Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board

the IRC, tax may be computed without regard to that transaction.
Can Your Related Finance Company Meet the Test?
There are several valid business purposes for establishing Related Finance Companies (RFC). An
RFC enables dealers to sell cars to customers with marginal or non-existent credit. Individuals
who can afford car payments but who have poor credit history were an untapped market prior to
Buy-Here Pay-Here (BHPH) lots and RFCs.
An effective RFC removes the collection burden from the dealership, allowing dealership
personnel to focus on what they do best, sell cars.
Some RFCs are so well managed that discount rates can be lower than those offered by a third
party. The RFC may be more familiar with the contracts it purchases due to its close relationship
with the dealership and the dealership may be more selective when it offers credit. An RFC may
allow a dealership to free itself from any restrictive regulatory and licensing requirements to
distance itself from adverse publicity resulting from collection activity.
Even when there are valid business purposes for forming an RFC, care must be taken to perfect
the form and operations of the business. The RFC must be operated as a separate entity from the
dealership and in a business-like manner. Among other things, an RFC should have separate
books, a written contract with the dealership(s), its own location and employees (Additional items
are included in the checksheet at the end of this section).
It is clear that some BHPH lots and RFCs are legitimate and were established for valid business
purposes. The MSSP Independent Used Car Audit Technique Guide (ATG) contains an excellent
section on related finance companies. It was prepared with the assistance of the National
Association of Independent Auto Dealers (NAIA) and includes many characteristics of a valid
RFC.
If the finance company exists only in form and the transactions lack economic substance, the
losses on the sale of receivables to the RFC should be disallowed to the dealership. IRC
section 482 also permits the reallocation of income and expenses between related taxpayers to
clearly reflect income. As the Supreme Court ruled in Lucas v. Earl, 281 U.S. 111 (1930), the
income is taxable to the earner.
The following checksheet can provide a quick test of the validity of your BHPH lot and RFC. If
the answers to the questions below are no, the issue probably merits further analysis.
16-3