A transportation subsidiary can benefit from tax exemptions offered in most states even where its operation provides transportation services to its parent, if it is sufficiently separated from its parent in organization and operation.
Separate organization and operation of the transportation subsidiary requires a good deal of effort. Drafting and filing organizational documents, complying with state filing requirements in the states where the transportation company will do business, and registering tax identification numbers are just a few of the steps involved. The transportation company also will have to establish its own U.S. Department of Transportation number and register operating authorities with the Federal Highway Administration and state regulatory agencies.
Then, it must demonstrate that it operates as a public transportation company. States vary regarding the factors considered in determining whether an entity operates as a public transportation company and thus qualifies for sales tax exemptions, especially where the company primarily transports product for its parent. But all states make this fact-sensitive determination, in large part, based on the degree of separation of the transportation company from the business shipping the product and whether the transportation service is provided for consideration. Some factors may include whether the subsidiary is sufficiently capitalized, maintains its own books, records and bank accounts, and issues its own W-2s. States also observe whether charges are invoiced for transportation services to the parent.
Achieving the degree of separation from the parent sufficient to qualify as a public transportation company also requires adoption of a new mind-set. Fleet operations previously performed in-house now reside in the new subsidiary. The transportation subsidiary must be in all respects an independent provider of transportation services. Essential to the creation of this distinction is the transportation subsidiary’s effort to hold itself out to the public as an available for-hire transporter of property, seeking opportunities to haul product for unrelated companies.
Efforts payoff in exemptions
Clearly the effort and upfront costs involved in creating a transportation subsidiary can be substantial. Nevertheless, with benefits ranging from increased control over compliance and safety and isolation of liability exposure to significant sales and use tax savings, a new transportation subsidiary is worthy of consideration.
Take, for example, a company that budgets $1 million annually in purchases of major transportation equipment. If just half of their purchases qualify for exemption, based on the states where the purchases are made and the use of the equipment in those states, then the potential sales and use tax savings would be about $30,000, assuming a tax rate of 6%. Exemptions from sales tax on purchases of repair and replacement parts, tires, fuel and lighter equipment available in many states will add even more tax savings. Within a few years, the tax savings should outweigh the outlay.
A company managing its own fleet operations should talk to a tax professional, who can gather data and assess the potential for tax savings based on the nature and location of the company’s transportation-related purchases and activities. The steps to create a transportation subsidiary and transfer fleet assets and operations to the new company should be identified, and the effort to maintain adequate separateness from the parent should be evaluated. Then, once the company determines the filings and registrations required to claim exemptions where the company qualifies for them, let the purchasing begin. The company just might discover the benefits of a transportation subsidiary enjoyed by many others before it.
Stephen H. Paul is a partner at Faegre Baker Daniels, concentrating his practice on state and local tax. He can be reached at stephen.paul@FaegreBD.com. Fenton D. Strickland is an attorney at Faegre Baker Daniels and focuses his practice on matters of state and local tax, including tax controversies, planning and structuring. He can be reached at fenton.strickland@FaegreBD.com. Both have advised clients on the organization of transportation companies with fleets ranging from 25 to several thousand units.