Was a jet engine sold to a foreign air carrier taxable when possession passed in California for required acceptance testing before export?

Plain-English summary

Howard Frohlich of San Mateo Auditing asked in a November 25, 1986 memorandum whether two groups of aircraft sales were taxable. The request and audit workpapers are absent.

For the first issue, a redacted buyer bought a jet engine from a redacted seller. A January 3, 1984 invoice referred to a December 19 order, F.O.B. California shipment by a drayage company that day, later airfreight to Germany under waybill 220-83431725, $625,000 bank-to-bank payment due after test-cell acceptance and payment completed January 13. A January 6 purchase order required inspection and a test-cell run under the PWA overhaul manual, cash after a successful test and buyer-paid return transportation only for a failed test. Those documents are described or quoted but absent.

The seller argued the sale occurred in Germany after testing. Counsel disagreed: possession transferred for consideration in California because the buyer had to test the engine and pay if it conformed. Physical F.O.B. delivery completed the seller's performance, and any retained title would only be a security interest. The conformance condition did not make this a sale on approval because the buyer could not return a conforming engine.

The historical foreign-air-carrier exemption analysis expressly assumed the buyer met the federal definition as it stood on January 1, 1980 and applied section 6385 as it stood on the sale date. The seller needed a good-faith Certificate D before billing, within its normal billing-and-payment cycle, or no later than engine delivery; the carrier needed California records such as a bill of lading, air waybill or cargo manifest documenting foreign transport. Counsel said the seller was relieved if those conditions were met and should be assessed if the certificate was not timely. No certificate, export record or assessment is supplied.

The second issue involved numerous claimed-exempt sales of engine parts to domestic air carriers. Exhibit C invoices reportedly showed the buyers directing delivery to redacted maintenance shops at SFO and in San Diego for installation on out-of-state airline engines. California delivery to buyer representatives completed the sales, so section 6396 did not apply. Installation was a California use beyond the purchaser-carriers' transportation role and defeated section 6385 even if certificate and bill-of-lading requirements otherwise were met. Counsel recommended assessment. Exhibit C, the parts, amounts, installations and audit outcome are absent.

The PDF prints Regulation “16209(a)(1)” in the second analysis and has the January 26/January 16 date conflict. The live annotation publishes only the first transaction, misprints Commercial Code section 2326 as 2336, and omits the foreign-carrier assumption, certificate details, second parts issue, source defects, audit provenance and later-outcome gap.

Common questions

Why was the engine sale completed in California?

The seller transferred possession F.O.B. in California for the buyer's enforceable duty to test and pay $625,000 if the engine conformed.

Was this a sale on approval?

No. The buyer could return only a nonconforming engine, not a conforming one merely because it no longer wanted it.

Did foreign-air-carrier status automatically exempt the engine?

No. Counsel assumed that status and still required a timely prescribed certificate plus retained California export records.

What happened if the seller lacked a timely Certificate D?

Counsel said sales tax should be assessed, but the source supplies no later assessment record.

Why were the separately sold aircraft parts taxable?

They were delivered to buyer-directed California maintenance shops, and installation here exceeded the carriers' transportation role.

Does the live annotation cover the aircraft-parts issue?

No. It publishes only the engine issue and also prints section 2336 where the supporting opinion cites 2326.

Citations and references

• Revenue and Taxation Code sections 6006(a), 6051, 6385 and 6396; Commercial Code sections 2326 and 2401; Regulation 1621 — cited historical rules and conditions
• 49 U.S.C. section 1301 as of January 1, 1980 — foreign-air-carrier definition assumed, not reproduced
• BTLG Annotation 570.1320 and Southern Pacific Equip. Co., 16 C.A.3d 302, 307 — installation and carrier-role authorities cited for the second issue
• Orders, invoice, waybill, Certificate D, export proof and Exhibit C — described or quoted but absent
• Official Annotation 325.0612 — publishes only the first issue and misprints section 2326 as 2336

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: Annotation 325.0612
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/325-0612.pdf

Original ruling text

State of California

Board of Equalization

Memorandum
To:

Mr. Howard Frohlich
San Mateo Auditing

From:

David H. Levine
Tax Counsel

Subject:

I--- A--- S--- I--S- -- XX-XXXXXX

325.0612
Date:

January 26, 1987

This is in response to your memorandum dated November 25, 1986. You set forth two sales of aircraft parts and ask if either is subject to sales tax. I. X--- purchased a jet engine from I--- A--- S--- I--- (“I---”). A sales invoice dated January 3, 1984 and issued by I--- provides the following information: the order date was December 19, 1983; the engine was shipped FOB to [city], California on January 3, 1984 by C--- D---; the engine was to be shipped by X--- to [city], Germany on airfreight waybill #220-83431725; “payment due upon completion of test cell acceptance”; and payment of $625,000 was to be made by bank to bank transfer (which was done on January 13, 1984). A purchase order dated January 6, 1984 indicates FOB [city] for shipment by X--- to
[city], Germany and states:
“Engine unused and in same condition since previously received from X---. Acceptance of engine after inspection and test cell run in accordance to the PWA overhaul manual at X--- [city]. In case test run negative X--- will pay for transportation cost back to owner. Payment terms: cash after successful inspection and test run.” DISCUSSION I--- contends that the sale occurred in Germany after the tests performed by X---. We disagree. For purposes of the Sales and Use Tax Law, a sale is any transfer of title or possession, conditional or otherwise, for a consideration. (Rev. & Tax. Code § 6006(a).) The consideration I--- received for the transfer of possession was X---’s obligation to test the engine and pay I--$625,000 if the engine conformed to the contract. The only condition to that transfer was that X--- pay the sale price or return the engine if it did not conform to the contract. Therefore, I--sold the engine in [city], California when it transferred possession to X---.

