The Internal Revenue Service (IRS) recently stated its position with regard to manufacturer incentives paid to dealers to incentivize them to upgrade their facilities.
As factory image programs have grown in recent years the tax consequences of these payments from the manufacturer have also become more important.
Every manufacturer’s program has been different and/or changed over time. The clear purpose of these programs has been to incentivize dealers to modernize and upgrade their facilities to meet the factory image program requirements. However, the payments are often based on meeting targeted Customer Satisfaction Index (CSI), sales goals or other objective criteria that have nothing to do with the actual facilities.
The tax code requires dealers to capitalize the cost of upgrading, modernizing, expanding their facilities and take a depreciation deduction over 40 years. Since the manufacturer’s payments are intended to subsidize the cost of improving the facilities, and they have a vested interest in standardizing the look of the dealerships that represent their brand, it would seem logical that manufacturer’s payments should reduce the amount capitalized. The IRS’ position is contrary.
The IRS’ ruling provides three different examples of image program incentive payments to dealers and in each case the IRS has ruled that the payments are income to the dealership in the year they are received.
Here's an example. Dealership A decides to spend $1,000,000 to upgrade their facilities to be compliant with their manufacturer's current image program. The manufacturer agrees to help pay for the upgrade by paying the dealership $450,000 upon completion of the upgrade. The net investment made by Dealership A is $550,000.
Unfortunately the IRS's ruling requires Dealership A to pay tax on $450,000 and increase the depreciable cost of the upgrade from $550,000 to $1,000,000. The $1,000,000 would usually be depreciated over 40 years but other recent IRS changes have made changes to facility depreciation methods which could help reduce the negative tax impact of this ruling.
Dealers anticipating upgrading their facilities to comply with manufacturer image programs should consult their tax advisors to make sure they fully understand the tax consequences of these payments.
To review the memorandum from the IRS, click here.
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