Ohio Finds that Auto Finance Company’s Receipts are Not “Gross Receipts” Under the Commercial Activity Tax

Ohio’s gross receipts-based Commercial Activity Tax (CAT) excludes from the tax certain categories of receipts, including those from certain financial transactions, so it is important for taxpayers to be aware of the nature of their transactions in order to not overpay their CAT liabilities.

By Jess Johannesen, SALT Manager

Ohio’s Commercial Activity Tax (“CAT”) is a gross-receipts based tax levied by the state on businesses in lieu of a more traditional net income tax and it broadly taxes a business’ gross receipts sitused to Ohio. To determine the CAT base, a business first determines its receipts that qualify as “gross receipts.”  It then applies a variety of sourcing rules depending on the type of gross receipt (e.g., sale of good, service, etc.) to compute its taxable (i.e., Ohio-based) gross receipts.

A recent Ohio Board of Tax Appeals (the “Board”) case reversed the Tax Commissioner’s initial determination that certain types of Hyundai Motor Finance Company’s (nka Hyundai Capital America) (“HCA”) revenues were subject to the CAT.  Instead, the Board held that Hyundai properly excluded the revenues at issue from the CAT base, and in doing so the Board relied upon the federal tax and GAAP treatment of intricate financing transactions.[1]

HCA is a captive automobile finance company that provides loans and other financial services to customers of Hyundai and Kia dealers.  The case addresses HCA’s revenues generated from 3 different business activities.

First, HCA purchases leases from the dealers and also purchases the vehicles subject to such leases.  During or at the conclusion of a lease term, lessees may purchase the vehicle from HCA at a set rate based on the lease agreement.  Otherwise, HCA may sell the vehicle at auction or to another dealer.  HCA argued that the receipts from the sale of automobiles were not a gross receipt since Ohio law excluded receipts from the sale of assets described in section 1231 of the Internal Revenue Code (“IRC”), regardless of the length of time the asset is held.[2]

Essentially, a section 1231 asset is property used in the trade or business generally subject to depreciation and not includable as inventory or otherwise held primarily for sale to customers in the ordinary course of business.  The Commissioner argued that such a vehicle is “dual-purpose property” held simultaneously for sale or lease, and therefore, the vehicles were not sectioned 1231 assets.  The Board determined that although some of the leased vehicles were eventually sold to lessees, the vehicles were primarily held for lease and not includable in HCA’s inventory.  Accordingly, HCA’s sales of such vehicles were properly classified as sales of section 1231 assets and the receipts were excluded from the CAT.

Second, HCA engages in securitization transactions by purchasing car loans referred to retail installment sale contracts (“RISCs”), packaging them into pools and selling those pools to a trust.  The trust issues fixed-rate notes that are collateralized by the pooled RISCs.  As the trust collects on the RISCs, it uses those funds to pay its noteholders, with any excess funds going to HCA.

HCA characterized the transactions as “secured financings” which are not treated as sales for federal income tax purposes, and argued therefore, that the receipts from those transaction are excluded from the CAT as the “principal amount received . . . on account of any transaction properly characterized as a loan.”[3]  While the Commissioner made various arguments to classify the receipts as sales, the Board ultimately relied on the federal income tax treatment to determine that HCA was not selling assets but rather collateralizing assets to create a loan.  Accordingly, the receipts from securitization transactions were excluded from CAT gross receipts.

Lastly, HCA receives payments from manufacturers and dealers in connection with certain financing programs that allow RISCs and leases to be made to customers at below-market interest rates.  Essentially, the manufacturers and dealers make HCA whole for the below-market terms HCA provides to the consumer.  The Commissioner argued that these associated payments are rebates as opposed to interest payments, but the Commissioner did not dispute that such payments were treated as interest for federal income tax and GAAP purposes.  The Board relied upon such GAAP and federal income tax principles to determine that these payments constituted interest, which is an excluded category of gross receipts under the CAT.[4]

While this case concerns the Ohio CAT, it illustrates how important revenue classification can be for state and local tax purposes.  Whether a gross receipts-based tax like the CAT or the measurement of economic nexus thresholds for sales/use tax purposes, the proper classification and treatment of receipts based upon your business’ specific activities and operations can have a significant impact on your state and local tax obligations.

Aprio’s SALT team has experience assisting clients with these state tax issues and we can assist your business to make sure that you are minimizing your SALT risk.  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 Jess Johannesen, SALT manager, at jess.johannesen@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the March 2020 SALT Newsletter.

[1] Hyundai Motor Finance Company (nka Hyundai Capital America) v. Jeffrey A. McClain, Tax Commissioner of Ohio, Ohio Bd. of Tax App. Case No. 2015-785, 02/06/2020.

[2] Ohio Rev. Code Ann. § 5751.01(F)(2)(c).

[3] Ohio Rev. Code Ann. § 5751.01(F)(2)(e).

[4] Ohio Rev. Code Ann. §5751.01(F)(2)(a).

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.

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