United and American Fuel Buying Policies Face a Legal Challenge

When I first saw a story about United and American being sued over their fuel buying policies in Chicago, I wasn’t too interested. But then I started digging in and it’s actually a fascinating fight that we’re likely to see play out with various business all over the US as municipalities and public agencies struggle to raise revenues. I’m not a judge, but it appears that what the airlines are doing is lawful, but it’s not exactly adhering to the spirit of the law. The Regional Transportation Authority (RTA) disagrees, and is suing to make it stop.

United and American have both set up fuel buying/selling subsidiaries in the small town of Sycamore, Illinois. Sycamore has a mere 17,500 people and lies an hour west of O’Hare in DeKalb County. (O’Hare and Chicago itself are in Cook County.) Why did these major airlines set up fuel buying subsidiaries here? Well clearly it’s because of the annual Sycamore Pumpkin Festival which is just a delight. Or not. More likely it’s because the airlines found a friendly local government that could save the airlines a boatload of cash.

The suit that was filed is solely against United, because the RTA didn’t want to bother suing an airline in bankruptcy. I’d expect to see that one to come after American exits. For that reason, I’ll focus on United for this story, but you can replace that with American and you’ll get the exact same thing. This chart should sum things up nicely as to what’s happening here.

Chicago vs Sycamore Sales Tax

If United buys fuel from a company in Chicago or at O’Hare (also part of Chicago), it’s subject to a 9.5 percent sales tax. In Sycamore, it’s only 8 percent. On big fuel purchases, that’s a lot of money to be saved. But it’s actually even bigger savings than that.

United undoubtedly found an army of tax law specialists, and they learned that the airline could save money by opening a subsidiary, United Aviation Fuels Corp. The state tax code states that “the seller’s acceptance of the purchase order or other contracting action in the making of the sales contract is the most important single factor in the occupation of selling.”

Here’s how that plays out. United set up a wholly-owned subsidiary that acts as an intermediary. The airline (along with some partner airlines) then technically buys its fuel from the intermediary in Sycamore. The result is that since the subsidiary accepts the purchase orders in Sycamore, the taxes in Sycamore apply, or so says United. That alone saves that 1.5 percent in sales tax. But wait, there’s more.

Part of the deal that United made is that all but just a few hundred thousand dollars of the sales tax that goes to Sycamore gets refunded to the airline. So the savings are huge, to the tune of over $300 million over the last few years across both United and American.

Why would the good folks of Sycamore do this? It’s a no-brainer. They weren’t going to get anything without this deal. But with just a tiny office set up in their town, they now get $430,233 this year with a 2 percent annual increase through 2026 from United alone. That’s a lot of cash for a tiny town. Everyone’s happy, right?

Of course not. Those taxing agencies that are losing out on taxes are angry, and I don’t blame them. This deal has been in place for more than a decade, but they’re just figuring it out now at the RTA. I assume that’s because as funding gets squeezed, United Aviation Fuels Corpthey need to aggressively look for more ways to supplement what they get. (Otherwise public transit rates will keep going up.)

The RTA says that arrangement is not following the law. According to the complaint filed, the RTA cites another part of the tax code to claim that “‘acceptance’ of the subject jet fuel sales does not truly occur in Sycamore nor does United Fuels engage in sufficient sales activity in Sycamore to allow such sales to be sited there for sales tax purposes.”

At right, you see the front door of the United Aviation Fuels Corp. office in Sycarmore. It’s a shared law office. Apparently it has one person who doesn’t come in every day. There isn’t even a computer there. So the RTA says that there isn’t enough of a presence in Sycamore for it to be legitimate.

United says this is bull. The only statement the airline gave is a terse one.

We believe this suit is without merit. The operation of our fuel subsidiary in Sycamore has been examined by tax authorities in the past and has been determined to comply with all applicable laws. We will vigorously defend ourselves against these claims.

So who is right in all this? The judge will give us the answer, I suppose. But I tend to think that United’s lawyers have probably done a pretty thorough job of making sure this was legal when it was set up. If we look at this without a legal lens on, it certainly does have a shady feel to it, but shadiness isn’t a legal issue. (And would you really not do the same thing if it was completely legal?)

The fuel buying decisions for the airline are made in Chicago and the fuel is delivered at O’Hare. But that doesn’t really matter in the eyes of the law, or so it seems. Maybe the RTA will get a victory here but will that get United to stop this practice? I can’t imagine it will. There’s so much money on the table that worst case, United just builds a bigger fuel subsidiary out in Sycamore so that it has more of a presence.

