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

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

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19.10.2014 Views

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 19-19

when the back-end distributions are made on a pool of installment contracts. Similarly, the portion of a back-end distribution that is not unstated interest is a recovery of basis received from the sale of the installment contract. When the back-end distributions are made on a pool of installment contracts, it is not clear to which installment contract the recovered basis should be attributed. The following facts and circumstances pertinent to each dealer should be considered when determining the value of the right to back-end distribution payments includable in the amount realized on the sale: 1. Has the dealer received any back-end distribution payments? 2. What is the amount of back-end distribution payments received? 3. How long has the dealer been involved in the program with the finance company? 4. Has the dealer capped any pools of contracts? 5. Are the pools collateralized? 6. Has the dealer’s involvement in the program with the finance company been terminated? 7. Has the finance company changed the dealer’s collection rating since joining the program? 8. What is the historical rate of default for the dealer’s customer base? 9. Has the current customer base changed? 10. How does the taxpayer value the right to back-end distribution payments? 11. Have the terms of the servicing agreement between the dealer and the finance company changed? This list is not all inclusive. The examiner will need to probe further to develop the facts in each case. Audit Techniques 1. Initial Interview At the initial interview, ask the taxpayer if any retail installment agreements for the customer purchases of vehicles are transferred to any unrelated finance companies. The taxpayer may use more than one finance company or switch from one finance company to another. Almost any finance institution may be involved with non-prime or sub-prime paper, including major banks and financing arms of major vehicle manufacturers. 19-20

when the back-end distributions are made on a pool of installment contracts. Similarly, the<br />

portion of a back-end distribution that is not unstated interest is a recovery of basis received from<br />

the sale of the installment contract. When the back-end distributions are made on a pool of<br />

installment contracts, it is not clear to which installment contract the recovered basis should be<br />

attributed.<br />

The following facts and circumstances pertinent to each dealer should be considered when<br />

determining the value of the right to back-end distribution payments includable in the amount<br />

realized on the sale:<br />

1. Has the dealer received any back-end distribution payments?<br />

2. What is the amount of back-end distribution payments received?<br />

3. How long has the dealer been involved in the program with the finance company?<br />

4. Has the dealer capped any pools of contracts?<br />

5. Are the pools collateralized?<br />

6. Has the dealer’s involvement in the program with the finance company been terminated?<br />

7. Has the finance company changed the dealer’s collection rating since joining the program?<br />

8. What is the historical rate of default for the dealer’s customer base?<br />

9. Has the current customer base changed?<br />

10. How does the taxpayer value the right to back-end distribution payments?<br />

11. Have the terms of the servicing agreement between the dealer and the finance company<br />

changed?<br />

This list is not all inclusive. The examiner will need to probe further to develop the facts in each<br />

case.<br />

<strong>Audit</strong> <strong>Technique</strong>s<br />

1. Initial Interview<br />

At the initial interview, ask the taxpayer if any retail installment agreements for the customer<br />

purchases of vehicles are transferred to any unrelated finance companies. The taxpayer may<br />

use more than one finance company or switch from one finance company to another. Almost<br />

any finance institution may be involved with non-prime or sub-prime paper, including major<br />

banks and financing arms of major vehicle manufacturers.<br />

19-20

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