Michigan Rules That Repossessed Property Does Not Preclude Bad Debt Sales Tax Refunds

Businesses that write off bad debt may be able to claim sales tax refunds, and as this Michigan Supreme Court case reveals, taxpayers need to make sure they follow technical procedures and maintain appropriate supporting documentation.

Has your business ever written off a bad debt?  Have you considered the sales tax implications of that write-off?  Typically, for companies reporting sales tax on an accrual method as well as those that provide seller or third-party retail financing, sales tax is typically remitted on a transaction well before the cash comes in.  If those bills are ultimately not paid and the debt is written off, there is an opportunity to recover sales tax.  Not surprisingly, rules vary by state as to the recovery method (i.e., tax credit on a future return, deduction of the unpaid balance on a future return, or a cash refund).  In addition, many states have very specific rules and procedures in place for determining whether a lender (as opposed to just the retailer) can claim the sales tax refund, and the documentation required to support the refund claim.

Sales tax refunds for bad debts often arise in the auto industry, where financing is very common.  One of the interesting issues that arises when a car debt goes unpaid is what impact does a repossession of the car have on the sales tax refund claim.  On July 20, 2018, the Michigan Supreme Court issued an opinion addressing this issue.[1]

Two separate suits were brought by Ally Financial Inc. (“Ally”) and Santander Consumer USA Inc. (“Santander”), challenging the Michigan Department of Treasury’s refusal of refunds for taxes paid on vehicles financed through installment contracts that were written off as bad debts. Both companies entered into written agreements with automobile dealerships. The dealerships had sold vehicles to individual purchasers who entered into installment contracts with the dealerships in order to finance the vehicle purchases. Both dealerships included sales tax in the purchase price and remitted the tax to Michigan. The dealerships then assigned the installment contracts to Ally and Santander in exchange for the purchase price plus the sales tax, giving Ally and Santander the right to collect the payments and repossess the vehicles upon default. Eventually, Ally and Santander both repossessed the vehicles and resold them for lesser amounts than each purchaser’s unpaid balance. The outstanding balances (net of the amounts received from the repossession sale) were written off as bad debts, and refund claims for sales tax were filed in Michigan. The Michigan Department of Treasury denied the claims.

Michigan’s sales tax rules permit recoupment of sales tax paid based on gross proceeds (i.e., sales price) that become worthless by allowing a deduction of the amount of the bad debt from gross proceeds used to compute the amount of sales tax due.[2]  A “bad debt” is defined as follows: “any portion of a debt that is related to a sale at retail . . . and that is eligible to be claimed, or could be eligible to be claimed if the taxpayer kept accounts on an accrual basis, as a deduction pursuant to section 166 of the internal revenue code. . . .  A bad debt shall not include . . . repossessed property.”[3]  The issue faced by the Court was the meaning of “repossessed property.

The state argued that term “repossessed property” refers to the entire value of the account (i.e., the unpaid balance before the property was repossessed), thereby disallowing the entire sales tax refund claim.  Ally and Santander, on the other hand, interpreted the term to mean the value of the repossessed property, which would allow them to claim a sales tax refund on the remaining balance of the debt after the proceeds from the repossession sale were applied.  The Court agreed with the taxpayers, concluding that the Department’s interpretation was not a reasonable reading of the statute since it would deny sales tax refunds on amounts that become uncollectible.  The Court also noted and was swayed by the fact that several other states have a similar interpretation of “repossessed property.”

Despite succeeding on this argument, the taxpayers were ultimately denied their refund claims by the Court because they were not able to present evidence required by the Department of Treasury. The Department required Form RD-108, which is issued by the Secretary of State once sales tax is paid, since it considered such form the best evidence of the amount of sales tax paid.  Ally and Santander argued that the Department acted arbitrarily by not allowing alternative documentation (i.e., the taxpayers’ own spreadsheets), since the dealerships are the ones that maintain the RD-108 forms (and don’t always keep those forms forever) and that it would cost $11 for each form Ally and Santander requested from the Secretary of State.  Nonetheless, the Court upheld the Department’s requirement to require those forms since the bad debt refund claim statute states that any claim “shall be supported by that evidence required by the department.”[4]

This case demonstrates the importance of recognizing when a business may have a right to claim a sales tax refund and of understanding and complying with all procedural requirements relating to such claims.  Aprio’s SALT team is experienced with sales tax refund claims and can review and recommend changes to your sales tax processes to ensure that you are collecting and maintaining any documentation that may be required or that will be helpful to support a potential sales tax refund claim.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact  Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the August 2018 SALT Newsletter.

[1] Ally Financial, Inc. and Santander Consumer USA, Inc. v. State Treasurer, Docket Nos. 154668, 154669, and 154670 (Mich. Sup. Ct., July 20, 2018).

[2] MCL 205.54i(2).

[3] MCL 205.54i(1)(a).

[4] MCL 205.54i(4).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.