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Rare Taxpayer Victory at the Office of Tax Appeals

If your company has been paying use tax liability in California based on the fair rental value on out-of-state leases of tanks and other containers, a recent Office of Tax Appeals opinion could offer an opportunity for some tax relief.


In a pending opinion released last month, Appeal of Adler Tank Rentals, LLC (“Adler”), the Office of Tax Appeals agreed with the taxpayer that containers without the ability to transport persons or property “substantial” distances did not constitute mobile transportation equipment (“MTE”) for sales and use tax purposes.  What constitutes MTE has been a long-standing issue of concern for business taxpayers.  This opinion provides some further definition and guidance into this fact-intensive area of the law.  The taxpayer Adler Tank Rentals, LLC, was represented by Bewley, Lassleben & Miller partners Joseph A. Vinatieri and Patricia Verdugo.


After October 31, the OTA will publicly release its opinion in Adler, which held that the taxpayer was entitled to an adjustment measuring $952,317.00, which was a full reversal of that audit item, and restoration of a bad debt deduction of $387,041.60, which was an 80 percent reversal of that audit item.


There were two issues on appeal:


  1. Whether the containers in question qualify as MTE; and
  2. Whether the appellant is entitled to a bad debt deduction.


The taxpayer in this case is a California-based lessor of storage containers for storing hazardous and non-hazardous liquids and solids, which leases the containers to in-state and out-of-state customers.


During an audit, the State Board of Equalization, now the California Department of Tax and Fee Administration (“CDTFA”) alleged that all of the taxpayer’s containers constitute MTE, and thus use tax was due on the out-of-state leases measured by the fair rental value of the containers.


There are three categories of containers at issue for purposes of the appeal: large tanks, small tanks, and boxes.


The taxpayer argued on appeal that the tanks are not MTE because they are “not capable of transporting persons or property, and tanks and boxes are not component parts of MTE because they are only temporarily attached to MTE when they are transported to and from the customer’s location.”


The CDTFA argued that the large tanks are MTE because they are “designed to transport themselves over substantial distances at highway speeds, and are hitched to a semi-trailer truck which is MTE.”  Similarly, the agency argued that the small tanks are MTE because they are “affixed as a component part of MTE, and there is insufficient evidence to conclude that it is physically incapable of transporting property since there are no warning signs posted on the small tanks.”  Lastly, it argued that the boxes were MTE because it “transports property over substantial distances and is affixed as a component part of MTE during such transport.”


The OTA’s analysis turned to California Code of Regulations, title 18, section 1661 (“Regulation 1661”), which defines MTE for sales and use tax purposes.  The OTA summarized Regulation 1661’s definition of MTE in the opinion:


“MTE includes: (1) equipment for use in transporting persons or property for substantial distances, including specifically listed equipment (first prong); and (2) tangible personal property which does not independently meet the definition of MTE set forth in the first prong but which, by nature of its attachment to MTE, becomes a component part of other property meeting that definition of MTE (second prong).”


In this case, the facts established that all the containers are transported by means of temporary affixation to MTE.  Thus, the key issue for the analysis regarding the taxability of the containers was whether, by nature of their attachment to MTE, the containers are a “component part of MTE.”


For the large tanks, the OTA concluded that they are not considered “equipment for use in transporting persons or property for substantial distances,” and would only constitute MTE if they are considered a component part of the MTE.  The OTA believed that the temporary “hitching property to MTE solely for purposes of transport is not sufficient to transform the property into a component part of MTE.”  Under the OTA’s interpretation of Regulation 1661, “becomes a component part of MTE” does not include property which “(1) is only temporarily attached to MTE solely for transport and must be detached from any MTE prior to use; (2) is not registered as a vehicle or trailer with DMV, and (3) is not designed or used to transport persons or property for substantial distances.”  Consequently, the OTA held that the large tanks do not qualify as MTE and the OTA used the same analysis to conclude that the small tanks do not qualify as MTE.


For the boxes, the undisputed facts indicated that the taxpayer’s reusable boxes are designed to transport hazardous waste for substantial distances for disposal.  The OTA cited Annotation 335.0015, in which CDTFA similarly concluded that “debris boxes designed to transport garbage to a disposal facility constitute MTE on the basis that they qualify as reusable cargo shipping containers and, as such, are considered MTE” to support its conclusion that the boxes met the statutory definition of MTE under Regulation 1661.


Since the taxpayer and the CDTFA agreed that 100 percent of the taxpayer’s liability for unreported out-of-state leases of MTE is allocable to large tanks, the OTA reversed the CDTFA’s decision to impose additional use taxes for those leases.


Furthermore, the parties also agreed that if the OTA concluded that the large tanks and small tanks do not qualify as MTE, but that the boxes do qualify, then the allowable bad debt deduction would be 80 percent of the claimed amount.  As the OTA held that the large tanks and small tanks did not qualify as MTE, but the boxes did, the OTA adjusted the allowable bad debt deduction for tax years at issue to approximately $387,041.60.

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