I---A--- S--- I---

-2-

January 16, 1987
325.0612

The provisions of the Uniform Commercial Code as adopted by California are consistent with this conclusion. Under Commercial Code section 2401(2), the contract of sale was consummated when I--- completed its performance with reference to the physical delivery of the engine at the FOB site, [city]. The purchase order and sales invoice do not provide for passage of title, but even if they did, a retention of title by I--- would be limited in effect to a security interest. (Comm. Code § 2401(1).) For purposes of discussion, I note that a contract that could be confused with the one here is known as a “sale on approval.” If I---’s contract with X--- were a sale on approval, the sale might not be subject to tax depending on where the sale is determined to have occurred. However, I---’s contract with X--- is not a sale on approval. Commercial Code section 2326 specifically states that “if delivered goods may be returned by the buyer even though they conform to the contract, the transaction is [a] ‘sale on approval’ if the goods are delivered primarily for use….” (Emphasis added.) The contract here does not permit X--- to return the engine regardless of its conformance to the contract. Rather, a fair reading of the sales invoice and the purchase order discloses a good faith duty by X--- to test the engine and pay the sales price if the engine conforms to the contract. This is not a sale on approval. Since the sale occurred in California, it is subject to sales tax unless it satisfies the requirements of Revenue and Taxation Code section 6385 as they existed at the time of the sale (all references to section 6385 are to that section as it existed on January 3, 1984). (Rev. & Tax. Code § 6051; regulation 1621.) I assume that X--- is a foreign air carrier as that term was defined in Section 1301 of Title 49 of the United States Code on January 1, 1980. Based on this assumption, subdivision (b) of section 6385 sets forth the applicable exemption. (Regulation 1621(b)(2), (d)(2), and Certificate D.) “To qualify for this exemption, [X---] shall [have] timely furnish[ed] to [I---] a certificate in writing that the [engine] shall be transported and used in the manner described in this subdivision. Such certificate shall be substantially in the form prescribed by the board. Acceptance in good faith of such a certificate shall relieve [I---] from liability for the sales tax.
[X---] shall maintain records in this state, such as a copy of a bill of lading, an air waybill or cargo manifest, documenting its transportation of the [engine] to a foreign destination.” (Rev. & Tax. Code § 6385(b).) The requirements to qualify for the Section 6385 exemption are mandatory. If they are not satisfied the exemption does not apply. I--- must produce a certificate in substantially the same form as Certificate D of Regulation 1621 accepted in good faith and received before I--billed X---, or within the I---’s normal billing and payment cycle, or no later than delivery of the engine to X---. (Reg. 1621(d)(2) and (e)(2).) If I--- received the required certificate within these time limits, it is relieved from liability for the sales tax. (X--- must, of course, have the required records in this state.) If not, I--- should be assessed the sales tax.

I---A--- S--- I---

II.

-3-

January 16, 1987
325.0612

You ask whether the following transactions are subject to sales tax: “I--- has claimed numerous sales to domestic air carriers as exempt. The merchandise, generally engine parts, was shipped to California aircraft maintenance shops (J--- at SFO and K--- in San Diego) where the parts were installed on the out-of-state airline engines. The engines were then shipped outof-state.”

DISCUSSION
These facts do not bring the transactions within the interstate shipment exemption of Revenue and Taxation Code section 6396. The invoices you provided us as Exhibit C show that the out-of-state purchasers directed I--- to ship the parts to facilities within this state. The sale occurred when I--- completed its performance with reference to the physical delivery of the parts to the buyer’s representatives in California. (Comm. Code § 2401(2), Rev. & Tax. Code § 6006(a).) Sales tax applies, unless otherwise exempted, despite the sale having preceded the parts’ movement to a point outside this state. (Reg. 16209(a)(1).) Further, the tax applies even though, with better planning, the parties may have been able to structure the transaction in a manner that would have avoided taxation. I--- also cannot prevail with an argument that the sale qualifies for the Section 6385 exemption, even if it otherwise satisfied the timely bill of lading and certificate requirements. (See Reg. 1621.) Installation of the parts sold by I--- is a use in this state and defeats a claim of Section 6385(a) exemption. (Reg. 1621(b)(1)(C); BTLG Anno. 570.1320 (10/15/69).) That is, “for the exemption to apply, the role of the purchaser-carrier inside the state must be limited solely to its capacity as a common carrier transporting the purchased property.” (Southern Pacific Equip. Co. v. State Bd. of Equalization (1971) 16 C.A.3d 302, 307.) The purchasers’ representatives in this state, the repair shops, did not act solely in this capacity. Therefore, tax should be assessed on I---’s sales structured as those represented by Exhibit C.

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