iOne of the biggest expenses for club and fitness facilities year in and year out is the purchase of new equipment for its members. Beyond the actual expense of the equipment, sales tax must be paid on the equipment unless there is an applicable exemption available. Sales tax can run into the hundreds of thousands of dollars depending on the amount of equipment purchased.
Some club and gym facilities have taken the position that sales tax is not due on equipment purchases because of a “reselling” exemption. However, last month the Texas Court of Appeals ruled in Fitness Int’l LLC v. Hegar, Dkt. No. 03-15-00534-CV (Tex. Ct. App. 3rd Dist.)(June 16, 2016) that LA Fitness was indeed liable for $764,000 in sales tax on gym equipment such as treadmills and stationary bikes.
Case Background
LA Fitness, legally known as Fitness International LLC, sued the Texas Comptroller in 2014 to recover $764,000 it was ordered to pay after an audit found it underpaid sales taxes on everything from scales to shampoo. A trial judge found that some items — like shampoo — were “resold” and used by gym members, but most of the taxes remained in place, spurring the company to appeal.
On appeal, the Texas appeals court reviewed whether the health club’s purchases were exempt sales for resale. The lower court ruled that the resale exemption applied to the club’s purchases of towels, basketballs, and personal sanitation consumables (e.g., body wash, shampoo, and hand sanitizer). However, purchases of exercise machines, weight racks, scales, and promotional flyers were not considered purchases for resale.
The question before the appellate court was whether the taxpayer purchased the items at issue for the purpose of "reselling" or "transferring" them to its members. Members of LA Fitness testified that, because they paid membership dues, they "rented" the exercise equipment and that the equipment was repeatedly "transferred" from one member to another for short periods of time.
Longtime managers testified that “members are essentially paying a monthly rental fee” to use the equipment. Fitness trainers and other employees don’t actually use the gear to “perform” services, but to "provide" them, they testified, which is an important distinction under Texas tax law. The appellate court, however, disagreed with this position and determined that the witnesses’ testimony was at odds with the taxpayer’s operations and membership agreements.
According to the appellate court, the membership agreements could not reasonably be construed as leases or rental agreements, nor could the taxpayer’s making the equipment available to its members for use while at the gyms be construed as "transferring possession." The court concluded that the taxpayer merely provided access to and use of the exercise equipment under terms and conditions completely within its own discretion for a specified monthly fee. The court upheld the trial court’s determination that the taxpayer was not entitled to the resale exemption for the items at issue.
What Club and Gym Facilities Need to Know
In every state, certain types of items are exempt from sales tax or are taxed at lower rates. Certain types of sales transactions are exempt from sales tax, not because the item itself is nontaxable but because of some characteristic of either the buyer or the seller.
The general rule is that each retail sale of tangible personal property is presumed to be taxable. In other words, if you make retail sales, you generally must collect or pay sales tax with respect to each sale unless you can show that the sale was somehow exempt from tax. The most common sales tax exemption flows from the fact that sales taxes are assessed on retail sales, which are sales to the ultimate user or consumer of the item being sold. In other words, sales tax is due only on the final sale of the property. Accordingly, if you purchase items that you intend to resell prior to making any significant use of it, there is generally no tax due on your purchase.
The exemption usually continues as long as you do not make any use of an item being held for resale other than for display or demonstration purposes. If you do use the item for other business or personal purposes, you become liable for use tax on the item. Here, as part of its analysis the court defined key terms for the sale-for-resale exemption, including “transfer,” “possession,” and “sell,” which will likely be useful in future cases in determine whether the taxpayer is considered the end-user of the item or not.[1]
[1] LA Fitness compared patrons’ use of its fitness equipment to renting a bike to pedal around town or renting a pair of specialized shoes at a bowling alley. Even though patrons return the shoes, Texas tax authorities have still found that those transactions are tax-free “rentals,” and the gym argued the same standards should apply to their ab machines, ellipticals and other heavy equipment even if customers cannot take them home.
