Taxpayer disputes the assessment of use tax on the purchase of a recreational vehicle. There are three interested parties; a Montana LLC, Taxpayer, and Taxpayer's president. Taxpayer is a farming business and is the only member of the LLC. The Indiana Department of Revenue ("Department") issued Taxpayer's president a use tax assessment. Taxpayer's president protested the assessment, an administrative hearing was conducted during which the president's representative explained the basis for the protest. A Letter of Findings (Letter of Findings 04-20110504) was issued denying this first protest.
Subsequently, the Department issued a second assessment against Taxpayer (the farming business).
Along with challenging the underlying assessment of sales/use tax on the purchase of a vehicle, Taxpayer also challenges the assessment of the fraud penalty which had the effect of doubling the underlying assessment. Taxpayer states that the fraud penalty is "neither applicable nor proper." Taxpayer further argues that imposition of the penalty represents "the use of strong-armed, improper and slanderous tactics by the Department of Revenue . . . ."
Assuming for the moment that the proposed assessment of sales/use tax was correct and that the Department properly assessed use tax on the out-of-state acquisitions the recreational vehicles, the Department must determine whether the 100 percent penalty was properly imposed.
Taxpayer – as the "sole member of the Montana LLC" – conferred with a Montana lawyer to establish the LLC to hold title to the vehicle. A cursory search of publicly available information reveals that this attorney offers various services to its clients stating that, "Register your vehicle in Montana. Avoid sales tax and licensing fees. Forming a Montana business entity (Montana LLC or Corporation) may allow you to avoid sales tax and lower your licensing fees on your automobile, recreational vehicle, trailer, boat or airplane."
The attorney reassures potential clients stating that, "A simple legal procedure is involved which, in most cases, helps [our] clients save a great deal of money on taxes and licensing fees through creating a Montana LLC and then proceeding with Montana vehicle registration or Montana RV registration within the legal bounds of a Montana LLC."
The Montana Secretary of State duly approved the filing of the documents for the LLC. Purportedly acting as an "agent" for the LLC, Taxpayer's president proceeded to purchase the recreational vehicle. The LLC then "took possession" of the recreational vehicle. Taxpayer asserts that the recreational vehicle was then "titled to the Montana LLC" because Montana was the legal residence of the LLC.
In order to sustain the imposition of the penalty, the statute requires that all five elements – misrepresentation, scienter, deception, knowledge, injury – be established. In this instance, it is sufficient to review the "scienter" requirement. The term is defined as follows:
A degree of knowledge that makes a person legally responsible for the consequence of his or her act or omissions . . . [a] mental state consisting in an intent to deceive, manipulate, or defraud. Black's Law Dictionary 1463 (9th ed. 2009).
However unlikely the legal contortions may have been, Taxpayer (or Montana LLC or Taxpayer's president) apparently consulted the Montana attorney in good faith, paid that attorney to establish a Montana LLC, and believed the attorney's explanation that establishing the LLC would allow Taxpayer to avoid paying Indiana sales or use tax. As such, it is not possible to establish – by "clear and convincing evidence" – that Taxpayer possessed the requisite "degree of knowledge" or scienter sufficient to sustain the imposition of the 100 percent penalty.
Montana LLC purchased a recreational vehicle from a Florida dealership. The recreational vehicle cost approximately $500,000. The dealership did not collect, and Montana LLC did not pay, Florida's six-percent sales tax. The "purchase contract" stated that sales tax was "N/A." Taxpayer does not explain why Florida sales tax was inapplicable except to say that the "tax was deferred to the State of Montana . . . ."
Taxpayer explains that its president "completed the purchase of the RV on behalf of and as an agent for his corporation and the corporation's LLC."
Thereafter, the recreational vehicle was titled to the Montana LLC which – as Taxpayer explains – is the "legal residence of the LLC." Taxpayer further explains that the recreational vehicle "was purchased by the Montana LLC for use by the [Taxpayer] in its business and personal use by the shareholder, for travel and vacationing primarily outside of the State of Indiana." Although Taxpayer argues that the recreational vehicle was used outside of Indiana, Taxpayer was unable to provide any documentation establishing the amount of time the vehicle was used outside Indiana.
The Department assessed Taxpayer use tax on the purchase of the recreational vehicle. The Department imposed use tax after determining that no sales tax had been paid on the purchase of the recreational vehicle.
