17 February 2020 Ohio Board of Tax Appeals relies on federal income tax and accounting treatment in reversing assessment against captive automobile financing company In Hyundai Motor Finance Company,1 the Ohio Board of Tax Appeals (BTA) reversed an assessment by the Ohio Department of Taxation (Department) under the Commercial Activity Tax (CAT) against a captive automobile financing company. In its decision, the BTA considered whether the CAT applied to three categories of transactions: receipts from sales of retired leased vehicles, securitization transactions, and subvention and interest buy-down payments. The BTA applied federal income tax concepts even though it historically has not considered itself bound by such concepts when addressing CAT matters. The taxpayer, Hyundai Capital America (HCA), purchased leases from automobile dealers, along with the vehicles subject to those leases. During the lease term, or at its conclusion, a lessee could purchase the vehicle at a rate prescribed in the lease agreement. If a lessee did not purchase the vehicle, HCA either sold it at auction or to a dealer. Ohio Revised Code (ORC) Section 5751.01(F)(2)(c) excludes from gross receipts the receipts from the "sale, exchange, or other disposition of an asset described in Section 1221 or 1231 of the Internal Revenue Code … ." HCA relied on this exclusion in determining its taxable gross receipts in its CAT filings. The Department assessed these receipts, claiming that the leased vehicles were "dual-use property" under the Federal Court of Claims ruling in Recordak Corp.2 and IRS Revenue Ruling 80-37 and, as such, held that the underlying sales are not income from the sale of an IRC Section1231 asset. The BTA disagreed with the Department's analysis and held that the leased vehicles were "properly characterized [by HCA] as [IRC] Section 1231 assets" and were not dual-use purpose property. The fact that the vehicles were ultimately sold was not dispositive in the BTA's analysis. The BTA also focused on the facts that the vehicles were not included in HCA's inventory, they were subject to depreciation, and the nature of HCA's holding of the vehicles was not for simultaneous offering for sale or lease.3 As a captive automobile finance company, HCA provides financing by purchasing retail installment sales contracts (RISCs) and leases from dealers. HCA engages in securitization transactions with the purchased RISCs. HCA packages the RISCs to use as collateral to borrow funds through the issuance of notes backed by the RISCs. HCA transfers pools of RISCs to a wholly owned, bankruptcy-remote entity (i.e. an entity whose bankruptcy would have little to no effect on other group members), which transfers the pool of RISCs to a trust. The trust then issues notes that are backed by the RISCs and receive a fixed rate of interest. HCA receives the excess funds remaining from collections after the noteholders have been paid. The Department assessed the receipts from these transactions. HCA argued that any of the following ORC provisions should exclude the transactions from CAT:
The Department rejected HCA's contentions, finding that (1) the notes sold by HCA were ordinary assets under IRC Section 1221, (2) the notes were neither held for more than one year nor subject to the allowance for depreciation as required by IRC Section 1231, and (3) no amounts pertaining to the securitization transactions were previously reported as gross receipts. The BTA agreed with HCA that the RISCs' pool transfer transactions were secured financing transactions. The BTA also agreed with HCA's reliance on IRS Technical Advice Memorandum (TAM) 9839001, which concluded that similar transactions were secured financing transactions, and not sales, for federal income tax purposes. The BTA focused on the substance of the transactions and concluded that HCA was not selling assets, but "collateralizing assets to create cash flow — a loan." While the BTA found TAM 9839001 persuasive, it did not find that applying its reasoning led to "any wholesale adoption of federal income tax definitions for purposes of applying the CAT … " HCA receives certain payments for its role in special financing programs that allow RISCs and leases to be made to customers at below-market interest rates. Manufacturers make interest subvention payments to HCA to obtain HCA's participation in these financing programs. The manufacturers, in effect, reimbursed HCA for the difference between the interest rate HCA would have collected at the market rate and the below-market rate HCA collected from the subvented RISCs and leases. HCA treated these payments as excluded interest income under ORC Section 5751.01(F)(2)(a). The Department assessed the payments, characterizing them as rebates. The Department argued that there were no borrowing transactions from which interest could have accrued and HCA was, in effect, receiving someone else's interest. The Department also cited HCA's identification of the payments as "subsidy amounts" in its financial statements in support of its position. The BTA disagreed with the Department, citing testimony provided by HCA's expert witnesses that the payments were treated as interest for both federal income tax purposes and under Generally Accepted Accounting Principles (GAAP). Even though the BTA acknowledged that the "federal treatment is not necessarily controlling," it nonetheless found the authorities and testimony presented by HCA persuasive. The Department historically has not considered itself bound to federal income tax concepts despite references in the CAT statute to terms defined in federal tax law.5 The BTA's decision does not represent a "wholesale adoption" of the IRC, or GAAP concepts, in computing CAT gross receipts. However, it is a welcome development in that taxpayers' reliance on federal income tax and GAAP treatment of their transactions may be considered relevant by the BTA. Taxpayers affected by this decision that have been assessed in past audits may consider pursuing refund claims. The statute of limitations for CAT is four years from the payment of the tax. It is unknown whether the Department will appeal this decision. EY will continue to monitor developments in this area.
3 The BTA noted that the buy-out options under which customers would purchase the vehicles were part of the leases originated by the dealers. 4 HCA filed as part of a CAT combined group. A "combined" taxpayer does not eliminate intercompany, or intermember, receipts. Had HCA been part of a consolidated elected taxpayer group, the Department noted, the receipts from the securitization transactions, as well as the subvention receipts, would have been eliminated in computing CAT gross receipts. Document ID: 2020-0387 | ||||
