The California Office of Tax Appeals (OTA) recently sustained a $2.5 million tax assessment related to leases of tangible personal property. K1 Speed, Inc. (K1), a company operating indoor go-kart racing venues in California and other states, failed to collect and remit tax on its rental receipts from leasing go-karts to its customers.
“While it may be true that the goal of each participant was amusement, the means of obtaining it was via go-kart racing and the go-karts themselves.”
ARRIVE & DRIVE
K1 describes itself as the world’s premier indoor go-kart racing operator since 2003, with over 59 locations worldwide. It offers several “arrive & drive” race packages, which allow customers to race laps around an indoor track for approximately $20 per person with discounted rates available for larger packages.
IMPORTED ISSUES
At the time of the go-kart purchase from a vendor in Italy, K1 did not remit sales tax to California or its vendor. Further, K1 did not report or remit to California any tax on its receipts related to the lease of the go-karts during the audit period resulting in a $2.5 million Notice of Determination from the California Department of Tax and Fee Administration (CDFTA).
A LEASE BY ANY other NAME
As stated in California statute, a “lease” includes “a contract under which a person secures for a consideration the temporary use of tangible personal property [TPP] which, although not on his or her premises, is operated by, or under the direction and control of, that person.”
Generally, a lease of TPP for California purposes is considered a “continuing sale” and “continuing purchase”, except when TPP is leased in substantially the same form as it is acquired, and the lessor chooses to pay tax on the purchase price. When the lease is considered a “continuing sale” and “continuing purchase”, use tax applies and is measured by the rentals payable. The lessor must collect tax at the time the rental is paid and remit it to the state.
NONETHELESS STILL A LEASE
In the Notice of Assessment, the CDTFA determined that K1’s transactions were rental agreements, synonymous with leases, and were therefore taxable. Further, K1 had not collected and remitted tax for the purchase price of the go-karts, even though the go-karts were provided to customers on a temporary basis in exchange for payment.
K1 argued that its go-kart rental transactions were not leases of TPP for two reasons: (1) the go-kart loans cost less than $20 and were used for less than a 24-hour period on its premises, and (2) go-kart racing is an amusement service, not a lease, because K1 maintained control of the go-karts.
the decision
K1’s first argument referenced an exclusion which excludes certain restricted grants of privilege to use property from the term “lease.” To qualify for the exclusion, the use of the TPP must be restricted to use on the business premises, the charge must be less than $20, and the use must be for a period of less than 24 hours.
However, after a thorough analysis of its pricing structure, the OTA determined that none of K1’s go-kart racing packages were available for less than $20 per transaction, making them ineligible for the exclusion.
K1’s second argument was that it provided a service, not a lease of TPP, because the true object of each transaction was the nontaxable amusement service rather than the possession and use of TPP.
However, in reaching its conclusion, the OTA determined that while the goal of each customer was in fact amusement, the means of obtaining the amusement was through the go-karts and go-kart racing. Thus, the true object of the transaction was the possession and use of the go-karts and as such taxable as a lease of TPP and transactions constituted leases of TPP. Accordingly, the OTA upheld the $2.5 million assessment on the rental receipts.
tax strategy
Unfortunately, K1 lost the opportunity to collect tax from its customers on the lease transactions during the years of the audit and appeal process, ultimately costing the company more than $2.5 million. Having a trusted tax advisor on your team is the recommended approach to tax compliance and strategy. No need to overthink the decision.