimmer USA

In defining control as it relates to “use,” courts have examined the intent of the legislature in enacting the definition. Sharper Image Corp. v. Mich. Dept. of Treas. The authority to tax must be expressly provided. Molter v. Mich. Dept. of Treas. Tax laws generally will not be extended in scope by implication or forced construction. Importantly, when there is doubt, tax laws are to be construed in favor of the taxpayer because the state is imposing a tax. Mich. Bell Tel. Co. v. Mich. Dept. of Treas. Tax exemptions are the opposite—strictly construed against the taxpayer who claims its products or services are exempt by law and thus carries the burden of proving the exemption is valid.

The lower court in Sharper Image Corp. opined that the definition of “distribution” was synonymous with the definitions of “give” and “transfer,” two terms within the statutory definition of “use.” In that case, the plaintiff, a foreign corporation, conducted business in Michigan through mail-order catalogs that were produced in Nebraska and shipped through the mail from the printer’s place of business. The catalogs were sent by third-class mail, and plaintiff retained no control over them once they were delivered to the postal service.

The Court of Appeals of Michigan concluded that to be taxed under the Michigan Use Tax Act (UTA), a taxpayer must perform in Michigan one of the activities listed in the definition of “use” (i.e., the exercise of a right or power of tangible personal property incident to ownership of that property including transfer of the property in a transaction where possession is given). In the Sharper Image court’s view, “indicia of control included the power to determine in what publications the advertisements were to be placed and at what time they would be distributed,” but these facts were not present in the case.

Zimmer argued that it did not exercise a right of power over the instruments, since it relinquished control of them to a common carrier. Moreover, the distribution/transfer of tangible personal property generally relinquishes the transferor’s control.

Zimmer’s contracts, however, required the customer to reimburse Zimmer for any loss, damage, or destruction of the instrument. The Court of Appeals of Michigan concluded that because Zimmer did not relinquish “total control” of the property when it shipped it into Michigan, it retained what this article hereinafter refers to as “lasting control.”

It is clear that courts consider control on a sliding scale, and whoever is considered to have a larger interest in the tangible personal property will be subject to the applicable tax. Taxpayers should consider their relationship with products they provide to customers. If a taxing authority determines that an element of “lasting control” is present post-sale, companies could potentially be liable for a use tax obligation that they failed to consider.

Possible Scenarios to Consider When Defining ‘Control’

In Ameritech Pub. Inc. v. Mich. Dept. of Treas., the court opened the door to the interpretation of control where an owner no longer exercises “a right or power over tangible personal property incident to the ownership of that property” when it cedes total control of the property to a third party. In that case, Ameritech Publishing, Inc. (API) published and distributed telephone directories to business and residential customers in Michigan. A third party printed, bound, and cut the directories at its printing facility in Illinois. The Ameritech Pub. court analyzed WPGP1 Inc. where, because of leases to use aircrafts, plaintiff at no time used, stored, or consumed property in Michigan.

In WPGP1 Inc. v. Mich. Dept. of Treas., the leases did not give the lessee “permanent control” of the airplanes due to plaintiff’s ownership interest in airplanes, but the leases gave “total control” or exclusive authority over the use, storage, and consumption of the airplanes during the duration of the leases to the lessee, Southwest Airlines Inc., and thus plaintiff exercised no right or power over the airplanes.

In other words, by virtue of the leases, the taxpayer ceded control of the airplanes to Southwest, and therefore could not have “used” the airplanes for purposes of use tax liability under the UTA. According to the WPGP1 court, just because taxpayer “owned” or retained title to tangible personal property does not mean the taxpayer controlled it.

In contrast, the Ameritech Pub. court determined that “a review of the carrier contract and the distribution contract establishes that API did not cede total control of the directories while the directories were transported to Michigan by the contract carrier or when they were distributed to Michigan businesses and residences by the [product development corporation or PDC].” Unlike the plaintiff in Sharper Image, who lost all control over the catalogs once they were delivered to the postal office, API never lost all control over the directories after they were transported by the third party’s printing facility to the distribution centers.

