Spring 2012 issue of Horizons

Tax Impact of Factory Image Upgrades Funded by the Manufacturer Over the past several years, manufacturers have developed certain programs to help soften the amount of financial burden placed on dealers for these factory image upgrades. Under these programs, manufacturers will absorb certain costs associated with the upgrades to encourage dealers to construct new dealership properties or to upgrade their current facilities. Typically, manufacturers will agree to pay a specific amount to dealerships based on: • Completion of facility construction and satisfaction of program requirements • Number of vehicles sold for a given period of time upon completion of construction and satisfaction of program requirements • Number of vehicles sold for a given period of time based on meeting certain facility milestones and possibly additional requirements The programs vary by manufacturer, but all programs generally provide payments to dealers related to facilities’ upgrades. Over the past few years, these payments made by manufacturers for dealership upgrades have caused some tax debate. Some in the auto industry maintain that all imaging payments must be reported in income. Others claim that the payments should be excluded from income and reduce the basis of the property being renovated and or constructed. In response to this tax debate, the IRS issued an IRS Automotive Alert in January 2012 regarding the dealerships’ tax treatment of factory upgrades. In general, each program must be evaluated individually by the dealership with the help of its tax advisor and treatment of the manufacturer payments should be determined based on the facts and circumstances of that particular program.

However, dealers have expressed concern about these requirements for the past several years and still remain concerned that some of the facility standards are both unreasonable and unnecessary, and will ultimately place significant financial burden on the dealers. They also continue to argue that certain costly upgrades will not lead to a return on their investment. In some cases, the lack of available financing and unwillingness of dealers to infuse significant amounts of capital into their businesses for these upgrade requirements have forced dealers to make the critical decision to cash out and exit the auto industry. Some of the perceived unreasonable and unnecessary facility standards include specifications about towel bars in restrooms, tile color used on the sales floor, picture frames and computer accessories on salesperson desks, and the height of salespersons’ cubicle walls. In response to numerous expressions of concern by dealers across the country, NADA launched a Factory Image Program Study in August 2011. According to Glen Mercer of NADA, the ultimate goal of this study “was to open up a dialog in which all parties could discuss facility requirements on a more rational, informed and fact driven footing.” The results of this study were released on February 4, 2012 at the NADA/ATD convention in Las Vegas. As a result of the project, NADA was able to identify common issues for each attribute of facility image programs and was also able to pinpoint issues that cut across all three attributes of a typical program. Overall, the study found that the best approach for a dealer facing facility upgrade pressure is to engage the manufacturer in a timely business discussion around the cost-benefit analysis of the demands in hopes of coming to a reasonable solution for both parties. A full download of the study, as well as an executive summary of the study, can be found at http://www.nada.org .

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