Ohio rules auto finance firm exempt from CA tax


Ying Lee
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Christopher J. Garman
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Jamie C. Yesnowitz
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Lori Stolly
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Patrick Skeehan
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On Feb. 6, 2020, the Ohio Board of Tax Appeals (BTA) reversed an Ohio Tax Commissioner decision and held that an automobile finance company taxpayer did not owe Ohio commercial activity tax (CAT) on three separate streams of receipts.1 Specifically, the BTA determined that receipts from sales of retired leased vehicles, receipts from securitization transactions, and subvention payments were exempt from CAT.

Ohio CAT The CAT is a privilege tax which generally applies to taxable gross receipts in Ohio received on and after July 1, 2005.2 The base of the CAT is gross receipts, defined as the total amount realized, without deduction for the cost of goods sold or other expenses incurred, from activities that contribute to the production of gross income.3 Several statutory exemptions are available.4 For taxpayer groups meeting at least a 50% common ownership requirement, a combined return including all members with Ohio nexus must be filed.5 Intercompany gross receipts remain subject to tax on combined returns.6 However, Ohio also provides an election to file CAT returns as a consolidated elected taxpayer group is available.7 For consolidated elected taxpayer groups, all members with common ownership must be included, but receipts from transactions between members are not subject to the CAT.8

Background The taxpayer, Hyundai Capital America (HCA), serves as a captive automobile finance company and provides certain financing services to a related company manufacturer and its dealers. Generally, HCA provides indirect retail vehicle loan and lease financing by purchasing retail installment sale contracts (RISCs) from dealers, direct wholesale financing by financing dealers’ purchases of inventory, and loans to dealers for their facilities and working capital requirements. During 2011, Ohio conducted an audit of HCA, and issued an assessment for CAT liability related to: (i) receipts from sales of retired leased vehicles; (ii) receipts from securitization transactions; and (iii) subvention payments. HCA challenged the entire assessment, which the Tax Commissioner affirmed.

Ohio BTA decision In appealing to the BTA, HCA asserted several constitutional arguments regarding the assessment. After acknowledging the taxpayer’s burden of proof, the BTA recused itself from considering these issues due to its lack of authority to resolve constitutional challenges. Instead, the BTA focused on the CAT taxability of the three income streams at issue, specifically the applicability of several potential exclusions from the CAT definition of “gross receipts.”

Receipts from sales of retired leased vehicles When HCA purchases leases from automobile dealers, it concurrently obtains the corresponding legal title to the underlying collateral (i.e., the vehicles). Pursuant to terms of the underlying leases, each lessee typically has the option to purchase the vehicle at a set rate. If this option is not exercised, HCA sells the retired vehicle, generating receipts. The Tax Commissioner assessed tax on the gross receipts from these sales to Ohio customers.

HCA claimed that the vehicles qualified as IRC Section 1221 or 1231 assets excludible from the CAT definition of gross receipts.9 While the Tax Commissioner acknowledged the existence of the exclusion, he proposed that the vehicles were “dual purpose property” held simultaneously for sale or lease, and that receipts from their sales were not income from the sale of an IRC Section 1231 asset.10 In support of its position, HCA cited rulings in Philber11 and Mafco,12 in which federal courts held that leased property was “available for purchase” based on the purpose for which the property was held, and therefore entitled to the benefits that such classification conveys, including classification as IRC Section 1231 assets. Further, HCA noted that the vehicles were depreciated under IRC Section 167 and not includable in its inventory. Finding this evidence compelling, the BTA agreed that the vehicles were properly characterized as Section 1231 assets and not dual-purpose property, highlighting “[t]he fact that assets are ultimately disposed of by sale is not necessarily decisive.”

Receipts from securitization transactions Following purchases of RISCs from dealers, HCA packages them for use as collateral to borrow funds. Specifically, the instruments are transferred to a related party, which then issues notes backed by the RISCs. In return, HCA receives the excess funds remaining from collections after the noteholders have been paid (i.e., the residual profit on the lease, after liquidation of collateral). The Tax Commissioner found the gross receipts from these transactions to be subject to the CAT and sitused to Ohio based on the location where the loan was originated. HCA argued that such receipts qualified for exclusion from the CAT. Specifically, HCA asserted that the receipts were excludible as: (i) interest income;13 (ii) proceeds from repayment, maturity, or redemption of the principal of a loan;14 (iii) the principal amount received under a repurchase agreement or on account of a loan transaction;15 (iv) receipts from the sale of an IRC Section 1221 or 1231 asset;16 or (v) amounts realized from the sale of an account receivable.17 The Commissioner acknowledged the exclusions, but rejected each contention based on the general conclusion that no loan or borrowing occurred. Further, he noted that the amounts at issue could have been excluded as intercompany payments if HCA’s combined taxpayer group had elected to file its CAT returns on a consolidated basis.

