Provider of Go-Kart Racing Subject to California Sales Tax as Lessor of Property  

By:  Tracey Stewart, SALT Associate

At a glance

• The main takeaway: A California tax appeals decision illustrates how it’s not always clear when a business is providing a nontaxable service or engaging in a taxable lease of personal property. 
• Assess the impact: Businesses who provide possession of a tangible property in connection with a service must consider whether the transaction will be treated as a taxable lease of property.
• Take the next step: Need assistance determining your transaction types? Aprio’s State and Local Tax (SALT) team can help your business understand its sales tax obligations, so you do not incur any unexpected tax liabilities and penalties.  

Schedule a free consultation today to learn more!

The full story:

In last month’s SALT Newsletter, we wrote an article about a bike/kayak tour operator that was found liable for California sales tax since it was determined that the operator was leasing bikes/kayaks as opposed to proving a service (i.e., the tour). This month we are addressing another California Office of Tax Appeals (OTA) decision addressing the same issue.¹

Background on the case

In this case, the taxpayer, K1 Speed, Inc. (K1 or the Taxpayer), offered a variety of packages for indoor go-kart racing. These packages are grouped into three main categories — single standard arrive and drive races, discounted multi-race packages for individuals and group packages. Prices range from $20 for single races to up to $100 per person for group packages. K1 also charged a mandatory $5.95 license fee, which is paid by each participant and is good for one year. The license fee included the use of a helmet and a head sock during races, online access to race scores and racing history, and a monthly newsletter with special offers.

When K1 purchased the go-karts from its vendor in Italy, it did not pay California use tax. Additionally, it did not collect and remit tax to California on any of its receipts from go-kart racing and licensing fees.

The ruling explained

For sales and use tax purposes, states typically equate a sale with a lease or rental. Thus, when a lessee leases property that is taxable, the lessor will treat each lease payment as a taxable transaction and will collect and remit sales tax on the rental price. In addition, when the lessor purchases the property from its vendor for the purpose of leasing it to customers, it is permitted to provide its vendor with a resale certificate.  

California generally follows these rules, but with a slight wrinkle. The state exempts leases of “tangible property leased in substantially the same form as acquired by the lessor” when the lessor paid sales tax measured by the purchase price of the property.² Essentially, this provision allows a taxpayer to choose whether to pay the sales tax on its purchase of the property or to collect and remit the sales tax on the rental revenue.

In addition, California excludes a transaction from being considered a “lease” if it meets three conditions: 

1. The property is used on the grantor’s premises, 
2. The charge is for less than $20 and 
3. The use is for less than a 24-hour period.³

First, the Taxpayer argued that it met the lease exclusion since it charges less than $20 per race. However, California’s OTA, found these arguments to be unpersuasive. Specifically, regarding the multi-race packages, the OTA explained that the total price is the relevant data point, not a “per-race” price, based on an example in the regulations where a customer rented multiple tools. While the specific rental rate for each tool was under $20, the lease did not meet the exclusion because the aggregate rental amount exceeded $20. The OTA also noted that the taxable amount of the go-kart packages must include the license fee as it is a payment required by the Taxpayer.

Next, K1 argued that the go-kart racing packages constitutes an amusement service and not a lease of tangible personal property since the true object of the purchase is to participate in races and not specifically the possession of the go-karts themselves. 

The OTA disagreed again, explaining that the test here is whether possession and control of the property in question was transferred to the lessee, as distinguished from situations where the lessor retains possession of and operates the property under a service agreement. In this case, the customer had sufficient control over the operation of the go-karts since it primarily controlled speed and direction.  The lessor’s control over the go-karts was limited to the following: 

• Programming go-karts to a variety of pre-set speeds to accommodate various skill levels; 
• Automatically reducing the go-kart speed while in the pit area; and 
• Remotely turning off the go-karts in the case of emergencies. 

Based on this, the OTA concluded that K1 was liable for sales tax as a lessor of tangible personal property.

The bottom line

Businesses involved in providing possession of tangible property in connection with a service or for a particular purpose should consider whether the transaction will be treated as a taxable lease of property.  

Aprio’s SALT team has experience with these types of transactions and can assist your business to determine its sales tax obligations so that you do not incur any unexpected tax liabilities and penalties. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter. 

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¹ In the Matter of the Appeal of K1 Speed, Inc., 2023-OTA-294, OTA Case No. 20015720, December 19, 2022.

² Cal. Rev. & Tax Code §§ 6006(g)(5) and 6010(e)(5); Cal. Code Regs., tit. 18, § 1660(b)(1)(E).

³ Cal. Code Regs., tit. 18, § 1660(e)(1).