Avoiding and Defending Florida License Tax Audits
- Florida hotels and restaurants are facing license tax audits, assessments and penalties in increasing numbers. The Florida Department of Revenue has come to interpret the license tax expansively as applicable to any type of ancillary business arrangement where a vendor makes a payment to use floor, shelf or counter space.
- The two most common arrangements in the restaurant and hotel industry are on-site vendor arrangements and retail placement arrangements. Tax counsel can provide guidance on ways to structure your vendor relationships and allocate payments in the text of your agreements between taxable and nontaxable uses to minimize taxation.
Florida hotels and restaurants are facing license tax audits, assessments and penalties in increasing numbers. A "license" is statutorily defined as the granting of a privilege to use or occupy a building or real property. The Florida Legislature added "licenses" to "leases" and "rentals" of real property as subject to Florida's commercial rental tax in 1986, ostensibly to close a "loophole" enabling parties to characterize their leases as licenses to avoid taxation. But the Department of Revenue (DOR) has come to interpret the license tax expansively as applicable to any type of ancillary business arrangement where a vendor makes a payment to use floor, shelf or counter space. Below, we discuss the two most common arrangements in the restaurant and hotel industry: on-site vendor arrangements and retail placement arrangements.
On-Site Vendor Arrangements
On-site vendor arrangements are taxable as licenses because they involve realty. They come in several varieties such as AV equipment rentals at resorts, beach chair rentals for hotel guests, and even movies on demand which require a satellite dish and black box on the premises. Unless an on-site vendor offers these services to the hotel's customers, the hotel itself would have to offer them. Instead, the hotel typically enters into a single-source agreement with the vendor to assure provision of the services. Usually, neither the hotel nor vendor views the arrangement as primarily concerned with realty, but DOR does and classifies it as a taxable license.
Retail Placement Arrangements
Retail placement arrangements are also common in the restaurant and hotel industry, most commonly involving concessions (e.g., video rental machines, ATMs, videogames, or vending machines). In the typical placement arrangement, the restaurant permits a vendor to place a machine on its property in exchange for participating in a portion of the revenue that the machine generates. Ordinarily, the fee varies with the amount of transactions on it. There may or may not be any base payment. Neither the machine-owner nor restaurant ordinarily regards the arrangement as a "lease" or "license" to use real property, or the machine owner as a "tenant." But DOR does and holds the restaurant responsible to collect the license tax while reserving the right to hold either the restaurant or vendor liable.
DOR is on the prowl for on-site vendor and retail placement arrangements for which it has not collected taxes. In the event of an audit, DOR typically assesses a tax on the full amount paid the hotel or restaurant, imposes a penalty, and charges interest. Fortunately, the assessment on the full amount paid is rarely, if ever, justified. You may be able to convince DOR that only a fraction of the payment relates to property because the arrangement also involves nontaxable elements. In some cases, sales taxes will also be due on the goods sold through equipment placed at the hotel or restaurant and, in these cases, the vendor may believe no more tax is due. Despite the appearance of double taxation, the portion of the receipts paid to the hotel or restaurant is, in DOR's view, separately subject to the license tax.
The Air-Vac Case
As authority for taxing the entirety of a payment, DOR relies primarily upon a case which held that the operator of a gas station and convenience store was engaged in the business of granting a license for use of real property when it contracted with the defendant to place coin-operated "air-vac" machines attached to concrete pads in the merchant's parking lot. In return, the merchant received a percentage of the gross receipts generated by the units. The court agreed with DOR that the amount paid the merchant was fully taxable. Hotels and restaurants may be able to distinguish this case on several grounds.
First, bailments are not taxable as a license. The typical bailment involves relinquishment by the bailor of possession, dominion and control of something to the bailee, but not necessarily in the entirety. There can be some sharing of possessory rights without defeating a bailment. Thus, the question whether a placement agreement is exempt from taxation as a bailment is a fact-specific inquiry based on the respective rights and responsibilities the agreement assigns to the parties or their course of conduct. The hotel or restaurant operator may be responsible for providing Wi-Fi, security, signage, liability insurance, utilities and more. The bailor may be responsible for maintenance on call and for insurance. In short, whether a placement arrangement amounts to a nontaxable bailment depends upon how a deal is structured with the assistance of counsel.
Second, joint ventures are also not taxable as licenses. They require: (1) a community of interest in the performance of the common purpose, (2) joint control or right of control, (3) a joint proprietary interest in the subject matter, (4) a right to share in the profits, and (5) a duty to share in any losses which may be sustained. Once again, each of these requires a fact-specific inquiry. The missing element that disqualifies many on-site vendor and retail placement arrangements as joint ventures is the sharing in losses. To the extent they arise at all, losses ordinarily arise in unconventional ways in on-site vendor and placement arrangements. Just as with every other defense to taxation, this one cries out for transactional planning.
Intrinsically Valuable Personal Property
Third, on-site vendor and placement arrangements that do not constitute bailments or joint ventures may, nevertheless, concern "intrinsically valuable personal property." The Tax Code provides as examples franchises, trademarks, service marks, logos, or patents. On-site vendor and placement arrangements may provide for cross-branding and cross-licensing of intellectual property rights. Even more commonly, on-site vendor arrangements and placement agreements ordinarily forbid competitors on the same premises as a critical inducement to the arrangement, independent of the right to use or occupy the real property. Exclusivity is a form of nontaxable intrinsically valuable personal property.
Fourth, a franchise also is not taxable as a license. The Tax Code does not define a "franchise," but it is defined elsewhere as a contract or agreement, either expressed or implied, whether oral or written, between two or more persons wherein: (1) a commercial relationship of definite duration or continuing indefinite duration is involved; (2) one party is granted the right to offer, sell, and distribute goods or services manufactured, processed, distributed or, in the case of services, organized and directed by another party; (3) the franchisee as an independent business constitutes a component of franchisor's distribution system; and (4) the operation of the franchisee's business franchise is substantially reliant on franchisors for the basic supply of goods.
Once again, whether an on-site vendor or retail placement arrangement constitutes a franchise is a factual question. The extent to which services, machines or goods are integrated into a hotel or restaurant's primary business by driving customers to the location, satisfying needs that they reasonably expect the operator to fill, or even providing them with the money to purchase product (e.g., via ATMs) is important to whether there is a franchise.
Oftentimes, an on-site vendor or retail placement arrangement will provide for payments that are, in fact, partially attributable to real estate. In this event, the Tax Code provides for a "reasonable allocation" of payments between taxable and nontaxable amounts. With the assistance of tax counsel, the taxpayer can allocate these payments prospectively by agreement in favorable ways or, if it is too late for that and the taxpayer is under audit, through expert testimony.
The tax on licenses to use real property has much broader application than many hotels or restaurants realize. It may be time to revisit the law. Meanwhile, you should consult with tax counsel about ways to structure your vendor relationships and allocate payments in the text of your agreements between taxable and nontaxable uses to minimize taxation. If it is too late and you are already subject to audit, this is another important reason to contact counsel to determine what your rights and responsibilities may be and to evaluate your defenses and cross-claims against your vendors or machine owners.
This article was published on Law360.com (Aug. 29, 2014).
To ensure compliance with Treasury Regulations (31 CFR Part 10, §10.35), we inform you that any tax advice contained in this correspondence was not intended or written by us to be used, and cannot be used by you or anyone else, for the purpose of avoiding penalties imposed by the Internal Revenue Code.
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem. Moreover, the laws of each jurisdiction are different and are constantly changing. If you have specific questions regarding a particular fact situation, we urge you to consult competent legal counsel.