I recently spoke at the annual convention of COST (Committee on State Taxation) in Phoenix, along with other western states taxpayers association representatives.

Many state reports told of challenges in getting state legislators to enact appropriate economic-growth tax reform, of biased or unqualified tax commissioners, and flawed tax filing and tax appeal processes.

I was pleased to report on Utah’s success at the most recent legislative session wherein we won victories on major tax reforms, including single sales factor income tax apportionment and elimination of all sales taxes on business inputs for manufacturing and mining operations.

I also reported our success over the years of increasingly stringent qualifications for Utah State Tax Commission nominees to the extent that now we have all experienced experts in taxation on the four member panel instead of the ‘bad old days’ of political appointees without expertise. The recent confirmation of Dr. Larry Walters, one of the world’s leading authorities on ad valorem taxes is an example of this.

I reminded COST members of the fact that in Utah we have established a tax court with tax-trained judges at the district court level. This ensures that in the event of an appeal of the tax commission’s decision, the taxpayer doesn’t have to pay their attorneys to educate renaissance judges on technicalities of tax law. What’s more, appeals to district court are trial de novo, not simply a review of the record of the tax commission hearing.

Utah State Tax Commission Shows Bias Against New Business
As much as we have to be proud of regarding Utah’s tax structure and tax administration process, there is one area that still causes grave concern: the tendency of the commission and administrative law judges to favor sales tax auditors who are still too often motivated by revenue enhancement instead of fair application of the law.

After returning home from the COST meeting, I was disappointed to discover that in a recent taxpayer sales tax appeal, the commission was willing to give their auditors undue deference, supporting the auditors’ requirement that the taxpayer’s small business produce more than a quarter of a million dollars before he could appeal to the district court.

The most offensive part of this particular ruling is the requirement of the payment of years of uncollected sales taxes from a business which relied on a published tax commission rule stating the activity was not sales taxable. Since there had been no case law on sales taxability of this new type of business, and without any precedent such as audits or private letter rulings, a more reasonable ruling would be to require the collection of the tax going forward. However, this ruling requires the small business to not only pay years of back taxes, but also penalties and interest, potentially putting the business into bankruptcy.

Things a Reasonable Person Would Expect to Be Non-Taxable
“The power to tax involves the power to destroy” was made famous an 1819 US Supreme court case, McCullouch v. Maryland. It appears the Utah State Tax Commission has used this power to potentially destroy a first of its kind business in Utah in a cavalier fashion.

Let me explain why I say the tax commission and their sales tax auditors are cavalier in the requirement to remit sales taxes which a business never collected from customers, despite the business following to the letter a tax commission administrative rule. The sales tax typically constitutes a dollar value significantly higher than the net profits a retailer earns on the same transaction. In other words, the government, through sales taxes, makes more on each transaction than the business does. Consequently, when a retailer is required pay the 7% sales tax and their net profit on the same transaction is 3.5%, the business would have to give over to the tax collector twice as much as the business has made. Essentially giving up six years of business profits for three years of un-collected sales taxes. Property and income tax deficiencies are only a fraction of that impact: Income taxes are no more than 4.95% of a person’s income or a business’ profits and property taxes are less than 1.5% there is one area that still causes grave concern: the tendency of the commission and administrative law judges to favor sales tax auditors who are still too often motivated by revenue enhancement instead of fair application of the law of the property’s value.

IFLY is the only wind tunnel skydiving instruction center open to the public in Utah. IFLY is a wind tunnel in which participants can take part in wind tunnel flying. This is very similar to skydiving, but more difficult and precise. It is a challenging and physically demanding activity that can be dangerous to participants if safety procedures are not followed. Gary Nielsen, owner of IFLY, said the entire IFLY activity from start to finish is a lesson and involves constant instruction on wind tunnel flying, geared to teach people how to progress in this activity.

Tax Commission auditors issued a deficiency plus penalties and interest of more than $250,000 for failure to collect sales taxes on lessons in the wind tunnel. IFLY had been collecting sales taxes on merchandise sales made at the business, but did not collect sales taxes on the lessons given by instructors.

Tax Commission Calls its Own Rule “Guidance”, Not to be Followed in this Case
IFLY had been operating under Tax Commission Rule R865-19S-33, which states that lessons, public or private, are not subject to sales tax. The Tax Commission auditors called the receipts “admission fees” which are subject to sales taxes for amusements.

The liability to the IFLY’s owners is immense if constant instruction is not provided. At all times, a certified wind tunnel instructor is inside the wind tunnel with the participant and a second instructor is outside the tunnel operating the wind flow. No participants, no matter how advanced, are allowed in the wind tunnel without a certified flight instructor. All instructors are required to be certified by the International Body Flight Association which requires many hours of training for certification.

Mr. Nielsen demonstrated that the entire IFLY activity is a “lesson” from beginning to end and therefore is not subject to tax based on the provisions of Utah Administrative Rule mentioned earlier. Unfortunately, in its ruling the tax commission stated that the rule should be considered “guidance” and is therefore not binding.

Additionally, the Tax Commission ruled that since 95% of customers are not “repeat” customers, they are consuming this more as a recreational activity, not a lesson. However, this fact actually proves that at least 95% of the customers were specifically paying for lessons and training as the activity cannot be engaged in without constant instruction from experts.

Since wind-tunnel skydiving training is relatively new and IFLY is the only provider in Utah and has never been subject to a sales tax audit, the tax commission should not have used its power to destroy in this manner. To require IFLY to pay a nearly 7% tax which was never collected from customers and which is more than the net profits on the business’s IFLY income, the tax commission should have established the precedent going forward instead of potentially putting a legitimate business into bankruptcy.