In “The Car Dealer's Guide To CA Sales & Use Tax Audits - Part 3,” we discussed what happens after a Notice of Determination is issued, California's special tax districts, DMV registration fees, not-so-secret warranty strategies and the importance of keeping your bill of lading.
In Part 4, we continue with processing transactions such as unwinds and the more complicated rollback. We will also discuss why it is a bad idea to try to avoid paying sales taxes on repossessions.
Finally, if perchance you do get audited, we've provided a list of records you should be keeping in your deal jackets and several reasons it would be a good idea to hire an attorney to represent you.
Unwinds & Rollbacks
Although in each of the following cases the dealer winds up in possession of the car, the following transactions vary for sales tax purposes. The main distinction to be cautious of is between an unwind and a rollback.
An Unwind references an incomplete vehicle transaction where a Report of Sale has been completed, but the customer did not take delivery of the vehicle. Processing an unwind is relatively easy.
The dealer will simply void the Used Report of Sale and complete a Statement of Facts that confirms the vehicle never left the dealer’s possession and was not operated.
The dealer must retain all copies of a voided report of sale and the REG 256, with the book copy, at the dealer’s primary business location so it is available in the event of an audit.
In the event that the return takes place after the customer has received delivery and operated that vehicle, this transaction must be treated as a rollback.
Under the DMV’s Vehicle Industry Registration Procedures handbook, a sale is triggered for registration purposes once the vehicle is operated by the customer. The report of sale cannot be voided when this occurs; all fees are due from the date of sale and must be submitted promptly to DMV.
A rollback usually happens financing could not be secured by the dealer, and so the dealer exercises a valid contractual right to rescind the transaction before some enumerated deadline in the contract.
When this occurs, down payment and other money paid by the customer should be returned and the dealer takes back possession of the vehicle. Although there may be other reasons why a vehicle is returned, this is the most common circumstances for a return after operation.
As stated above, once the vehicle is operated, a dealer is required to submit registration fees. Although the dealer may think the deal is null and void, a sale has essentially been recognized and recorded in the DMV database.
The process for handling a rollback is much more complicated than an unwind. In addition to the basic transfer requirements in Chapter 11 of the DMV Procedures Manual, the following are required:
- A Statement to Record Ownership (REG 101) form in the name of the second buyer that includes the name of the legal owner (lienholder), if appropriate
- A Lien Satisfied/Titleholder Release (REG 166) form from the lienholder for the first sale, if applicable. A REG 166 is not required when:
- Financing was not approved for the first sale or the dealer entered the information in error. Accept a Statement of Facts (REG 256) form or a Statement of Error/Erasure (REG 101) form from the dealer regarding the lienholder information.
- The lienholder remains the same for the second buyer. The lienholder must be shown on the REG 101 for the second buyer.
- A REG 256 containing the following information:
- Name of the person who returned the vehicle to the dealer and the date returned.
- Reason the vehicle was returned (for example, credit unavailable).
- If the vehicle was voluntarily returned by the prospective purchaser.
- If the vehicle was sold under conditional contract, chattel mortgage, etc.
- If the trade-in, if any, was returned to the prospective purchaser.
- If the down payment was returned and whether it was a cash down payment or cash in addition to the trade-in
- A Vehicle/Vessel Transfer and Reassignment Form (REG 262) from the first buyer to the dealer.
- Two Report of Sale–Used Vehicle (REG 51) forms: one for the first buyer andanother for the second buyer.
- A smog certification, if appropriate.
- Two transfer fees and any other fees due.
Because the CDTFA auditor will crosscheck the dealers reported sales with the DMV database, these rollback sales may become problematic if the dealer is unable to prove that the sale did not go through and all payment was refunded to the customer.
Another way a car might make its way back to the dealer is if it is repossessed. Regardless of time elapsed, a repossession does not negate sales tax. Even if the repossession occurs before the end of the reporting period, sales tax is owed on the entire taxable amount.
Auditors are trained to assume that dealers are repossessing the vehicles and inappropriately treating them as unwinds to avoid paying tax without having returned any of the funds. This is a temptation for many dealers, and you should avoid this at all cost.
However, there is a process to claim credit for sales tax paid on bad debt. A dealer must first claim this bad debt as a loss when filing their federal returns. Once the dealer has made this claim on their federal returns, they may apply to be credited for a prorated portion of the sales tax which corresponds to the bad debt.
For example: if 50% of the agreed taxable amount is charged off as a loss, you can reclaim 50% of the sales tax paid once you have filed your federal return.
Although this is particularly useful for dealers who carry deals in-house, almost all dealers can take advantage of claiming credit on bad debt. Think about all the pick-payments your dealer has allowed in the past year. These deferred down payments may go unpaid notwithstanding your best collection efforts.
If you find yourself in an audit, be sure not to leave any money on the table. Sales tax credits like the one above can be identified and used to help offset areas of liability.
Reach out to an industry knowledgeable tax professional today if you believe that you have unclaimed sales tax credit owed to you.
Keeping Good Records
Unlike franchise stores, used car dealers are not required to maintain certain types of records. This ends up being a major pitfall for most independents. Poor record keeping practices can land you in hot water once a tax audit rolls around.