I can understand why the RTA wants this to change, but it seems like the best way to do that is to get the tax code altered. Then again, I’m sure that this case will go a lot deeper than I did in my research. We could always be surprised.

57 Responses to United and American Fuel Buying Policies Face a Legal Challenge

  1. Gary Leff says:

    “This looks shady” but so does extracting an extra $300 million from airlines at O’Hare, no? Rather, that’s extortion. So this doesn’t seem all that shady by comparison.

    • Sean S. says:

      So taxation=extortion? Fuel taxes are a pretty cut and dry form of taxation used to fund a variety of transit projects in addition to roads, depending on how the individual state breaks down its various transit trusts. While in many states fuel tax goes purely to road costs, clearly in Illinois it is also used to subsidize mass transit, which in a city the size of Chicago, is essential. If United wants to complain they can put their hub elsewhere where there is less taxation and less pax then Chicago. You can’t complain about the necessary funding to maintain a major city and then be surprised when your part of it comes due.

      • Brian says:

        There’s nothing shady about this structure. It’s merely the invisible hand of the market at work. People go to purchase goods where the goods are the least expensive. If Chicago so desperately needs the income, it should consider lowering taxes to entice the airlines back into the city to purchase fuel.

        • Or having state governments close loopholes. I’m not sure about IL, but WA’s tax structure is a set of loopholes…

          Governments have been amazingly outfoxed by corporate lawyers..

      • DS says:

        Why do airline passengers need to “subsidize” Chicago’s mass transit system? The people using the mass transit system should pay for it. Here’s an idea, why don’t you “subsidize” my vacation budget?

        • Jim M says:

          100% correct. Why are municipalties so dependent on rental car tax, hotel tax, etc. so fund essential services that travelers never use?? Its taxation without represnetation and its bull. Raise taxes on either goods sold or income produced. Don’t just stick it to the traveling public (who use little services and dump a lot of cash in a town/city/state).

          • DS says:

            Jim, in a lot of cases (including here at DFW) it’s to fund giant sports arenas / stadiums into which most travelers never step foot.

        • Sean S. says:

          Why do we have income taxes? Or any tax thats not specifically earmarked for every little thing? Because that would turn into a hilariously overwrought mess. Can you imagine the nickel and dime type scenario your nightmare world of use taxes would create? And trust me, if you actually had to pay for the true cost of your vacation, you would be unable to take it, unless of course you have a problem with the infrastructure, agencies, and other attendant services paid for by those pesky non-specific taxes that allow you to fly and travel on one of the worlds most advanced transportation infrastructure.

          • DS says:

            Good question Sean. If you go back in history the income tax was instituted for one purpose, to fund a war. Of course now it has metastasized into a giant slush fund covering who knows what. All the infrastructure, and agencies that make up the air travel system are paid for by passenger fees, departure taxes, landing fees, concession rents, etc. so I’m not sure who you think is subsidizing my vacation.

            I get your point about it being unwieldy to have use taxes for everything but the problem is that we do have specific user fees (i.e., metro fares) in addition to the broad-based taxes (income and sales), and there is no transparency or accountability in broad-based taxes. Your example of having other taxes subsidize the RTA shows this lack of accountability.

            I also suspect that there are specific portions of the Cook County tax structure that are designated for the RTA (in our area it’s 1% of the total sales tax rate) so they should raise that portion of the taxes if it isn’t enough to fully support the system instead of depending on some other bucket. Yes, I can imagine a Utopian world of transparency and accountability created by use based taxation.

    • While few passengers use transit to get to airports, many who work at airports use transit to get to work. That’s its real importance to airlines. What United and American are doing is probably legal. The laws will probably be changed if the RTA loses.

  2. D-ROCK says:

    This is all going to depend on the judge and what law “biases” he has. United is going to hope that he is biased to the “plain meaning” or “letter” of the law, while the RTA is hoping him to interpret by the “spirit” or “intent” of the law. Unless there’s specific legal precedent from an IL appellate court, I see this being tied up in the legal system for a while (due to the issues and amount of money involved). (Hey Business Law in the MBA program seems to be good for something!)

  3. MeanMeosh says:

    Ultimately, this is yet another example of the games that get played in a complicated and inefficient tax system. Chicago, Cook County, and the RTA see a source of “free” money to fund programs they can’t afford. The airlines finally had enough and found a team of accountants and lawyers to come up with a (seemingly) legal loophole to keep the money for themselves. This will probably go all the way to the Illinois Supreme Court, and if the RTA loses, you’ll probably see a boatload of pressure on the Illinois legislature to change the law, which I suspect will ultimately happen.

