Earlier this year, the New York Supreme Court, Appellate Division examined just such a case involving CLM Associates LLC, and concluded that a transfer of certain motor vehicles between affiliated entities for no cash consideration was, in fact, a taxable transaction [CLM Associates, LLC v. N.Y. Tax App. Trib., 122 N.Y.S.3d 375 (March 5, 2020)]. The CLM case serves as a helpful reminder for CPAs and taxpayers of yet another potential sales tax trap for the unwary. This article will provide an overview of this decision and the issues to be aware of.
Overview of the CLM Associates Case
There is nothing particularly novel about the transactions at issue in CLM Associates: A group of affiliated companies, operating as a family of car dealerships, underwent a relatively typical corporate reorganization involving an asset transfer.
CLM and 11 other dealerships, each a single-member LLC, were wholly owned subsidiaries of a common parent, the Premier Group. Through its dealerships, Premier sold various makes, including Land Rovers, Volkswagen, Jaguars, and Volvos. In addition to auto sales, the dealerships also provided maintenance and repair services. As is customary within the industry, the dealerships offered loaner cars to customers whose cars were in the shop. Eventually, each loaner car was converted to a used car and sold to customers.
Historically, the loaner cars were each titled to their respective dealership. In 2002, as the result of a restructuring, CLM ceased operating as a dealer; instead, it became an administrative entity serving the other 11 dealerships. Under the restructuring, CLM began handling the accounting, human resource, IT, marketing, and record retention functions for the group. Furthermore, as part of the restructuring, the loaner fleet was centralized under CLM. The loaner cars were retitled and insured in CLM’s name, but as a practical matter the cars, including the title paperwork, remained in the possession of the various dealerships.
The restructuring allowed Premier to streamline the loaner car program, better manage expenses, and limit the insurance risk of any one dealership. But it seems that no one was considering sales taxation. Several years later, a New York auditor assessed nearly $2 million in sales tax and accrued interest.
The dispute between CLM and New York’s auditors centered on the issue of whether the loaner car transfers constituted taxable retail sales. Although CLM raised several arguments in its defense, the primary argument was a simple one: this was nothing more than a nominal transfer of legal title between related parties with no exchange of money, so how could it be a sale? Ignoring the economic reality of the transaction, the auditors dug a bit deeper.
To effectuate the transfers, the dealerships created a bill of sale for each transaction listing CLM as the purchaser. Sales tax was sometimes reflected on these invoices, but in practice it was not collected. Other DMV forms were prepared treating the transfers as retail sales listing CLM as the purchaser. In addition, accounting entries were made on CLM’s books to reflect the transfers (i.e., the loaner cars were entered into CLM’s booked inventory and a payable was entered on CLM’s general ledger). Accordingly, from an accounting perspective, the transfers were treated as sales.
From a sales tax perspective, under New York law, a sale is defined, essentially, as any transfer of title or possession, in any manner, of tangible personal property for consideration [Tax Law 1101(b)(5)]. The first prong of this test was clearly met: title to each loaner car was indeed transferred from the various dealerships to CLM. The dispute centered on the second prong: whether there was a sufficient exchange of consideration. The auditors advanced several theories, which the courts subsequently found persuasive.
Consideration Means More than Cash
Under the regulations, consideration is defined broadly to include “monetary consideration, exchange, barter, the rendering of any service, or any agreement therefor” including the assumption of liabilities [20 NYCRR 526.7(b)]. New York courts have also broadly defined consideration by taking into account “some right, interest, profit or benefit accruing to one party or some forbearance, detriment, loss or responsibility, given, suffered, or undertaken by the other” [CLM Associates, LLC citing to In re Hygrade Casket Corp., D.T.A. No. 809681 (Tax App. Trib. 1993), aff’d 212 A.D.2d 843 (3d Dep’t 1995)].
The auditors argued, and the courts agreed, that the various benefits gained by the dealerships, as well as the liabilities assumed by CLM incident to the transfers, constituted the necessary consideration. First, by acquiring title to a loaner car, CLM assumed any accompanying liability, including personal injury liability, thereby allowing the dealerships a significant benefit of spreading insurance risk and avoiding catastrophic financial loss. Second, CLM assumed responsibility as a joint and several obligor on the dealership financing for the loaners. Third, consolidation of the titles under CLM made them easier to manage, thereby reducing the dealerships’ burdens of ownership.
In summary, CLM had assumed responsibilities that it did not previously have, while the dealerships gained certain benefits, both “hallmarks” of consideration. Consequently, the title transfers were treated as taxable sales, with sales tax due.
These disputes can take a long time to work their way through the system. The sale tax audit concluded in 2013; CLM appealed the case before an Administrative Law Judge, who agreed with the auditor’s conclusions in 2017. CLM then appealed to the New York Tax Appeals Tribunal, which ultimately agreed with the auditors in 2018. CLM next appealed the case to the New York Supreme Court, Appellate Division (the case at issue here), which ultimately agreed with the auditors in 2020.
While the taxpayer lost, the Appellate Division represented a Pyrrhic victory. The Appellate Division is constrained to accept a lower court’s ruling provided that ruling is rationally based and supported by substantial evidence, even if a different conclusion would have otherwise been reasonable. Given such a limited scope of review, the Appellate Division sustained the lower court ruling but offered the following critique nevertheless:
We are troubled that such a technical application of the Tax Law does not comport with ‘the spirit underlying our sales tax law, which is to impose the tax only upon the sale to the ultimate consumer.’
The Appellate Division raised a concern that the decision against the taxpayer “may result in an unwarranted windfall to the state,” because it will receive sales tax from CLM and again a few months later when the loaner car is sold as a used car. Perhaps other taxpayers may have better luck than CLM in future disputes involving similar issues.
Often a savvy tax advisor can learn from the misfortune of others. As such, CLM Associates offers several valuable lessons:
- Corporate transactions and reorganizations involving tangible personal property should always undergo a sales tax review.
- Consideration involves more than mere cash payments. If a transfer involves leased or encumbered assets, affects financing, or affects insurance risk, among other factors, then there may be an exchange of adequate consideration to trigger sales taxation.
- Transactions among affiliated entities may nevertheless trigger sales tax; notwithstanding, the group otherwise operating as a single economic unit.
- While income tax disputes may have to contend with “substance over form” considerations, sales tax disputes often have to contend with “form over substance” considerations. Taxpayers are often bound by the form they have chosen for sales tax purposes.
- Lastly, there may have been a way to plan around this result. For example, it may have been possible for the dealerships to contribute the loaner cars into a newly formed entity as contributions of capital and potentially avoid the issue altogether.
These issues can be especially perplexing when dealing with transfers between affiliated entities. Taxpayers may consider the movement from “right pocket to left pocket” as immaterial, whereas a sales tax auditor may take an entirely different view. CPAs should keep a careful eye on the manner in which transactions are structured, documented, and recorded. Understanding when to charge and collect sales tax, even on transfers between affiliated companies, can be critical.