Were purchasing and handling markups taxable when a railroad billed other owners for repair parts and a joint venture for supplies?

Plain-English summary

A railroad repaired cars owned by other rail lines and billed scheduled prices that included purchasing and handling markup. Tax counsel said an actual markup was part of the price charged to the owner and was taxable. But it distinguished a 1942 letter based on facts suggesting no real overall markup; if those older facts still controlled, the earlier treatment would remain relevant.

The railroad also supplied cups, brushes, seat covers, and similar items to an operation involving three railroads. Assuming that operation was a bona fide separate partnership or joint venture, the markup was taxable because one entity sold to another. The entire markup remained taxable even though the seller effectively bore part of the allocated charge and sometimes serviced its own car.

The memorandum expressly declined to resolve the result if the operation was merely jointly owned rather than a separate entity.

Citations and references

• California Sales and Use Tax Ruling 55, section A-2-(b) — as cited; ruling text, date, version, and copy not supplied
• August 26, 1952 San Francisco Tax Administrator memorandum asking about two railroad markup transactions — memorandum and attachments, if any, not reproduced; source prints the date as August 26,1 952
• December 22, 1942 T. H. Mugford letter to Southern Pacific's attorney concluding on then-understood no-markup and overall-average-loss facts — letter, supporting data, analysis, and copy not supplied
• Association of American Railroads repair-price schedules, foreign-line cars, reciprocal charges, tax-paid repair parts, purchasing and handling markup, and possession after repair — schedules, repair records, parts invoices, tax-payment records, billings, and accounting records not reproduced in the official PDF
• Three-railroad agreement and preamble, partnership or joint-venture operation, permit file, track-mileage allocations of approximately 41, 37 and 22 percent, train servicing, supplies, tax-paid cost, freight and handling markup — agreement, permit, file, mileage records, service records, supply invoices, allocations, and accounting records not reproduced in the official PDF
• June 26, 1953 internal tax-counsel memorandum assuming a bona fide separate joint venture and expressly leaving a merely jointly owned railroad unresolved — no administrator response, additional facts, transaction treatment, audit, assessment, refund claim, agency adoption, appeal, or later outcome supplied
• Official PDF's formal June 26, 1953 date versus continuation-page literal June 265, 1953 — no correction supplied; live annotation uses June 26
• Official Annotation 295.1380's foreign-line-car repair-parts markup and taxable-price conclusion and June 26, 1953 date — annotation omits the August 1952 request and delayed-response note, 1942 letter and conditional fact distinction, AAR schedules, joint-venture supply transaction and unresolved alternative, Ruling 55, conflicting continuation date, missing records, later outcome, and reliance status and supplies no additional proceeding record

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: https://cdtfa.ca.gov/lawguides/vol2/suta/295-0000-all.html
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/295-1380.pdf

Original ruling text

State of California

Board of Equalization

Memorandum

To:

San Francisco – Tax Administrator (OSS:REP)

From:

Headquarters – Sales Tax Counsel (WWM)

Subject:

W--- P--- R--- Company
XXX --- Street
--- ---, California

295.1380

June 26, 1953

SS – XX XXXXXX

Please refer to your memorandum of August 26,1 952. You inquire whether the sales tax should apply to the following transactions. In the first, the taxpayer makes necessary repairs to foreign line cars in order to maintain them in proper operating condition. These are foreign line cars used by W--- P--- as the operating line. The W--- P--- is apparently a bailee for hire or lessee of these foreign line cars. Charges to the foreign lines for labor and material for these repairs are taken from schedules of prices prepared by the Association of American Railroads and are identical with similar charges made by the foreign lines in repairing W--- P--- cars. Taxpayer is purchasing the parts used on a tax-paid basis. However, the A. A. R. scheduled prices involve an element of markup for purchasing and handling expenses. You inquire whether this markup should be subject to the tax. In our opinion, the tax should apply to the element of markup since it is part of the price charged the foreign line. We believe that Mr. T. H. Mugford’s letter of December 22, 1942 to Mr. H--- H. M---, Attorney for Southern Pacific, in which Mr. Mugford expressed the view that the tax should not apply to the markup, was based on the fact that, in most instances, there was no such markup, and on the fact that at that time, the price charged the foreign lines on an overall total average was not equal to the cost of the parts purchased by S--- P---. Apparently, this situation has been changed, or you would not have made the inquiry. If the situation has changed, Mr. Mugford’s letter is not, of course, controlling. If, however, the facts are the same as those upon which his letter was based, we see no reason to adopt a different view now. The fact that W--- P--- has possession of the cars after repairing the same, would not, of course, affect the application of the tax since the cars are owned by the foreign line, W--- P--- merely having the right to possess them.

San Francisco – Tax Administrator (OSS:REP)
Re: W--- P--- R--- Company

-2-

June 265, 1953
295.1380

The second item involves sales by the W--- P--- R--- Company to what is apparently a partnership or joint venture consisting of W--- P--- R--- Company; The C---, B--- and Q--- R--Company; and the D--- and R--- G--- W--- R--- Company, dba the C--- Z--- Trains (Permit No.
--- - XXXXX). The Z--- Trains, all individually owned by the companies involved in the joint venture, are serviced at W--- P---’s --- terminal. The charge for the servicing is billed to the joint venture companies on the basis of track mileage owned by the three companies, approximately 41% to C.B.&Q., 37% to W.P., and 22% to D.&R.G.W. As we understand it, the same percentage charge is made irrespective of whose car is serviced. In connection with the servicing operations, supplies furnished to the units of the Z--Trains include such items as Dixie cups, brushes, seat covers, etc. The total charge for such items to the joint venture includes the tax-paid cost, foreign line freight, plus handling charges. It is our opinion that the tax should again apply to the markup. In accordance with Section A-2-(b) of Ruling 55 we feel that the fact that the supplies will not be immediately consumed at the time of installation does not alter the application of the tax. In reaching our conclusion that the tax should apply to the markup we assume that Z--- actually constitutes a separate entity (a bona fide joint venture) for sales tax purposes. This assumption seems warranted by the reference in the preamble of the Agreement between the three lines to the “3 partnership lines”, to “any one partner line”, and to “all three partners”. In the next paragraph reference is made to the “3 partner railroads”. Based on that assumption, there is a sale from one entity to another and accordingly, the tax should apply to the markup. Furthermore, the tax should apply to the entire markup irrespective of the fact that approximately 37% of the markup is paid by W--- P---, and the tax would apply even where the supply is furnished for a W--- P--car. If the Z--- is not a bona fide separate entity but merely a jointly owned railroad operated by the separate entities in their individual capacities, the application of the tax, measure of tax, and other related problems are extremely complicated. Accordingly, if you have some doubts in this connection, we would appreciate your further comments together with any other factual information you may wish to present. We have examined the file of the the C--- Z--- Trains (--- - XXXXX) and it appears to us to be a separate entity for sales tax purposes. We are sorry that we delayed in answering this.

WWM:ja