    • Sean S. says:

      “Free” money? Since when does tax evasion/aggressive tax avoidance mean that governing bodies are going after “free” money? To fund programs they can’t afford? Well they could afford it if the corporations in question paid their due!

      This sort of circular logic is maddening. Government agencies, due to a combination of huge loopholes and aggressive tax avoidance, are often short-changed necessary funding, and then when they continue to attempt to expand and provide necessary servies (such as the RTA and its mass transit systems) people become apopolectic that they seek funds to do so.

      • DS says:

        Sean, I’m betting that you agree that all of my income that the government so benevolently allows me to keep is a “tax expense” to them? In other words, all of our money really belongs to the government so any tax they concoct is justified, right?

        • Sean S. says:

          Hilarious, but no. Taxation is a fair price to pay for a society that isn’t Somalia. Unless of course you think you can make “your money” without the accoutrements that our collective taxes pay for. I would love to see you, in whatever line of work you do, wake up tomorrow and do your job or make your money without relying upon a single tax funded or subsidized service or infrastructure.

          • DS says:

            Sean, I never said all taxes were unjustified and I understand that the people who use infrastructure must pay for it. My objection is to your implication that all government spending is justified and therefore every person and company should “pay their due” whether or not they had a vote in said tax implementation. The system I prefer engenders transparency and accountability, and ultimately inefficiency, whereas the system you seem to favor breeds the opposite.

          • DS says:

            inefficiency -> efficiency

      • MeanMeosh says:

        Sean – I can see you subscribe to the Democratic/Progressive theory that government spending is inherently good, and the problem is with all those evil rich guys and big corporations who don’t pay their fair share. I won’t argue with you, as we clearly have diametrically opposing views on the role of government and whether we have a spending vs. revenue problem, and nothing I say will change your mind on the subject (or vice versa).

        However, what you say exactly demonstrates the point I was trying to make. I have to imagine that way back when, the state of Illinois set an aviation fuel tax. At some point along the way, Cook County/Chicago/the RTA decided they needed more revenue to fund the government programs they wanted to offer, and tacked on an additional levy (I might add, stuff like this is a clever trick used by dishonest politicians in both parties to tell the local voters that they’re providing social services “without raising taxes” – but I digress). DeKalb County apparently decided not to tack on anything to the fuel tax in that county. Some enterprising accountant or lawyer at UA/AA saw a loophole and decided to exploit it. And that is the problem – in a free society, if you want to raise taxes or fees with the idea that big, bad United Airlines needs to “pay its fair share”, UA (or any taxpayer) can decide they’re not getting value for their tax money, and take their business elsewhere. People move, or exploit legal loopholes. Don’t like it? Call your state representative or senator and ask them to change the law, which is what I suspect is going to happen eventually anyway. But then don’t be surprised when the airlines come up with something equally creative to get around it.

        And by the way, what UA/AA are doing in this case isn’t “evasion”. We can argue about the propriety of using loopholes, but they are legal means to reduce your tax liability. Evasion would be something like not paying use tax on all the stuff you buy online, or from Wisconsin or Indiana, because you are breaking the law when you don’t – and I’m sure you ALWAYS pay your use tax on those purchases, right?

        • MeanMeosh, its not even an aviation fuel tax. Its a plain ‘ol simple sales tax. It just also applies to aviation fuel. If anything the people of Chicago as a whole probably want their transit system, and would like for it to be properly funded.

          I know that the people of Seattle like their transit system and would like for it to be funded even more. The city pays for additional transportation above and beyond what the county is able to operate.

  4. I dont know about what the law exactly says. However, I have to imagine that “delivery” is the most important thing. As long as delivery is at ORD, I think they will likely face the tax. Look at how many states now do that to you with online shopping. NY doesn’t care where you buy your stuff online, it will tax delivery to NY residents.

    I don’t blame UA/AA for playing the game as it stands, but the rules of the game will likely be changed

    • Matt Weber says:

      This is going to depend on whether it is a sales tax, or sales & Use tax. I haven’t read the statute, but many states require that you pay sales tax based upon where the product is used even if purchased elsewhere. In theory, most goods sold on the Internet across state lines are in fact be subject to local sales & use taxes. However the cost of enforcement makes actual enforcement rare. As I recall if you pay customs duties on personal goods entering in California, if you are a California resident, you can expect a bill in the mail from the State for the applicable use tax.

      • David M says:

        I don’t know about customs duties for items brought into the state from out of country, but there is a line on California’s income tax forms to pay the use tax for items purchased out of state and brought into the state, when California sales tax isn’t paid. They do credit, however, for sales taxes paid to other jurisdictions.

