Bad Debts: How Contractual Terms and Sales Tax Intersect Thomas Zessman Senior Tax Manager U.S. Bank Minneapolis, Minnesota thomas.zessman@usbank.com Kyle Brehm State and Local Tax Director PricewaterhouseCoopers LLP Minneapolis, Minnesota kyle.m.brehm@pwc.com
Agenda Bad Debt Credits Transaction Walkthrough Customer Retailer Bank Customer Retailer Bank Merchant Bank Customer Retailer Historic Results Recent Results Historic Progeny Potential Opportunities 2
Bad Debt Credits Typical requirements: Retailer makes credit sale and collects/remits sales tax Customer defaults on debt Retailer charges-off debt under IRC 166 Clawback: If write-offs later collected, tax is due 3
Transaction Walkthrough Buyer Goods (Value = $10,000) Credit Transaction: $10,000 Goods $800 Tax Seller $800 - Tax 1. Seller makes credit sale of $10,000 (taxable good) + $800 (tax @ 8%) to Buyer 2. Buyer makes no payments 3. Seller writes off $10,800 under IRC 166 4. State likely refunds $800 in tax to Seller State 4
Transaction Walkthrough Loan Application: $10,800 Buyer Goods (Value = $10,000) Loan Disbursement: $10,000 Goods $800 Tax Seller $800 - Tax 1. Seller makes sale of $10,000 (taxable good) + $800 (tax @ 8%) to Buyer, financed by Lender 2. Buyer makes no payments to Lender 3. Lender writes off $10,800 under IRC 166 4. State may or may not refund $800 in tax to Lender, dependent on several factors Lender State 5
Transaction Walkthrough Goods (Value = $10,000) Credit Card Payment: Goods $10,000 Tax $800 Lender Interchange Buyer Credit Card Authorization: $10,800 Credit Card Authorization: $10,800 Credit Card Payment: Goods $10,000 Tax $800 Credit Card Authorization: $10,800 Seller $800 - Tax Credit Card Payment: Goods $10,000 Tax $800 Merchant Bank State 1. Seller makes sale of $10,000 (taxable good) + $800 (tax @ 8%) to Buyer, ultimately financed by Lender 2. In order to obtain financing, Seller contacts their Merchant Bank, who contacts the Interchange, who contacts Lender with request for payment of $10,800. 3. Lender issues payment of $10,800 to Interchange, who issues to Merchant Bank, who issues to Seller. 4. Buyer makes no payments to Lender 5. Lender writes off $10,800 under IRC 166 6. Very few states will refund $800 in tax to Lender, and this is highly dependent on several factors 6
Historic Results Michigan Bad debt exemption requires a properly completed form documenting tax paid. Bad debt exemption does not include value attributed to repossessed property. Ally Financial, Inc. v. State Treasurer, Docket No. 327815 (Mich. Ct. App. Sept. 20, 2016). 7
Historic Results Washington Retailer not entitled to bad debt deduction debt held by affiliated entity that issued private label credit cards on behalf of Retailer. Washington Department of Revenue stated: If business contracts with financial company to provide private label credit card program, and Financial company becomes exclusive owner of credit card accounts and solely bears the risk of all credit losses; Business is not entitled to resulting bad debt deduction. Also applies when companies file a federal consolidated return. Determination No. 13-0095, Washington Department of Revenue (4/8/2013, released 12/23/2016). Slide 8
Historic Results Illinois Governor signed new bad debt clarification provisions extending the bad debt deduction to private label credit cards. Favorable to retailers because debt written off on books, and held by private label credit cards is now eligible for a deduction or refund from the state s Retailers Occupation Tax. SB 507, Laws 2015, signed by Governor on 7/31/2015. Slide 9
Historic Results Illinois Retailers can assign right to receive sales tax refunds attributable to uncollected debt to third-party financing company. [B]ecause the retailers would have been permitted to obtain a refund had they not assigned the accounts, Citibank, by stepping into the retailers shoes via assignment, should also be permitted to obtain a refund. Citibank N.A. v. Dept. of Revenue, Ill. App. Ct., No 13 L 50072 (11/2/2016). Slide 10
Historic Results Tennessee Retailer cannot receive a bad debt deduction for purchases made using its store credit cards when it has been paid in full by the credit card company. Retailer argued that the relevant Tennessee statute doesn't require the dealer claiming the deduction to be the entity that charges off the bad debts. Court provided that this wasn't supported by plain language of the statute and that such an interpretation would unjustly enrich the retailer. Tennessee Supreme Court denied retailer s request to review the Court of Appeal s decision. Sears, Roebuck & Co. v. Dep t of Revenue, Tennessee Court of Appeals, No. M2014-02567-COAR3-CV, discretionary review denied (9/23/2016) Slide 11
Historic Results Vermont Neither the bank who issues private label credit cards nor the retailer is allowed to deduct bad debts. Both Citibank and retailer claimed they were entitled to bad debt exclusion. Court ruled that the exclusion applies only to one who is both 1) required to collect the sales tax, and 2) actually suffers the loss associated with the uncollectible debt. Under the arrangement between the retailers and Citibank, neither party is entitled to the bad debt exclusion since neither meets both requirements. Citibank v. Dept. of Taxes, et al., Vermont Supreme Court, Dkt. No. 2015-280 (6/17/2016) Slide 12
Historic Results North Carolina Retailer was not entitled to a bad debt deduction on accounts held and charged off as worthless by affiliated private label credit card. Third-party banks provided private label credit cards for the retailer. Court determined that bad debt refund statute applies to accounts between the retailer and its customers but not to accounts held by a third party. Although taxpayer and banks had a contractual relationship that involved a certain degree of collaboration, decision making and agreement, the relationship did not create a single tax-paying unit. Credit Card agreement clearly indicated that the bank was the sole and exclusive owner of all accounts and related information. Banks were entitled to the bad debt deduction, not the retailer. Home Depot U.S.A., Inc. v. North Carolina Dept. of Revenue, North Carolina Superior Court, Decision No. 11 CVS 2261 (11/6/2015) For a similar case, see also Office Depot, Inc. v. North Carolina Department of Revenue, Office of Administrative Hearings (11/9/2015) Slide 13
Historic Progeny Historic Results Bad Results: Alabama, Arizona, Indiana, Kentucky, New Jersey, New York, North Carolina, Ohio, Oklahoma, Pennsylvania, Tennessee, Vermont, Washington Good Results: Illinois, Michigan, Missouri, North Carolina 14
Historic Results WA CA OR NV ID UT MT WY CO ND SD NE KS MN IA MO WI IL MI OH IN KY WV PA VA NY ME VT NH MA CT RI NJ DE MD DC AZ NM OK AR TN NC SC AK MS AL GA TX LA HI FL Favorable Treatment Unfavorable Treatment 15
Questions? 16