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

etained by the finance company is current expense to the dealership. Due to the front-loading
of interest expense in this scenario, back-end distribution payments would be unlikely since
the repayment of the loan principal (the up-front cash advance) is protracted.
It is anticipated that few, if any, of these transactions are likely to be true loans, under the terms
of the arrangements between the dealerships and the finance companies.
Treatment of a Sale
If the transfer of the installment contract to the finance company is deemed to be a sale by the
dealership, the amount realized on the sale is compared to the dealer’s basis in the contract to
determine the dealer’s gain or loss. Per IRC section 1001(b), and as amplified in a number of
TAMs, the amount realized from the sale is the cash plus the fair market value of any other
property received. This formula appears simple, but is actually difficult to apply. It is made more
complex by the impact of IRC section 483, which requires deferred payments to be
recharacterized in part as a payment of unstated interest.
The dealer receives cash in the form of advance payments. That is easy to quantify. However,
the dealer also receives the right to back-end distributions, which pursuant to IRC section 1001(b)
is "other property received." The fair market value of that right is difficult to determine, since
these contracts relate to non-prime and sub-prime customers who do not have good credit and the
back-end distribution payments are upon the recovery of the up-front cash advances, collection
fees and out-of-pocket costs. Thus, it is difficult to determine the amount realized from the sale
of the installment contract by the dealer to the finance company.
There is significant debate over the appropriate valuation of the amount realized upon the sale of
the contracts. Some argue that the full face value of the installment contract should be reported in
the year of the transfer. Others maintain that although some back-end payments may be made,
they will be de minimis and almost never match the remaining balance in the contract after cash
advances and fixed percentage collection fees. Yet others insist that the possibility of receiving
any back-end distributions is so remote it is almost moot, and the fair market value of the right to
receive the back-end distributions is zero.
If the dealership primarily does business with customers having very poor credit and/or there is no
historical receipt of back-end distributions, it MAY be reasonable to assign a $0 fair market value
to potential back-end payments.
If the dealership does have a history of receiving back-end distributions, these amounts should be
determined from the monthly statements received from the finance company. A rolling average or
some other type of methodology may be utilized to determine the fair market value of sales
occurring in the tax years under examination and for the future.
The amount of back-end distribution recharacterized as unstated interest may also be difficult to
determine. The regulation requires this amount to be determined by discounting the back-end
distribution at the applicable federal rate from the time the applicable installment contract was
sold until the back-end distribution is made. The regulations do not explain how to apply this rule
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