Taxpayers are a married couple and are residents of Indiana. The Indiana Department of Revenue ("Department") determined that Taxpayers purchased a recreational vehicle ("RV") during the tax year 2010 and had been using the RV in Indiana without paying sales tax in any jurisdiction. As a result, the Department issued proposed assessments for Indiana use tax, ten percent negligence penalty, and interest. Taxpayers protest that the RV was purchased and titled by a Montana LLC, of which Taxpayers were the only members and that no Indiana sales or use tax is due. Taxpayers also protest the imposition of negligence penalty.
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Taxpayers protest the imposition of use tax on the use and storage of an RV in Indiana. The Department imposed use tax after determining that Taxpayers had been using and storing the RV in Indiana and that no sales tax had been paid on the purchase of the RV. Taxpayers protest that the RV was titled by a Montana LLC and that all legal documents establishing the existence of the LLC were properly filed in Montana. Taxpayers state that they purchased the RV in question at a deeply discounted price and intended to sell the RV for a profit when the market improved. The Department notes that the burden of proving a proposed assessment wrong rests with the person against whom the proposed assessment is made, as provided by IC § 6-8.1-5-1(c).
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The Department determined that Taxpayers purchased the RV in 2010 but did not pay sales tax on the purchase. The Department therefore issued proposed assessments for Indiana use tax.
Other than the purchase of the RV, Taxpayers did not provide any documents establishing any LLC business or non-business activity at all in Indiana, Montana, or any other state in the union. Taxpayers did provide unsigned and undated federal partnership returns for the LLC. These federal returns were prepared after the administrative hearing was conducted. The returns do not show any activity by the Montana LLC. While the LLC made no attempt to undertake any further activity, the titling of the RV by the LLC did have a significant impact on Taxpayers' sales taxes. This leads to consideration of the "sham transaction" doctrine, which is long established both in state and federal tax jurisprudence dating back to Gregory v. Helvering, 293 U.S. 465 (1935). In that case, the Court held that in order to qualify for favorable tax treatment, a corporate reorganization must be motivated by the furtherance of a legitimate corporate business purpose. Id. at 469. A corporate business activity undertaken merely for the purpose of avoiding taxes was without substance and "[T]o 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 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, 1236-7 (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).
In this case, the facts are that the Montana LLC had no business or non-business functions and never attempted to acquire, maintain, or dispose of any property other than the RV in question. In fact, the LLC had no functions of any kind other than those directly related to the purchase of the RV in question. The titling of the RV in Montana, a state without a sales tax, was merely an attempt to reduce or eliminate Taxpayers' sales and use tax liabilities. The formation of the LLC and the titling of the RV in the name of the LLC was therefore a "sham transaction."
In conclusion, Taxpayers never intended for the LLC to have any valid functions beyond avoiding sales and use taxes on the purchase of the RV. Therefore, the formation of the LLC and the titling of the RV by the LLC was a sham transaction. Consequently, Taxpayers acquired tangible personal property in a retail transaction, used and stored it in Indiana, but did not pay sales tax at the point of purchase or anywhere else. In such circumstances, Indiana use tax is due, as explained by 45 IAC 2.2-3-4 .
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In this case, Taxpayers incurred an assessment which the Department determined was due to negligence under 45 IAC 15-11-2 (b), and so was subject to a penalty under IC § 6-8.1-10-2.1(a). After a review of the circumstances in this case, Taxpayers have not established that the assessment arose due to reasonable cause and not due to negligence, as required by 45 IAC 15-11-2 (c). Therefore, the negligence penalty will not be waived.
