Tuesday, November 4, 2008

Great Southern Bank v. Director of Revenue[1]

Opinion handed down November 4, 2008
Link to Mo. Sup. Ct. Opinion

The "taken in trade" provision of Missouri tax law exempts a party from a sale or use tax on a newly acquired asset up to the value of the traded-in asset. In a case of first impression, the Supreme Court of Missouri strictly construed the exemption and held that a transaction by Great Southern Bank did not qualify as a tax-exempt trade because it was a mere legal fiction created to minimize taxation.

I. Facts & Holding[2]

Great Southern Bank ("Great Southern") agreed to sell its Beechcraft airplane to Jet 1, Inc. ("Jet 1"), for $1,025,000. Nine days later, Great Southern transacted with Scag Engineering, LLC ("Scag Engineering") to purchase a Cessna aircraft for $1,925,000. The purchase agreement included a section for "Trade-In Aircraft," which was left blank by the parties.

For federal tax purposes[3], Great Southern entered into an exchange agreement with Wachovia Bank, N.A (“Wachovia”). The exchange agreement provided that: (1) both Great Southern and Scag Engineering deliver title of their respective planes to Wachovia; (2) Jet 1 forward the purchase price of $1,025,000 for Great Southern's Beechcraft to Wachovia; (3) Great Southern forward the purchase price of $1,925,000 for Scag Engineering's Cessna to Wachovia; and (4) Wachovia transfer the airplanes to the rightful parties, the $1,925,000 to Scag Engineering, and the $1,025,000 to Great Southern. Great Southern paid use taxes[4] on $900,000, the difference between the purchase price of the Cessna ($1,925,000) and the sale price of its Beechcraft ($1,025,000).

The Director of Revenue determined that Great Southern owed use tax on the full price of the Cessna. Great Southern filed a complaint with the Administrative Hearing Commission ("AHC") and the AHC concluded that Great Southern's transaction did not qualify for the "taken in trade" exemption under section 144.025 "because there was no trade."[5] Great Southern appealed. The Supreme Court of Missouri affirmed the AHC's ruling. It held that, as tax code exemptions are strictly construed against the taxpayer under Missouri law, the transaction did not qualify as a tax-exempt trade because it was not an actual trade. It was instead a legal fiction created to reduce tax liability.

II. Legal Background & Instant Decision

Section 144.025.1 of the Missouri tax code exempts the trade value of a newly acquired asset from sales or use tax when the asset is "taken in trade."[6] As the term "taken in trade" was not defined in the statute and had not been previously interpreted by a Missouri court, the Court first looked to the ordinary meaning of the words.[7] The Court concluded that a "trade" requires that the parties each have title to, or ownership of, their respective items and that they exchange them.[8]

Next, the Court analyzed a Tennessee Supreme Court case involving a similar exchange agreement and "taken in trade" exemption. In Hutton v. Johnson,[9] Hutton sold his Beech aircraft to Bell Aviation, Inc. ("Bell Aviation) and contracted with Cessna Aircraft Company ("Cessna") to purchase another plane.[10] Before the transactions were complete, Hutton assigned his rights under his agreement with Cessna to Bell Aviation. Bell Aviation forwarded the money from its purchase of Hutton's Beech to Cessna. Cessna then gave title to the new airplane to Hutton.[11] A provision of the purchase agreement between Cessna and Hutton provided that "[t]his agreement is the only agreement controlling this purchase and sale.” Another provision of the agreement indicated that no allowance for a trade-in had been made.[12] Hutton attempted to evade Tennessee's use tax through a "taken in trade" statute substantially similar to Missouri's.[13]

The Tennessee Supreme Court held Hutton's acquirement of the airplane did not qualify for the "taken in trade" exemption because it did not constitute a trade. "The two transactions involved in this case had independent significance. Neither of such transactions was dependent on the carrying out of the other."[14] As there was no trade, the "taken in trade" exemption did not apply.

The Missouri Supreme Court adopted much of the reasoning of the Tennessee Supreme Court, stating that "the sale of the Beechcraft and the purchase of the Cessna were two separate transactions."[15] While Wachovia technically held legal title to the aircraft for a short period, the Court noted that Wachovia had no actual control over the disposition of either aircraft and equated the company to an agent of Great Southern.[16] "When determining the merits of revenue cases, it is important to look beyond legal fictions and academic jurisprudence in order to discover the economic realities of the case."[17] A trade had not occurred and Great Southern was not entitled to the exemption.[18]

III. Comment

The proposition that tax exemptions are a matter of legislative grace and are to be strictly construed against the taxpayer is well-ingrained in both the federal and Missouri tax codes. Both the transaction at issue here and the one examined in Hutton v. Johnson appear to be attempts to skirt state taxation. This is most likely a result of both deals primarily focusing on qualifying for the non-recognition provision of IRC § 1031. The parties’ attempts to qualify for state "taken in trade" exemptions from use tax seem to be a secondary goal, perhaps even an after-thought.

Assuming these two deals are representative structurings of similar transactions, and not poorly-conceived outliers, practitioners must consider whether there is a way to structure deals in a manner that allows a client to enjoy both tax breaks. If it is not possible to take advantage of both, the diligent practitioner must determine which tax break will save her client more money. For example, assuming a six percent use tax in Missouri, Great Southern's use tax increased by $61,500 as a result of the unfavorable ruling, a sum generally not considered negligible.[19] At the very least, an informed client could choose to transact with a company that will actually "trade" assets with her.

- David R. Swaney

[1] No. SC88943 (Mo. November 4, 2008) (en banc). The West reporter citation is Great Southern Bank v. Director of Revenue, 269 S.W.3d 22 (Mo. 2008) (en banc).
[2] Id.
[3] Section 1031 of the United States Internal Revenue Code allows for deferment of realized gain on property "if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment." IRC § 1031(a)(1) (2000).
[4] Generally, a use tax is imposed on a transaction in which the sales tax is not collected, often because the state where the transaction took place does not have sales tax, and the good is used in the jurisdiction imposing the tax. See Manzi, Nina, Use Tax Collection On Income Tax Returns In Other States, at 1. (available at http://www.house.leg.state.mn.us/hrd/pubs/usetax.pdf).
[5] Great Southern, 2008 WL 4830070, at *3.
[6] The relevant section of § 144.025.1 provides:
“[I]n any retail sale other than retail sales governed by subsections 4 and 5 of this section, where any article on which sales or use tax has been paid...is taken in trade as a credit or part payment on the purchase price of the article being sold, the tax imposed by sections 144.020 and 144.440 shall be computed only on that portion of the purchase price which exceeds the actual allowance made for the article traded in or exchanged...” Mo. Rev. Stat. § 144.025 (2000).
[7] Great Southern, 2008 WL 4830070, at *3.
[8] Id. at *4.
[9] 956 S.W.2d 484 (Tenn. 1997).
[10] Id. at 486.
[11] Id. at 487.
[12] Id. at 486.
[13] Id.
[14] Id. at 489.
[15] Great Southern, 2008 WL 4830070, at *5.
[16] Id.
[17] Id. (quoting Scotchman's Coin Shop v. Admin. Hearing Comm'n, 654 S.W.2d 873, 875 (Mo. 1983) (en banc).
[18] Great Southern, 2008 WL 4830070, at *5.
[19] $900,000 multiplied by six percent equals a $54,000 Missouri use tax liability, with an exemption. $1,950,000 multiplied by six percent equals a $115,500 Missouri use tax liability without the exemption. $115,500 minus $54,000 equals $61,500.