The BTA ultimately focused its opinion on the potential characterization of the receipts as interest income. For federal income tax purposes, HCA characterized the RISC pool transfer transactions as secured financings, which are not treated as sales.18 Although not dispositive, the BTA found the federal treatment persuasive given the similar facts at issue. In its analysis, the BTA primarily focused on the substance of the transactions and found it clear that HCA was not selling assets, but rather collateralizing them to create cash flow. Therefore, the BTA determined that receipts from the RISC transactions were properly characterized as financings, and excluded from CAT under Ohio Rev. Code Ann. Sec. 5751.01(F)(2)(e) as the principal amount received under a repurchase agreement or on account of a loan transaction.19

Subvention payments HCA underwrites special financing programs that allow leases to be made to customers at below-market interest rates. In such cases, automobile manufacturers make subvention payments to HCA as reimbursement for the difference between market-rate interest and the reduced rate actually collected. Alternatively, dealers may also offer below-market rate financing directly to their customers, and remit subvention payments to HCA in exchange for HCA's financing of the vehicle purchases.

HCA initially excluded the subvention payments from its CAT gross receipts as interest income.20 In assessing the CAT on these amounts, the Commissioner rejected this characterization and instead treated the subvention payments as subsidies, with receipts sitused to Ohio on a proportionate-benefits basis. HCA noted that the receipts were treated as interest income for purposes of generally accepted accounting principles (GAAP) governing its financial statements, as well as the federal income tax. However, the Commissioner focused on HCA identifying the payments as “subsidy amounts” on its own financial statements. Further, the Commissioner argued that the amounts received were actually rebates since the auto manufacturers themselves were not being given a loan, and were not entitled to use of the money. Again, the BTA focused on the true character of the transactions as payments for the use of money, and specifically rejected the Tax Commissioner’s overreliance on HCA’s identification of the transactions in its financial statements as subsidy amounts. While acknowledging its limited application in the instant setting, the BTA was also persuaded by the GAAP and federal income tax treatment of the transactions in finding that the receipts qualified as interest properly excluded from CAT gross receipts.

Commentary Hyundai is the latest in a string of taxpayer-favorable CAT developments in Ohio, following most recently in the footsteps of Nissan21 (permitting the taxpayer to make a retroactive consolidated election, per the taxpayer’s intent). In both cases, the BTA has awarded significant deference to economic substance over form and affords some degree of weight to non-Ohio jurisprudence while intentionally avoiding overreliance. Further, it chips away at the “but for the consolidated election” defense sometimes used by the Department of Taxation, potentially creating a more positive environment for taxpayers with Ohio controversies to rely on legal arguments that include supporting federal tax concepts and substance-over-form arguments.

1 Hyundai Motor Finance Company v. McClain, No. 2015-785, Feb. 6, 2020.
2 Am. Sub. H.B. 66, Laws 2005.
3 OHIO REV. CODE ANN. § 5751.001(F).
4 OHIO REV. CODE ANN. § 5751.01(F)(2),
5 OHIO REV. CODE ANN. § 5751.012. Ohio generally employs a bright-line nexus requirement on entities with at least $500,000 in annual Ohio gross receipts. OHIO REV. CODE ANN. § 5751.01(H)(3),(I)(3).
6 OHIO REV. CODE ANN. § 5751.012(C).
7 OHIO REV. CODE ANN. § 5751.011. Taxpayers who are members of a commonly controlled group and do not elect to file consolidated are required to file a combined CAT return, in which intercompany transactions remain subject to the CAT, but only entities with Ohio nexus are included.
8 OHIO REV. CODE ANN. § 5751.011(C)(1)(a).
9 OHIO REV. CODE ANN. § 5751.01(F)(2)(c), providing an exclusion from CAT for receipts from the sale, exchange, or other disposition of an asset described in section 1221 or 1231 of the Internal Revenue Code.
10 Citing Recordak Corp. v. United States, 325 F.2d 460 (Ct. Cl. 1963) and Rev. Rul. 80-37, which held that the sale of dual-purpose property is not income from the sale of IRC § 1231 property for federal income tax purposes.
11 Philber Equipment Corporation v. Commr., 237 F.2d 129 (3rd Cir.1956).
12 Mafco Equipment Co. v. Commr., T.C. Memo 1983-637 (1983).
13 OHIO REV. CODE ANN. § 5751.01(F)(2)(a).
14 OHIO REV. CODE ANN. § 5751.01(F)(2)(d).
15 OHIO REV. CODE ANN. § 5751.01(F)(2)(e).
16 OHIO REV. CODE ANN. § 5751.01(F)(2)(c).
17 OHIO REV. CODE ANN. § 5751.01(F)(2)(ee).
18 Based on IRS Technical Advice Memorandum 9839001, which concluded that similar securitization transactions were secured financings, not sales, for federal income tax purposes under IRC Section 1001.
19 Having reached this conclusion, the BTA declined to consider HCA’s alternative arguments.
20 OHIO REV. CODE ANN. § 5751.01(F)(2)(a).
21 Nissan North America, Inc. v. McClain, No. 2016-1076, Ohio Board of Tax Appeals (Oct. 9, 2019). See GT SALT Alert: Ohio Board of Tax Appeals Allows Retroactive CAT Consolidated Election.

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