Certain Payments to Acquire Auto and Equipment Leases Must be Capitalized

(Parker Tax Publishing February 2020)

The Office of Chief Counsel advised that excess markup payments paid to acquire automobile leases from dealers and participation payments paid to acquire equipment leases from manufacturers must be capitalized because they are costs to acquire intangible assets under Reg. Sec. 1.263(a)-4(c). The Chief Counsel's Office reasoned that the payments are part of the purchase price of the lease agreements, and it rejected the taxpayer's arguments that there was an agency relationship between the taxpayer and the dealerships and that the payments represented compensation for services. CCA 202005019.

Background

A financial entity operating through its subsidiaries purchased automobile and equipment leases from third party dealers in the ordinary course of business. The taxpayer and the dealerships entered into master agreements that gave the taxpayer the opportunity to purchase vehicle lease contracts originated by the dealership if the dealerships meet the taxpayer's standards. The dealerships entered into master agreements with other financial institutions as well.

When a dealership entered into an automobile lease with a customer, the dealer collected information about the customer's credit and financial situation and entered it into a third party software program. The software system electronically forwarded the information to all banks or financial entities with whom the dealer entered into master agreements. The taxpayer and other entities submitted bids on the leases. The bid did not obligate the taxpayer to purchase the lease, and likewise the dealer was not obligated to choose the taxpayer's bid. The dealer ultimately decided to which bank it would sell the lease.

The taxpayer's master agreement provided that once the taxpayer's offer was accepted by the dealer, delivery of the executed documents to the taxpayer constituted a sale and assignment of the entire dealer's right, title, and interest in the lease contract, in the vehicle, and in any guaranty or other document executed in connection with the lease contract. Further, the master agreements acknowledged that the transaction was the purchase of a lease contract and that the dealerships were not an agent of the taxpayer.

There were two components to the fee the taxpayer offered to pay the dealerships to acquire the leases: (1) a lease acquisition flat fee, and (2) a premium on leases with an excess lease rate, referred to as an excess markup payment. The lease acquisition flat fee applied to every lease the taxpayer purchased. The excess markup payment applied only to leases with excess lease rates. The amount of the excess markup payment was based on a formula using variables that the taxpayer periodically distributed to the dealers. For book purposes, the taxpayer capitalized and amortized the excess markup owed to the dealerships. For tax purposes, the taxpayer deducted this amount under its current method of accounting.

In addition to vehicle leases, the taxpayer also acquired leases from equipment manufacturers and vendors. The acquisition process was similar to the process for vehicle leases in that: (1) the taxpayer entered into a master agreement with the manufacturers or vendors, (2) the manufacturers or vendors entered into lease agreements with customers, (3) the manufacturers or vendors decided to sell the lease, (4) the taxpayer identified leases it wished to purchase, and (5) the parties agree to the sale/purchase. Upon the purchase, the taxpayer received all payments due, or that would become due, to the vendor under the lease agreement, including any security deposits paid to the vendor. The pricing structure for the equipment leases was simpler than for the vehicle leases. For equipment leases, the taxpayer offered the vendors a set percentage applied to the equipment cost (i.e., a participation payment). For book purposes, the taxpayer capitalized the participation payments and amortized them over the term of the lease agreement. For tax purposes, the taxpayer capitalized and amortized any participation payments exceeding a certain amount, and deducted any participation payments below that amount under its current method of accounting.

Under Code Sec. 263(a), taxpayers must capitalize expenditures to acquire, create, or enhance separate and distinct assets and certain significant future benefits. Reg. Sec. 1.263(a)-4(c) addresses the tax treatment of amounts paid to acquire intangible assets. Under Reg. Sec. 1.263(a)-4(c)(1), a taxpayer must capitalize amounts paid to another party to acquire any intangible from that party in a purchase or similar transaction. The regulation lists various examples of intangibles within the scope of this rule. Reg. Sec. 1.263(a)-4(c)(1)(vi) specifically lists "a lease."

The Office of Chief Counsel was asked to advise whether the taxpayer was required to capitalize the excess markup and participation payments. With respect to the excess markup payments, the taxpayer argued that the dealers acted as an intermediary to assign the leases to the taxpayer, and therefore, there was no sale of an intangible asset for tax purposes. The taxpayer also argued that since the payments did not comprise or equate to the principal value of the lease contracts, they represented compensation to the dealers for services.

Office of Chief Counsel's Analysis

The Office of Chief Counsel advised that the excess markup payments and the participation payments fit squarely into the amounts paid under Reg. Sec. 1.263(a)-4(c) as costs to acquire an intangible. The Chief Counsel's Office reasoned that the payments were part of (or in the case of the equipment leases, the entire amount of) the purchase price of the lease agreement, and as such, were a direct cost of acquiring the leases. In the view of the Chief Counsel's Office, the payments represented what the taxpayer, as the buyer, was willing to pay for a valuable intangible asset. For the automobile leases, the price of the leases was directly tied to the expected profit and the lease rate negotiated with the customer. For the equipment leases, the purchase price was tied to the equipment being financed through the lease.

The Chief Counsel's Office said that the taxpayer's argument that the dealer was acting an intermediary was contrary to the master agreements, which specifically stated that there was no agency relationship between the taxpayer and the dealer. The Chief Counsel's Office observed that the master agreements with the dealers clearly described the transaction as a purchase of a lease contract, and the master agreements with the equipment manufactures stated that the manufacturer assigned and transferred the lease for consideration. Thus, both of these transactions qualified as a "purchase or similar transaction" under Reg. Sec. 1.263(a)-4(c)(1). The Chief Counsel's Office said that, even if the taxpayer were to successfully argue that the transaction did not constitute the acquisition of an intangible, the amount would then be considered paid to create an intangible under Reg. Sec. 1.263(a)-4(d)(6) and would nevertheless have to be capitalized. The Chief Counsel's Office also rejected the taxpayer's argument that the payments were compensation for services and concluded that the taxpayer provided no evidence to support that the payments should be treated other than as the acquisition of a lease.

For a discussion of the rules for amounts paid to acquire or create intangible assets, see Parker Tax ¶99,580.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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