IRS Technical Advice Memorandum 9704002

INTERNAL REVENUE SERVICE NATIONAL OFFICE TECHNICAL ADVICE MEMORANDUM

PRIVATE RULING 9704002

Section 1001 /Gain or Loss

DATE: October 1, 1996

ISSUE:

1 Was the transfer of notes from Taxpayer to Finance a sale

or other disposition of property within the meaning of section 1001

of the Internal Revenue Code?

CONCLUSION:

2 No. The transfer of notes from Taxpayer to Finance was not

a sale or other disposition of property within the meaning of section

1001 of the Code.

FACTS:

1. THE CAR DEALERSHIP

3 Taxpayer is a corporation that reports income for

financial and federal income tax purposes on an overall accrual

method of accounting. A is the sole shareholder of Taxpayer.

4 In addition to owning several incorporated car dealerships, Taxpayer

has two divisions, Division Y and Division Z (hereinafter referred to together

as Dealers), which operate used car dealerships. Most of Dealers' customers

are people who are unable to obtain bank financing. Dealers finance all of their sales.

5 Payment on the notes executed by customers of Dealers was

secured by the cars sold, which Dealers retained the right to

repossess.

6 Dealers included in income the total sales price as stated

on the sales invoice.

2. THE RELATED FINANCE COMPANY

7 In 1992, A formed Finance, which was incorporated under

State law. A is the sole shareholder of Finance. Finance was

capitalized with $1,000 in equity and a $24,000 loan from A. From

time to time during the period at issue, Dealers transferred to

Finance their installment notes from recent sales, and employees of

Taxpayer transferred the notes from Dealers' books to Finance's

books. Finance never acquired any notes from any car dealer other

than Dealers.

8 Dealers did not receive any cash payment from Finance when

they transferred notes to Finance. There was no fixed payment

schedule for Finance to pay Dealers.

9 On its returns for FYE 1992, Taxpayer deducted losses that

resulted from the transfers by Dealers of notes receivable to

Finance. The notes were transferred for face value less imputed

interest. Since the notes show no stated interest, they were

discounted for an imputed interest amount. Finance acquired all of

Dealers' notes, regardless of quality.

10 Dealers have not provided the Service with any written

sales contracts for the transfers of the notes from Dealers to

Finance or the terms of the sales.

11 Finance had no employees or facilities. Employees of

Taxpayer performed all administrative tasks for Finance. Taxpayer

made all collections and recordkeeping functions.

12 The vehicle buyers were not informed that the notes were

assigned to Finance. The notes were not marked that they had been

assigned. The vehicles' certificate of title continued to show

Dealers as the lienholders. If a vehicle was damaged in an accident,

Dealers, as the lienholders, and not Finance, had the right to any

insurance proceeds and transferred the proceeds to Finance.

13 Even after the notes were transferred to Finance, the

customers continued to make payments to Dealers. Dealers' employees

recorded the payments and performed necessary repossessions. A

percentage of Dealers' administrative expenses was allocated to

Finance, and Finance reimbursed Dealers for the allocated amounts.

14 Any repossessed vehicle was recorded in Dealers' used

vehicle inventory at a value shown in the NADA used vehicle guide.

The transaction was treated as if Dealers purchased the vehicle from

Finance.

15 Any profit of Finance was lent by Finance to related

businesses of Finance and Dealers. Since Dealers were listed as the

lienholders, Finance could not have sold the notes that it acquired

from Dealers.

16 Dealers and Finance operate in State. State has adopted

the UCC. Comment 1 to section 9-308 of the UCC states that in the

automobile field, when a car is sold to a consumer buyer under an

installment purchase agreement and the resulting chattel paper is

assigned, the assignee usually takes possession, the obligor is

notified of the assignment and is directed to make payments to the

assignee.

LAW:

17 Section 1001 of the Code specifies how to determine the

amount of gain or loss on sales. Section 1001 provides that the gain

from the sale or other disposition of property is the excess of the

amount realized therefrom over the adjusted basis provided in section

1011 for determining gain, and the loss is the excess of the adjusted

basis provided in that section for determining loss over the amount

realized.

18 For purposes of federal income taxation, a sale occurs

upon the transfer of the benefits and burdens of ownership rather

than upon the satisfaction of the technical requirements for the

passage of title under State law. Derr v. Commissioner, 77 T.C. 708,

723 (1981); see also Corliss v. Bowers, 281 U.S. 376, 378 (1930);

Grodt & McKay v. Commissioner, 77 T.C. 1221, 1237 (1981). The

question of when a sale is complete for federal tax purposes is

essentially one of fact. Derr v. Commissioner, 77 T.C. at 724. The

applicable test is a practical one that considers all the facts and

circumstances, with no single factor controlling the outcome. Derr v.

