IPT 2016 Sales Tax Symposium Indianapolis, Indiana September Credit Card Bad Debts Is Anyone Entitled to Sales Tax Refunds?

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1 IPT 2016 Sales Tax Symposium Indianapolis, Indiana September Credit Card Bad Debts Is Anyone Entitled to Sales Tax Refunds?

2 Presenters Tom Zessman, CMI Senior Tax Manager, U.S. Bank, N.A. Amy F. Nogid Counsel, Sutherland Asbill & Brennan LLP 2

3 Agenda Background, historical context, and statutory framework Mock Trial: Taxpayer Challenging Denial of Sales Tax Bad Debt Refund Claim Trial Summary Looking Forward: What Does the Future Hold? 3

4 Background 4 Sales taxes are collected when the sale is made If vendor s credit sale, vendor can usu. get refund for sales tax it paid on uncollectible amounts. If third party provides the financing, i.e., bank, most states deny sales tax refunds on the unpaid purchase price.

5 Historical context Many sales tax statutes were written when credit transactions were uncommon and, when available, did not involve third parties 5

6 Bad Debt Credit Statutes Typical requirements: Sales tax is remitted by retailer on a credit sale Customer later defaults in whole or in part Debt is charged off federally under IRC 166 and Clawback: if write-offs later collected, tax is due Only the retailer gets a credit sale tax refund from the state s overflowing tax bag Bag o tax 6

7 Overview of Consumer Lending Transaction Federal Income Tax Return 1. Borrower Purchases car from Dealer for $12,000 ($10,000 plus $1,000 in registration and fees plus $1,000 in sales tax) Borrower 2. Borrower obtains a loan from Bank (or uses credit card to finance) in the amount of $12, Dealer provides car to Borrower Bank 3. Bank transfers $12,000 to the Dealer for car loan provided 3 Months Later Borrower 9. Bank charges-off bad debt of $13,000 on Federal Income Tax Return 6. Assuming no payments were made, Borrower defaults owing the full principal of $12,000 plus $1,000 of accrued interest Bank Consumer Lending Sales Tax Bad Debts Refund Claim 10. Bank may claim refund of $1,000 (less post charge-off recoveries), attributed to sales tax paid to the state and not repaid by Dealer Dealer 5. Dealer remits $1,000 in sales tax to state 7. Bank does not have recourse against Dealer for non-payment by Borrower 8. Dealer cannot claim sales tax refund as they were paid for car purchase, including sales tax by Bank 7 Dealer

8 Mock Trial Facts: Savvy Seller sells wonderful widgets. To facilitate sales, Savvy allows its Prime Purchasers several financing options: Prime Purchasers can finance directly with Savvy Seller; Prime Purchasers can use their Savvy Seller private label credit card (PLCC), with Best Bank as the issuer based on terms Savvy negotiated with Best; or Prime Purchasers can use their general credit card issued by Bountiful Bank. 8

9 Mock Trial 9 Savvy has three Prime Purchasers who each purchase a wonderful widget for $100 using credit. Savvy, as trustee for Selfish State, collects the 5% sales tax on each of the sales and remits $5 on each sale (total of $15) to Selfish State. Each of the Prime Purchasers use a different financing option, but all three options require a monthly payment of $10. After paying the first $10 install, each of the three Prime Purchasers stops making payments. Savvy claims a bad debt expense under IRC 166 for the debt it self-financed. Savvy submits a refund claim for $13.50 (3 x $90 x 5%). Sneaky State denies the refund claim in full.

10 Mock Trial Selfish State s sales tax statute provides: A deduction from taxable sales shall be allowed for bad debts arising from a sale on which the tax imposed by this chapter was paid. (1) Any deduction taken that is attributed to bad debts shall not include interest. (2) For purpose of calculating the deduction, a bad debt is as defined in 26 U.S.C (3) The deduction provided for by this subsection shall be deducted on the return for the period during which the bad debt is written off as uncollectible in the claimant's books and records and is eligible to be deducted for federal income tax purposes. (4) If a deduction is taken for a bad debt and the debt is subsequently collected in whole or in part, the tax on the amount so collected shall be paid and reported on the return filed for the period in which the collection is made. 10

11 Mock Trial Who Should Get the Bad Debt Credits/Refunds?: No one Selfish State keeps the tax Savvy Seller Best Bank Bountiful Bank 11

12 Who Should Get the Bad Debt Credit/Refund? Arguments Supporting State s Retention of the Tax Sales tax became due and payable at the time the transaction took place No other party can establish that it has a statutory right to claim a refund: Vendor has been reimbursed by the bank/financing company, so the vendor suffered no loss Vendor did not deduct a bad debt expense on its federal income tax return Bank/finance company is not a vendor (no privity) 12

13 Who Should Get the Bad Debt Credit/Refund? 13 Arguments Supporting a Vendor s Right to Obtain a Refund It paid the sales tax to the state It bears the economic burden of non-payment by purchaser Failure to grant a refund converts a vendor into a taxpayer Financing transaction is separate transaction from the sales transaction Reference to IRC 166, simply means that collectability be bona fide, not that it be written off by the vendor Grant of a credit/refund is consistent with legislative intent that uncollectible sales not bear sales tax Fundamental fairness

14 Who Should Get the Bad Debt Credit/Refund? Arguments Supporting Financing Company s Right to Obtain a Refund Owns the receivables and suffers the loss Stands in vendor s shoes Is in the best position to know when a receivable becomes uncollectible Is generally the party to the transactions that is entitled to claim an IRC 166 deduction 14

