Auto dealer trade association executives are meeting with members of Congress this week, trying to end a taxation practice that threatens to upset the way that the subprime auto industry operates.
At issue is the way dealers account for money they get for the cars they sell. The Internal Revenue Service requires dealers to pay taxes on the entire amount of a car loan when it is made-despite the fact that dealers get only part of that money up-front from the lender.
The remainder, often referred to as a holdback, is realized over the life of the loan and-depending on the credit quality of the borrower-may never even be paid back.
Although the rule that tax is due on the full amount of a loan has been in place for years, the recent rapid growth in the subprime auto lending industry has spurred stepped-up enforcement by the IRS, dealers said.
"It's an impossible situation," said Philip White 3d, owner of White's Automotive Co., Chester, Va. An IRS audit of White's Automotive more than a year ago found that the dealer owed almost $200,000 in back taxes not paid on holdbacks.
Representatives of the National Independent Auto Dealers Association are trying to resolve the issue, a representative from the trade group said.
Meanwhile, Mr. White is appealing the audit in court and said the IRS is reconsidering its long-standing rule.
In fact, the IRS is considering two requests for technical advice on the issue but has yet to issue a ruling, a spokesman for the agency said.
If the IRS decides to uphold the current accounting standard, "it'll be another hit to the subprime auto industry," said Tom Komaitek, an analyst at Duff & Phelps. "There will probably be special charges to the dealers," he said.
In addition, if lenders subsequently find that loan amounts they have kept from dealers can no longer be classified as a portion of their loss reserves, the lenders themselves may be liable for taxes on these holdbacks, Mr. Komaitek said.
Enforcement of the rule could "make it very difficult to make these kinds of loans," according to a representative of the National Automobile Dealers Association. That trade group is also looking closely at the issue, he said.
The dealers and lenders most affected by this rule are the D-credit- quality players-those who primarily cater to customers with the worst credit.
Lenders in this market often give a dealer only half the loan amount up- front, explained Darrell Hendrix, an industry analyst at Freedman, Billings, Ramsey.
About 30% to 40% of these loans default, he said. "Lenders maintain that it is not our problem to pay taxes for our dealers-but it will be their problem if the dealer stops sending paper to them," Mr. Hendrix said.
National Auto Credit and Credit Acceptance Corp. are two of the largest lenders that specialize in this market. Top executives from Credit Acceptance have reportedly also been in discussions with members of Congress on the issue.