Commissioner, 77 T.C. at 724; see also Grodt & McKay v. Commissioner

77 T.C. at 1237.

19 It is well established that the economic substance of a

transaction, rather than its form, controls for federal tax purposes.

See Gregory v. Helvering, 293 U.S. 465 (1935). Although a taxpayer is

entitled to reduce the amount of its taxes by any means that the law

allows, "the question for determination is whether what was done,

apart from the tax motive, was the thing which the statute intended."

Id., at 469.

20 Rev. Rul. 60-331, 1960-2 C.B. 189, 191, states that " a

transaction which has no purpose other than the avoidance or

reduction of taxes, will be ignored for tax purposes." Also, the

courts have, in appropriate circumstances, disregarded for federal

tax purposes transactions entered into without any economic,

commercial, or legal purpose other than the hoped-for favorable tax

consequences. Grodt & McKay, 77 T.C. at 1243; see also Gregory v.

Helvering; Knetsch v. United States, 364 U.S. 361 (1960).

ANALYSIS:

21 As shown above, it is well established that the economic

substance of a transaction, rather than its form, controls for

federal tax purposes.

22 As stated above, courts have held that for purposes of

federal income taxation, a sale occurs upon the transfer of the

benefits and burdens of ownership. In the present case, we find

little evidence that the benefits and burdens of ownership have been

transferred between seller and buyer.

23 Upon the transfer of the notes, Dealers still had burdens

of ownership. Dealers' employees still had the administrative

responsibilities of collecting the payments from the car purchasers

and performing repossessions. It is true that a percentage of

Dealers' administrative expenses was allocated to Finance and Finance

reimbursed Dealers for the allocated amounts. Nevertheless, Dealers

continued to be responsible for these administrative burdens.

24 Also, Dealers continued to bear the risks of the credit-

worthiness of the notes. Upon the transfer of the notes, Dealers did

not receive any cash up front for the notes, and there was no fixed

payment schedule for Finance to pay Dealers. The only change for

Dealers after the transfer of the notes was that Finance, instead of

the car purchasers, was Dealers' debtor. This did not improve

Dealers' financial position. Finance was thinly capitalized with only

$1,000 in equity and a loan from A, and the only significant assets

of Finance were the notes it acquired from Dealers. Because of this,

whether Dealers ultimately got paid still depended on whether the

customers of Dealers made their payments on the notes.

25 Dealers also continued to bear burdens in the case of

default by their customers. Dealers were responsible for processing

repossessions. Also, repossessions were treated as if Dealers

purchased the vehicle from Finance.

26 Dealers continued to have the benefits of ownership after

the transfers of the notes. The notes were not marked to show that

they had been assigned. Also the certificates of title showed Dealers

as the lienholders. In the event that a vehicle was damaged in an

accident, Dealers, as the lienholder, had the right to any insurance

proceeds.

27 Finance did not get the benefits of ownership of the

notes. Since the notes did not show that they had been assigned and

Dealers were still listed as the lienholders, Finance could not have

sold the notes. Further, Finance would lend any profits to related

businesses of Dealers and Finance.

28 Here, the form as well as the substance of the transfers

make it questionable whether bona fide sales took place. Dealers have

not provided the terms of the sales of the notes to Finance and have

not provided any written sales agreement to the Service. Finance did

not provide any cash up front when it acquired the notes. There was

no fixed payment schedule for Finance to pay Dealers.

29 In many ways, Dealers and Finance did not act like arms-

length buyers and sellers. Finance and Dealers had the same owner,

employees, and facilities. Finance acquired all of Dealers' notes

during the period at issue. Finance never acquired any notes from any

car dealer other than Dealers. In the event that a vehicle was

repossessed, the transaction was treated as if Dealers purchased the

vehicle from Finance.

30 There are other ways in which Dealers and Finance did not

act like arms-length sales had taken place. The notes were not marked

to indicate that they had been assigned. Dealers continued to be

listed as the lienholders on the certificates of title. The customers

were not notified that the notes had been assigned and the customers

continued to make payments to Dealers. According to comment 1 to

section 9-308 of the UCC, this is not the usual procedure, in the

automobile field, when a note is assigned.

31 We also find that the transfers of the notes lacked

economic substance. As discussed above, Dealers did not reduce their

risk from the credit-worthiness of the notes as a result of the

transfers to Finance. Also, because Dealers did not receive any cash

up front upon the transfer of the notes, Dealers did not receive cash

any more quickly by transferring the notes.

32 Therefore, taking into account as a whole the facts and

circumstances of the transfers of the notes by Dealers to Finance, we

conclude that, for purposes of section 1001 of the Code, there were

no bona fide sales of the notes.