15 Actual Results Results have been inconsistent, but generally state courts and tribunals have upheld the refund claims denials, regardless of whether the claimant is the vendor or the financing company. 15

16 Actual Results Instances where refunds were allowed to vendors: Maryland: Home Depot USA, Inc. v. Comptroller, No. C (Md. Cir. Ct. Oct. 16, 2006) Michigan: S. Abraham & Sons, Inc. v. Dept. of Treasury, Mich. Ct. App. (2003) 16

17 Actual Results 17 Instances where a financing company was allowed a refund: California: In re WFS Financial, Inc., SR EEA (Calif. St. Bd. of Equalization Dec. 14, 2000) Legislation passed in 2000 (effective January 1, 2001), amended California Revenue and Taxation Code sections 6055 (sales tax) and (use tax) to allow retailers that sell their receivables without recourse, and meet certain conditions to either claim the refund themselves or have the lender claim the refund when financed receivables become uncollectible. Idaho: Dkt. No (Idaho Tax Comm n May 28, 2002) Indiana: 1 Stop Auto Sales v. Indiana Dep t of Revenue, 810 N.E,2d 686 (Ind. 2004)

18 Actual Results 18 Instances where the single-unit approach was successful: Michigan: DaimlerChrysler Svc. of N.A., LLC v. Dep t of Treasury, 271 Mich. App. 625 (2006). But curative retroactive legislation was enacted to reverse holding and limit the right to claim refunds to those persons with the legal liability to remit the tax on the specific sale at retail for which the bad debt deduction is recognized for federal income tax purposes. Pennsylvania: SUT (Pa. Dept, of Revenue, Aug. 23, 2000). Related financing companies could be assigned the right to receive refunds

19 Looking Forward: Legislative Fixes Legislation is the best fix, but tax hungry states may be loathe to adopt. Some examples of states that have (or had) curative legislation: California: Allows retailers that sell their receivables without recourse, and meet certain conditions to either claim the refund themselves or have the lender claim the refund when financed receivables become uncollectible. Cal. Rev. & Tax Code 6055 & Michigan: After September 30, 2009, a vendor and lender can elect to designate the party that may claim a deduction or refund of the tax if all of the following conditions are met: (a) No deduction or refund was previously claimed or allowed on any portion of the account receivable; and (b)t he account receivable has been found worthless and written off by the taxpayer that made the sale or the lender on or after September 30, Mich. Comp. Laws Ann L 19

20 Looking Forward: Legislative Fixes (cont.) New York: Tax Law 1132[e-l] was enacted in 2006, to clarify that a retailer or lender may elect to claim a sales tax refund, deduction or credit when sales tax is paid up front on the entire amount of the sales price of a taxable item in an installment credit sale and a portion of the purchase price is charged off by the lender as uncollectible to [sic] federal income tax purposes. [Emphasis added.] But, repealed in 2010 because it purportedly provided a windfall. Pennsylvania: Provides for refunds on uncollectible private label credit card accounts by either the retailer or the lender. To qualify, both parties must execute an election. Pa. Stat. Ann [a.2]. 20

21 Looking Forward: Other Fixes??? For PLCCs: Consider insertion of recourse language in merchant agreements and provision for transferring accounts of questionable collectibility to the vendor before they qualify as bad debts under IRC

22 Appendix Some Recent Case Developments Circuit City Stores, Inc. v. Dir. of Revenue, 438 S.W.3d 397 (Mo. 2014) Missouri Supreme Court reversed a decision of the Administrative Hearing Commission and held that the retailers had been fully paid by the bank for the purchases, including sales tax, they were not the party that wrote off the bad debts, and the retailers and banks were separate entities acting independently. Home Depot U.S.A., Inc. v. N.C. Dep t of Revenue, No. 11- CVS-2261 (N.C. Super. Ct. Wake Cnty. Nov. 6, 2015) (unpublished) Superior Court held that there is no windfall to the State; sales tax is merely a privilege tax that retailers pay to the State in exchange for the right to do business. Rejected claims by Home Depot that it acted as a single taxing unit with the bank, and that the denial of the claim violated Home Depot s rights to due process or equal protection. 22

23 Appendix Some Recent Case Developments 23 Citibank (South Dakota), N.A. v. Vt. Dep t of Taxes, 2016 Vt. 69 (2016) Vermont Supreme Court held that neither the retailer, Sears, Roebuck & Co., nor the bank were entitled to a sales tax refund. Rejected arguments that retailer and bank formed a single economic unit and qualified together as a person under the sales tax provisions. Upheld penalties on retailer for claiming bad debt deductions on its returns. Sears, Roebuck & Co. v. Comm r of Dep t of Revenue, No. M COA-R3-CV (Tenn. Ct. App. May 11, 2016) (appeal filed) Tennessee Court of Appeals rejected refund claim since the retailer did not charge off the bad debt for federal income tax purposes, and the retailer and Citibank acting together were not a person Sears Nat l Bank had previously issued the PLCCs and refunds/credits had been allowed.

24 Conclusions States are unjustly enriched if they fail to refund sales tax paid to them when purchasers fail to pay the full purchase price. Making parties to financing transactions foot the sales tax when the purchasers do not pay is inequitable and illogical. Taxing economically equivalent transactions (a retailer selffinanced sale and a third-party financed sale) differently is wrong. Retailers bear the economic burden for the bad debts even if they do not deduct the bad debts as such on the federal income tax returns. 24