PDF One area that many Buy Here Pay Here dealers struggle with is the accrual method of accounting. Without tax planning and structuring, you will pay taxes long before you ever receive the cash payments from customers. This is not a new problem, and you are probably aware of this issue as you read this. I want to bring to your attention some common sense that isn’t so common.
Many dealers create a Related Finance Company (RFC) to basically convert the recognition of income from Accrual to the Cash basis of accounting. This is where the risk and reward of operating a BHPH dealership get blurred. The fact of the matter is that a RFC is a separate company and should be operated as such. This includes many fixed operating costs that are not easily overcome. Think of all the fixed cost you already have in your dealership without selling a single car. Electricity, Property taxes, Rent, Accounting, and Legal are only a few of the normal expenses that a dealer has at bare minimum. That is just to keep the doors open. It would stand to reason that these are many of the same expenses that in most cases should be duplicated just to operate a finance company.
Generally when dealers ask me when it makes sense to start a RFC, I tell them around One Million in receivables. That may sound like a lot, but that is where the savings breaks even with the additional costs incurred to structure and properly run the RFC.
Let’s look at the Cash Flow of selling vehicle retail vs. selling it BHPH. It will be one vehicle with a cost of $2,000 and the sales Price of $5,000. We will also assume a $500 down payment for the BHPH scenario.
| Retail Sale Transaction | BHPH Sale Transaction | |||
| Vehicle Cost | -2000 | Vehicle Cost | -2000 | |
| Sale | 5000 | Sale | 5000 | |
| Taxable Income | 3000 | Taxable Income | 3000 | |
| Retail Sale Cash Flow | BHPH Sale Cash Flow | |||
| Vehicle Cost | -2000 | Vehicle Cost | -2000 | |
| Cash from 3rd Party Finance | 5000 | Cash Down Payment | 500 | |
| Gross Positive Cash Flow | 3000 | Principal received Y1 | 1600 | |
| 40% Blended Tax Rate | -1200 | Gross Positive Cash Flow | 100 | |
| Net Positive Cash Flow | 1800 | 40% Blended Tax Rate | -1200 | |
| Net Negative Cash Flow | -1100 |
So immediately you realize that BHPH can be a real cash drain. So what can be done? You can set up a RFC. Now let’s further my example and assume that your notes receivable are 1 Million dollars.
| Total Note Receivable Balance FMV |
1,000,000 |
|
| FMV Discount Percentage |
30% |
|
| Tax Deduction |
300,000 |
|
| Tax Rate (Blended) |
40% |
|
| Tax Deferral Amount |
120,000 |
|
| Return on Investment from Dealership |
25% |
|
| Cash Saved on Deferral |
30,000 |
|
| Increase in Annual Operating Costs | ||
| Incorporation/Accounting/Legal/Rent |
(15,000) |
|
| Annual Cost for increased Documentation, Computer Work, etc. |
(10,000) |
|
| Net Benefit |
5,000 |
|
This means that you will net a benefit of $5000 by setting up a RFC. But does that make sense? You can look for yourself above and probably rationalize that you could do better in one area or another, but realistically you will be close to the above result. My point is that you don’t want to create a lot of additional structure if it isn’t going to net a significant benefit. You will incur a lot of time managing the RFC. This is time spent by you to do the proper paperwork, title work, sale, and transfer etc. If I were to tell you that you spent approximately 5 additional weeks of your time in a year managing the RFC and only got paid $5,000 for it you would be very upset. That additional time could probably have made you more money doing something else and been much less of a headache.
Now look at an example with additional notes receivable. Notice that the fixed cost remains the same.
| Total Note Receivable Balance FMV |
2,000,000 |
|
| FMV Discount Percentage |
30% |
|
| Tax Deduction |
600,000 |
|
| Tax Rate (Blended) |
40% |
|
| Tax Deferral Amount |
240,000 |
|
| Return on Investment from Dealership |
25% |
|
| Cash Saved on Deferral |
60,000 |
|
| Increase in Annual Operating Costs | ||
| Incorporation/Accounting/Legal/Rent |
(15,000) |
|
| Annual Cost for increased Documentation, Computer Work, etc. |
(10,000) |
|
| Net Benefit |
35,000 |
|
That is a different picture isn’t it? The overall time managing the RFC does not change. In reality your fixed costs may rise slightly, especially if you have to hire someone to manage the RFC for you, but the more it grows the more it makes sense from a financial perspective.
What I have seen lately
Some dealers are exploring if they should do something prior to doing it and others are not. It is always best to have all possible information prior to making any big decision. You can cause yourself a lot of work and heartache by creating complexity that is not necessary. Keep in mind that corporate structuring is not something that should be taken lightly and a RFC is only one factor in a much larger picture. When speaking to your CPA and Attorney, they should always be able to tell you if not doing something is the correct course of action.
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John Donaldson, CPA
704-926-3300