While the majority of used car dealers do a decent job maintaining their deal jackets, this is just the baseline. Here are the contents of a well-kept deal jacket.
The following list of items should be kept in your deal jacket if they aren’t being filed there already:
- Auction Invoice or other Proof of Purchase
- Vehicle Reconditioning Receipts
- Smog Certificate (if applicable)
- Retail Contract Agreement Signed by Customer
- Bill of Sale (Reg 262)
- Report of Sale (ROS) Copy
- Optional Products & Services Disclosure Form
- Contract Cancellation Option Form
- Buyer’s Guide
- Signed NMVTIS (optional: AutoCheck/Carfax)
- Copy of Registration
- Copy of Vehicle Title
- Customer’s Credit Application and Disclosure (if applicable)
- Corresponding Spanish Contracts (if applicable)
- Copy of Check or Signed Receipt for Registration/License Fees Refunded to the Customer
- Copy of Gap and/or Warranty (If applicable)
A dealer must be careful to appropriately document any less than usual developments that take place after the sale of a vehicle. In a perfect world, every sale would stick. We all know that sometimes life happens; customers change their mind, financing falls through, or financial circumstances change.
How To Prepare For A Dealership Audit
In an ideal world, every business would be preparing for an audit at all times. Pristine record keeping, good systemization, and redundancies make coping with the demands of any audit so much easier, but reality rarely measures up to those standards of perfection.
If an audit takes you by surprise, you will need some time to prepare your books and records for inspection.
Speak to your attorney, bookkeeper and/or CPA about the documents required. You may wish to arrange for a reverse audit, where your tax attorney or other tax professional looks at the records for the time period of the audit.
Not only can they advise you of potential problem areas, they may even be able to find instances of overpaid tax. These credits could help to offset any assessment made by the CDTFA.
While it is possible that the CDTFA will approach you with an adversarial attitude, it is to your advantage to meet the auditor with calm professionalism. There is a lot you can do to boost your credibility and to help the audit proceed quickly, smoothly, and as painlessly as possible.
- MAKE A GOOD FIRST IMPRESSION - BE COURTEOUS AND HELPFUL.
Responding to all requests for meetings in a timely manner is a good start. Be aware that you can usually negotiate the timing of meetings so that they suit you and your business, as long as the request is reasonable and polite.
- PROVIDE EASY ACCESS TO YOUR FACILITY.
Obstructing site visits makes you look guilty and is likely to antagonize the auditor. If the auditor will be working on site for some time, provide them with a comfortable desk or office for their use.
- PROVIDE ACCESS TO ALL RECORDS AND INFORMATION THEY REQUEST.
Have the requested information ready in time for the meeting. Neat, careful, and convenient preparation of the requested documents will go a long way towards demonstrating transparency and willingness to work with the auditor.
- COMMUNICATE WITH YOUR AUDITOR WHEN REQUESTS ARE UNCLEAR.
Sometimes the requests for information are generic and may not apply to your particular business. In this case, feel free to talk to the auditor and ask about alternatives. If the auditor is planning to look at your records using a sample time period and you know that it was not a representative period for any reason, you may be able to negotiate. This is more likely to be successful if you have been reasonable and open throughout the process.
- IF POSSIBLE, PROVIDE ACCESS TO A KNOWLEDGEABLE STAFF MEMBER.
If the auditor has questions, having a designated point person who understands the daily workings of your business can expedite the process. On the other hand, make sure that the auditor is not conducting informal conversations with staff members with incomplete knowledge, as this could lead them astray in their investigations.
- TREAT THE AUDITOR WITH PROFESSSIONAL RESPECT. This is not the same thing as treating them like a friend of your business. Be ready to comply with their requests, but you are not required to volunteer additional information. You should not sign anything without careful consideration: the auditor is unlikely to explain the potential consequences of each document or agreement, so it is up to you to research and clarify anything that you don’t fully understand.
How A Tax Attorney Can Help
Going through an audit can be immensely stressful and isolating. If you have any reason to believe that the CDTFA may find discrepancies in your sales/use tax, the worry about impending consequences can cost you many nights of lost sleep.
Even if you think that everything is in perfect order, the sense of being a small business owner up against the behemoth of the CDTFA can leave you feeling outmatched and alone.
Hiring a qualified tax attorney is one of the best things that you can do for your business during an audit. You can expect your attorney to:
OVERSEE THE SALES AUDIT to make sure that the auditor is conducting the audit correction at every stage.
- ANALYZE AND DISSECT THE STATISTICAL METHODS used by the CDTFA in your case to ensure that you are being treated fairly.
- PREPARE AND PERFORM ANY PRESENTATIONS which must be made to the district principal auditor after the field work is finished.
- FILE ALL NECESSARY DOCUMENTS so that if it comes to an appeal process your rights will be fully protected.
- GUIDE YOU THROUGH ANY APPEALS PROCESS to make sure that every appropriate avenue for appeal is explored in order to minimize your liability.
- FILE all requests for oral hearings, petitions for rehearing or requests for relief from penalties.
- REPRESENT YOU at the Office of Tax Appeals
- DRAFT, FILE, AND NEGOTIATE any settlements, requests for reconsideration or claims for refunds.