It is common for groups of affiliate companies to record transactions within the group by “book entry” rather than actual transfers of cash. It is also common for one member of an affiliate group to undertake an activity that benefits all of the members of the group without necessarily passing on the cost of such activity. Because these inter-affiliate transactions may have no economic effect on the ultimate owner (as moving money from one’s “left pocket” to one’s “right pocket” would not), oftentimes taxpayers approach these transactions with a degree of casualness. However, a Tax Appeals Tribunal decision from earlier this year, CLM Associates, LLC, DTA No. 826735 (N.Y. Tax App. Trib., Feb. 12, 2018), is a reminder that form matters in such transactions, and that taxpayers should consider the risk that consideration may be deemed to have been paid between affiliates.
The case concerned “an automotive sales and service group” known as “Premier.” Premier had 12 wholly owned subsidiaries: “CLM” (the petitioner in the case) and 11 car dealerships. CLM was not a dealership, but, rather the “administrative” entity for the Premier group, providing “accounting, [HR], record retention, [IT,] and marketing” functions for all other members of the group. All 12 subsidiaries were disregarded as entities separate from Premier, and, therefore all of the entities were considered a single taxpayer for Federal income tax purposes. As a result, transactions between any of the group members are ignored for Federal income tax purposes.
As is common practice in the industry, the dealerships would permit customers to borrow “loaner” cars for use while the customers’ cars were undergoing repairs. To simplify management of the loaners and to deal with potential liability for the group attributable to accidents involving the loaners, Premier determined that it was best for CLM to have title to and carry insurance for all of the dealerships’ loaners. Under this arrangement, CLM and the lending dealership were jointly and severally liable for the “master floor plan lines of credit for the loaners,” the costs of which CLM passed through to the dealerships. Similarly, CLM and the dealerships agreed to be jointly and severally liable for any “losses stemming from claims for negligent deaths or injuries” in connection with the loaners. No such losses occurred during the period at issue.
To reflect the transfers of title to the loaners from the dealerships, the transferring dealership issued a bill of sale to CLM, sometimes showing sales tax. Premier would add the loaner to the books of CLM and show an amount payable to the transferring dealership. Likewise, the loaner would be taken off the books of the transferring dealership and show an amount receivable from CLM. When a loaner was later sold (as a used car), CLM and the dealership would “reverse” the bookkeeping described above. No cash was ever transferred between CLM and the dealerships and no sales tax was collected in connection with the transfers.
The Tribunal held that CLM owed sales tax with respect to the loaners that it acquired from the dealerships.
Under N.Y. Tax Law § 1101(b)(4)(i) and 1105(a) there is generally imposed a tax on the “ receipts” from “a sale of tangible personal property to any person for any purpose.” N.Y. Tax Law § 1101(b)(5) provides that a “sale” is “[a]ny transfer of title or possession or both … for a consideration.” 20 N.Y.C.R.R. § 526.7(b) defines consideration to include, among other things, “the rendering of any service” and “assumption of liabilities … or any other charge that a purchaser … is required to pay [by virtue of acquiring the property].”
Although cars held by a dealer as inventory are generally exempt from sales tax when purchased by reason of the resale exemption (under N.Y. Tax Law § 1105(a) and § 1101(b)(4)(i)), loaner cars are used in the dealer’s trade or business and therefore are taxable when purchased. Consequently, the Tribunal first determined that the transfers of the loaners from the dealerships to CLM constituted retail sales due to the form that the parties has followed, including issuing bills of sale and Department of Motor Vehicle forms and making inventory book entries. The Tribunal was unpersuaded by CLM’s argument that, despite these formalities, the transfers were merely “nominal.”
Second, the Tribunal found that, contrary to CLM’s argument that these were transfers for “no consideration” (and, therefore, that no tax was due) there was in fact ample consideration from CLM to the dealerships. In addition to the regulation referenced above, the Tribunal looked to a previous Tribunal decision, Hygrade Casket Corp., DTA No. 809681 (N.Y. Tax App. Trib., Dec. 16, 1993), confirmed 212 A.D.2d 843 (3d Dep’t 1995), for a broad definition of “consideration.” Hygrade concerned a company (“SCI”) that acquired caskets for sale in its affiliates’ funeral homes. When SCI transferred a casket to a funeral home (for sale to a customer), a book entry was made for the cost of the casket, and sales tax was paid. However, at the end of each year, certain administrative costs of SCI were allocated to the funeral homes (also by book entries). The Tribunal in Hygrade held that the additional allocation of administrative costs were additional consideration for the caskets, which were subject to sales tax.
The Tribunal in CLM found that “spreading liability and the benefit of centralized loaner management” constituted consideration from CLM to the dealerships. Further, the Tribunal stated that “[i]t is of no consequence that petitioner was never held liable for any loss resulting from a claim against one of its related dealerships.” The Tribunal in CLM goes even further than the Tribunal in Hygrade in pushing the bounds of what constitutes consideration. Whereas the costs allocated by SCI to the funeral homes in Hygrade were actually incurred, the assumed liabilities in CLM were contingent and never actually became payable. As recited by the Tribunal, no amounts had to be paid due to the death or injury of (or caused by) a customer who borrowed a loaner. Further, it is hard to measure the value of the utility of “the benefit of centralized loaner management.” While the Tribunal details what constitutes consideration, it does not go into any detail regarding how one actually computes such consideration and it appears that consideration was considered to be equal to the cost of the vehicles.
It is not clear what else Premier could have done to achieve its business goals of spreading liability and centralizing loaner management without incurring sales tax. It is possible the cars could have remained with the dealers and for the group collectively had entered into a joint liability agreement. It is also possible that the cars could have been distributed to Premier (the parent entity) and then contributed by Premier to the lower tier entities and such transactions may have qualified for the sales tax exemption for distributions from and contributions to business entities under N.Y. Tax Law § 1101(b)(4)(iv).
Nevertheless, this case provides general considerations to keep in mind when planning transfers of personal property among affiliated entities.
First, it is important to keep in mind that income tax and sales tax are separate regimes, and that a “nothing” for income tax purposes may be a “something” for sales tax purposes. In CLM, all of the transactions between CLM and the dealerships did not exist for income tax purposes; however they gave rise to sales tax liability.
Second, as evidenced by CLM, form matters. Presumably to ensure that it achieved its business goal of spreading liability among entities, Premier engaged in kind of record-keeping behavior that we generally think of as “good”: issuing bills of sale and keeping accounting records reflective of the transfer. While this form was part of the taxpayer’s undoing in CLM, a taxpayer can often engage in “self-help” by structuring a transaction to formally achieve the tax goal desired. (Taxing authorities may recharacterize a transaction when its substance varies too greatly from its form, but that is a topic for another column.)
Third, a taxpayer engaging in a transaction with an affiliate may be in the best position by setting a reasonable price for a purchase, properly documenting the purchase, and paying the sales tax due. In the event that the taxpayer, like SCI in Hygrade, engages in additional inter-affiliate “charge backs,” the taxpayer would be wise to document what those are for, and to evidence that they are unrelated to the sale giving rise to sales tax. Given the broad view of consideration that the Tribunal has taken in CLM, this may be the hardest aspect to plan for.
Joseph Lipari is a partner and Aaron S. Gaynor is an associate at the law firm of Roberts & Holland.