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

It appears clear that transactions associated with non-prime and sub-prime financing must be
reported on an accrual basis. However, it is important to understand all facets of the transactions
in order to properly account for them.
Two separate transactions occur. First, the vehicle is sold to the customer. Second, the
installment contract is transferred from the dealer to the finance company.
The Tax Reform Act of 1986 repealed the installment method of reporting for dealers in personal
property. Thus, the initial sale of the vehicle by the dealer to the customer must be reported in
full the year the sale occurred. The total sales price of the vehicle must be reported even if an
Installment agreement was executed. The dealership’s basis in the vehicle offsets the total sales
price to determine the gain or loss on the sale.
To determine the appropriate tax treatment of the second transaction, it must be determined if the
transfer of the installment contract to the finance company by the dealer is a sale or an assignment
of the contract or even a loan to the finance company. No matter what the character or tax
treatment of the second transaction, however, the initial sale of the vehicle to the customer must
be reported in full in the year of the sale.
Sale, Assignment, Loan or Pledge to Collateralize a Loan
Whether the transfer of an installment contract is a sale, assignment, loan or pledge to
collateralize a loan depends on the facts and circumstances. Many of the servicing agreements or
other arrangements between the dealerships and finance companies are worded in form like they
are assignments or loans. However, a close review of the provisions of these agreements often
reveal that in substance they are sales.
The following factors tend to indicate the transfer is a sale. The number of factors applicable to a
particular dealership, or the relative importance of one factor to another, must be considered in
determining whether a sale has occurred, or some other type of transaction:
1. The terms of the transfer are nonrecourse; i.e. the dealership is not responsible for payment
of any defaulted notes or payments (often after 90 days). This is an important distinction
from full recourse cases like Hansen v. Commissioner, 360 US 446.
2. The transfer gives the finance company unilateral power to dispose of the note
3. The dealership’s security interest in the financed vehicle was transferred to the finance
company.
4. The finance company receives all files and paperwork related to the customer note.
5. The finance company handles all collections and other administrative actions on the customer
note.
19-17