        If I order online from a business that operates within the state of California, the merchant collects the sales tax and nothing further needs to be done.

        If I go to Oregon (no sales tax) and buy something and bring it back, or order from a business that doesn’t operate in CA and doesn’t collect sales tax, then I pay use tax as part of my income tax return at the local sales tax rate of where I live.

        If I go to Hawaii and buy something and bring it back, and pay Hawaii’s lower sales tax rate on the item, then I pay the difference between that rate and my local rate as use tax on my income tax return.

    • CF says:

      Noah – The law very clearly states as I’ve noted above that the acceptance of the order is the most important factor. Read through the doc I linked to and you’ll see it says that delivery isn’t a primary factor.

  5. Can we get a quick mini-post on the ugly new AA livery?

  6. john says:

    I am think of starting StopAALiveryNow.net

  7. It may not look nice, but how many average people in America cross a state line to purchase a big ticket item because the next state has no or low sales tax? Is their home state trying to get tax money from them in court…no. It’s just part of doing things. They just need to change the tax code, but then again maybe for the state in the long run, the current tax code benefits the state somewhere else and UA/AA just found the small loop hole to help themselves.

    The news may now get other companies looking into the pratice and doing the same thing for their business.

    Don’t a lot of companies file bankruptcy in Delaware because it’s better for them to do it there then in other states? The RTA just needs to suck it up and go to the states lawmakers and not UA or AA.

    • Shane says:

      I think a better analogy of what is going on here would be if you went a furniture in Chicago/Cook County (or gas station or insert whatever example you want) and purchased furniture, but you paid the lower Sycamore sales tax because the phone line used for the credit card transaction had a Sycamore phone number assigned to it. Essentially United is routing phone calls and internet traffic through this office and calling it the place of purchase/delivery. I believe United will have to set up a real operation there in order to meet the letter of the law.

    • Illinois attempts to recapture lost sales tax revenue – a “use tax” on either form ST-44 or on line 23 of the IL 1040 state income tax returns.

    • Ron says:

      Several states (including Illinois) have a “use tax” which requires that for items bought out of state for use in the state, people pay to the state the difference between the state sales tax and the tax actually collected. States don’t typically go after individuals for small-ticket items carried of shipped over state lines, but the law is in the books and can be enforced when the state finds it worthwhile.

      I’ve never heard of a use tax at the local level, but that’s something Chicago might wish to consider.

      What’s more bothersome is the tax reimbursement. Did united go shopping around all the little cities in the area to see which would give it the biggest break?

      • Jason H says:

        I do remember back in the 1980′s a guy running for office in WA was found to be running afoul of the “use tax” of WA by buying his motorhome and cars in OR. I believe he dropped out of the race because of it. So the concept is there and probably should be better enforced by states/localities.

    • David, alot of companies file Bankruptcy in Delaware, because they’re incorporated in Delaware. They’re incorporated in Delaware since the corporate law there is very business friendly, and there is even a system of courts just for business.

      Bottom line: Delaware takes business very seriously.

  8. These kinds of tax considerations are why many companies are incorporated in the state of Delaware, whose tax laws are very corporate friendly.

    • It’s also why many people buy goods over the Internet to avoid state sales taxes.

    • max says:

      DesertGhost, they are a Delaware corporation. Being a Delaware corporation does not mean you are not liable for taxes in other states where you do business for transactions that take place in those states.

      • You missed my point. I was making the general statement that companies do many different things to avoid paying taxes of all kinds. Incorprating in Delaware is one of many tax avoiding strategies.

  9. Scott says:

    Here in California, it is a “sales and use tax,” so the tax is payable in the jurisdiction where the product is consumed. If I buy a jacket in Oregon (zero sales tax), I technically owe my 9.25% to the State of California and County of Los Angeles. If I buy a car in San Diego, I still pay the tax rate of the City and County where I register it. Not sure how Illinois law works but if it is a “sales and use” tax, then the folks in Chicago have a pretty good case.

  10. AND, as usual, our poor, struggling friends at UNITED are today AGAIN attempting to raise fares to increase their bottom line. They seem to be the leader in pushing for higher fares several times a year – EVERY YEAR. This is an airline that would train its flight attendents to pull gold out of the mouths of sleeping travelers, if their attorneys could find another loop hole in the law.

  11. A says:

    I know fully well this is NOT how things work in Cook County/Chicago but they should lower their taxes to be at parity with outlying counties. This would repatriate these taxes to Cook County and they would have more revune than before with the higher taxes. I know, I know, very Reganomics, but here’s just one example of a huge tax that is leaving their county. Others have already posted examples of minor purchases that are done all the time to avoid taxes.