Instead, API retained control by informing the PDC of the date a distribution was to be completed, what hours it was to distribute the directories, where it was to place the directories at a residence, when directories were to be mailed, and when they were to be received by the local post office. The PDC was required to provide reports that API used to continually monitor the PDC’s progress in distributing the directories. API also set minimum requirements for PDC’s staffing and quality assurance implementation, and API retained possession of any unused directories, which were to be disposed of by the recycler of API’s choice. Under these facts, the Ameritech Pub. court held API exercised a right or power over the directories incident to the ownership of the directories, while they were in Michigan, and thus, “used” the directories in the state.

More recently, in APLUX, LLC v. Mo. Dir. of Revenue, the taxpayer purchased two aircraft without paying sales tax and entered into three separate lease agreements for each aircraft: Two of the lease agreements were with the taxpayer’s parent company, and one lease agreement was with a private aircraft management and charter company. For the lease agreements with its parent company, the taxpayer remitted sales tax on the lease payments received from the parent company. For the lease agreement with the private charter company, the taxpayer claimed the lease payments were exempt because the private charter company qualified as an exempt common carrier.

The state defined “use” as the exercise of any right or power over tangible personal property incident to the ownership or control of that property. In this case, the lease agreements between the taxpayer and its parent provided the parent with the ability to use the aircraft on a non-exclusive basis. The taxpayer had priority to use the aircraft, could lease the aircraft to others, and retained the absolute right to determine whether to make the aircraft available to the parent. The lease agreement simply provided the parent with “operational control” of each aircraft while they were in the parent’s possession.

In comparison, the lease agreement with the private charter company required the taxpayer to deliver the aircraft to the charter company where it would be hangered and maintained by the charter company without interruption. The charter company was required to find pilots and crew for its charter flights, clean and maintain the aircraft, and provide insurance for the aircraft, and it could schedule flights with the aircraft at any time, provided the taxpayer had not already scheduled an owner flight.

In analyzing these lease agreements, the APLUX court determined that the agreements between the taxpayer and its parent did not constitute “sales” because the parent never had any right or power over the aircraft incident to ownership. The parent’s mere right of “operational control” over the aircraft during a flight was insufficient and instead demonstrated the taxpayer retained control over the aircraft.

For the lease agreement with the charter company, however, the APLUX court found that the charter company had significantly more control than just operational control during flight. Thus, the court held that no use tax was due on the aircraft subject to the lease agreement with the charter company, but that the taxpayer owed use tax on the other aircraft subject to the lease agreement with the parent company.

Businesses might consider two additional contexts when products (e.g., marketing materials) are shipped into Michigan or any other state. In one scenario, the business might deliver the products with a sales representative (e.g., employee of a company that distributes products to third party). Thus, the business might retain more control over the product. In the second scenario, the business ships or delivers the product directly to a third party with a common carrier. Thus, the business might retain less control over the product.

Generally, once a product is “handed over” or “distributed,” control is relinquished. However, when there is lasting control (e.g., an interest in the rights of the property) over the product, the Zimmer rule applies. Businesses might want to consider factors like conditional ownership (e.g., strings attached to the sale), and the length of time (e.g., momentary, a few days, months) in which the business maintains a relationship with the product it delivers (i.e., the longer the time, the more likely to trigger a use tax obligation).

While the Zimmer court does not define “lasting control,” businesses will want to avoid retaining such a relationship and consider when a use tax obligation begins based on the terms and conditions concerning use of the property. A state’s interpretation of what constitutes a taxable use, including fact patterns demonstrating “lasting control” may be found in court cases and other state guidance. If sellers or lessors have the ability to control or influence use of the property (i.e., rights incident to ownership), they are subject to a use tax obligation.

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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