Taxpayer disagrees with the assessment relying partly on the proposition that no sales tax was owed to Florida or Montana and that the Department is required to defer to those states under the Full Faith and Credit Clause of the United States Constitution. (U.S. Const. art. IV § 1). Taxpayer protests that the recreational vehicle was titled by a Montana LLC and that all legal documents establishing the existence of the LLC were properly filed in Montana. Taxpayer additionally maintains that the Montana LLC had a legitimate purpose, Taxpayer used the recreational vehicle for purposes related to its farming operation, and that the vehicle was used primarily outside Indiana.
In its original contact letter to the Taxpayer's president, the Department explained that use tax was being assessed because "sales tax was not paid to the vendor." The Department recognized that the vehicle(s) "was titled in the state of Montana in the name of a LLC" but that the Department "believed the RV is the only asset of the LLC and the LLC serves no other purpose but to avoid Indiana sales/use taxes due for vehicles that are otherwise garaged, serviced, and/or driven in Indiana by you as Indiana residents."
Taxpayer's president stated that he "is an individual, who had no part, individually, in the purchase of this RV from a Florida dealer" and "there is no legal basis to assess or tax him individually." Both Taxpayer's president and Taxpayer correctly point out there is nothing in the law which requires that a taxpayer maximize his or her tax liability but that "[a]nyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes." Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir.1934).
However it should also be pointed out that in the Supreme Court decision Gregory v. Helvering, 293 U.S. 465 (1935), challenging the previously cited decision, the Court stated that in order to qualify for favorable tax treatment, a business reorganization must be motivated by the furtherance of a legitimate corporate business purpose. Id. at 469. A business activity undertaken merely for the purpose of avoiding taxes was without substance and "to hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose." Id. at 470.
The courts have subsequently held that "in construing words of a tax statute which describe [any] commercial or industrial transactions [the court is] to understand them to refer to transactions entered upon for commercial or industrial purposes and not to include transactions entered upon for no other motive but to escape taxation." Comm'r v. Transp. Trading & Terminal Corp., 176 F.2d 570, 572 (2d Cir. 1949), cert. denied, 338 U.S. 955 (1950). "[T]ransactions that are invalidated by the [sham transaction] doctrine are those motivated by nothing other than the taxpayer's desire to secure the attached tax benefit" but are devoid of any economic substance. Horn v. Comm'r, 968 F.2d 1229, 1236 (D.C. Cir. 1992). In determining whether a business transaction was an economic sham, two factors can be considered; "(1) did the transaction have a reasonable prospect, ex ante, for economic gain (profit), and (2) was the transaction undertaken for a business purpose other than the tax benefits?" Id. at 1237. The question of whether or not a transaction is a sham, for purposes of the doctrine, is primarily a factual one. Lee v. Comm'r, 155 F.3d 584, 586 (2d Cir. 1998).
Taxpayer sets out putative reasons for titling a recreational vehicle in Montana but also points out that Montana does not require a business purpose to create or organize a Limited Liability Company and that the Department is constitutionally required to extend "full faith and credit" to Montana's decision that the recreational vehicles are not subject to sales and use tax. In addition, Taxpayer explains that the LLC was formed to insulate Taxpayer's Indiana business from any potential liability attributable to the recreational vehicle. In addition, Taxpayer explains that he uses the recreational vehicle to travel from state to state in order to examine farming practices in other states and the recreational vehicle is only temporarily stored in Indiana.
The Department does not deny that the LLC may have been formed for a purpose other than avoiding the tax. However, in determining that Taxpayer was entitled to rely on the representations of the Montana attorney to the extent that Taxpayer did not knowingly commit fraud, the Department also reasonably notes the attorney's own representations that the purpose of establishing a Montana LLC is to "save a great deal of money on taxes and licensing fees . . . ."
The Department is unable to agree that Taxpayer has met its burden under IC § 6-8.1-5-1(c) of demonstrating that the recreational vehicle is not used or stored in Indiana and that the Department erred in requiring an Indiana resident from paying use tax on a vehicle purchased outside the state.
Unfortunately, the Department is unable to accept the proposition that Indiana residents may avoid paying sales and use tax on tangible personal property simply by titling that property outside the state. In this particular case, the Department is unable to agree that either the law, the facts presented by Taxpayer, or simple common sense compel the conclusion that Taxpayer should not be responsible for paying use tax on this vehicle. Department has consistently determined as much. See Letter of Findings 04-20100111 (March 29, 2010), 20100526 Ind. Reg. 045100324NRA; Letter of Findings 04-20100299 (July 28, 2010), 20100929 Ind. Reg. 045100591NRA; Letter of Findings 04-20100175 (August 23, 2010), 20101027 Ind. Reg. 045100650NRA.