    Simply stated, the higher you raise a tax the harder people will work at avoiding it. Perfect example of one here.

    • RAW says:

      Taken that to its logical extreme, they should reduce tax rate to 0%. Then they would get all economic activity. Obviously, that’s a spurrious argument. It’s also doing “Reaganomics” a disservice. That school put some thoughts into its arguments. Fact is that O’Hare sits in Cook County. The economics activity is tied to the airport. If Sycamore elects to build an maintain an international airport, there’s both a morally and legally sound case to be made to situate your fuel trading subsid in Sycamore. Let’s not hold out breath that Sycamore’s tax rate stays at 8% once they’re done building their airport…

  12. Alison says:

    Interesting occurrance. As many have commented before if it is legal then I don’t blame them, they are merely using to their advantage the laws and opportunities that are in place. What I would be interested to know is, of that $300 million United are saving, how has this worked in passing on any of these savings to their customer base? I am not seeing fares from United any cheaper than any of the other major airlines so is the customer getting any benefit?

    • BW says:

      How many businesses do you know of that when they come up with a way to save cost, they immediately think of how they can pass that cost savings on to the customer?

      • DS says:

        How many industries do you know that have lost as much money (all carriers combined) as the airline industry over its lifetime? Truth is that (some) airlines have only recently become profitable and aren’t thinking about how to give money back to their customers, nor should they be.

    • CF says:

      Alison – You act like United is somehow raking in outsize profits. The right way to look at this is – how much more would consumers pay if United had to pay the additional tax?

  13. RICH says:

    I know of at least seven businesses, I deal with moved out of Cook County and Illinois because of the ridiculously High Tax rate and Political impotence.

  14. Chicago Chris says:

    I personally have to commend UA and AA for finding this one out. I think it’s another example of overtaxing in the Chicago-area and as many have pointed out the higher you tax the harder people work to avoid it.

    This is no different than people working in Chicago living in Indiana to avoid high taxes, New Yorkers shopping in Jersey to avoid high sales tax or in a more extreme example, people setting up cheap holding companies in Montana to avoid paying vehicle or private aircraft sales tax (MT has no sales tax).

    Cities and states have to realize there is competition for business and taxation is something owners review before setting up shop. In this case, UA and AA already have established roots here and contribute a significant amount to the local economy however this proves they’ll do what they have to in order to maintain a competitive advantage.

    Some have questioned whether this is passed on to the customer. You’re not going to see a discount for sales tax savings on your ticket, but it gives the airline a competitive advantage to maybe fly a route it wouldn’t otherwise fly or perhaps buy an extra aircraft to increase frequency or even lower fares to compete with Spirit that’s entrenching ORD.

    • DS says:

      Exactly. The flip side is that both AA and UA have made huge investments at ORD and aren’t able to just pick up and move without incurring significant costs and business disruptions. Of course the local governments knows this and so has no qualms about treating those businesses (and ultimately their customers, many of whom are constituents of said government agencies) like piggy banks to fund / subsidize their program, worthy or not.

      Regarding “…but it gives the airline a competitive advantage to maybe fly a route it wouldn?t otherwise fly or perhaps buy an extra aircraft to increase frequency or even lower fares to compete with Spirit that?s entrenching ORD.” or in the case of airlines, it might allow them to just recoup their cost of capital which many haven’t done for years.

  15. Jim says:

    The state of Illinois needs to fix their law to make it taxed at the point of delivery rather than “acceptance”.

    What if a guy with a Blackberry “accepts” the fuel purchase while flying over the Pacific Ocean? Does that make it tax-free?

    The state should ensure that companies cannot play the cities off against each other.

    • CF says:

      Jim – I think the key is that point of acceptance is the most important factor because it’s still within the state of Illinois. If it goes outside the state, then I’m sure they have other ways of looking at where it should be taxed in the state.

    • Ron says:

      “The state should ensure that companies cannot play the cities off against each other.” — Yeah, like L.A. against Vernon, Industry and Commerce (the names of the cities tell you pretty much everything).

  16. Oliver says:

    So could they avoid the tax altogether by putting that office offshore, in a mailbox in the Cayman Islands?

    • Well.. there probably is a portion of the tax code that covers out of state purchases, which are then probably governed by where they’re delivered. I’m quite sure this tax hacking only applies intra-state..

  17. Dave says:

    I have to commend United and American for finding a way to save money as long as it proves to be legal. In an industry that is seriously hurting financially, working as economically as possible is a must. They are still paying their fair share of sales tax, user fees, rent, etc. to the airport and the surrounding area, so if they can find a way to save a little somewhere else, then why not?

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