In a generic legal advice memorandum (GLAM 2014-004), the IRS determined that payments received by automobile dealerships from automobile manufacturers under a facility image-upgrade program were income under Section 61.

The facts in the GLAM indicate that to encourage automobile dealerships to expand, modernize or renovate their facilities, some automobile manufacturers offer payments to the dealerships to upgrade their facilities in accordance with the manufacturers' requirements. The payments also promote a standard brand image. Each dealership's participation in the payment program is voluntary and serves the sole purpose of defraying the dealership's costs for the upgrades.

Upon examination, the IRS has seen dealerships treat these payments inconsistently. Some dealerships exclude the payments from income as nonshareholder contributions to capital under Section 118. Other dealerships assert that the payments reduce the basis of the constructed assets and are not includable as part of gross income. Some dealerships treat the payments as a purchase price adjustment to the vehicles. In a few cases, the dealerships include the payments as income.

The IRS concluded that all the payments are includable in dealerships' gross income under Section 61. It noted that the dealerships, not the manufacturers, own the property that the dealerships construct or improve with the payments. Thus, the dealerships have an accession to wealth over which they have complete dominion and control.

The IRS also concluded that the dealerships must include the full costs of the construction in the basis of the newly constructed property under Section 1012 and include the costs of the capital improvements in the adjusted basis of existing property under Section 1016.

Some dealerships assert that the payments are purchase-price adjustments to the purchased vehicles but the IRS rejected this argument. The IRS stated that the contracts indicated no evidence that the payments were made with any intent to reach an agreed-to price for vehicles manufacturers sell to the dealership. The IRS noted that even if the amount of the payment is based on the dealership's number of vehicles sold or purchased, it is not a formula to reach the net selling price of the vehicles.

The IRS denied the dealerships the exclusion from income available under Section 118, determining that the transfer failed the standard outlined in U.S. v. Chicago, Burlington, & Quincy Railroad Co., 412 U.S. 401 (1973) for the following reasons:

  • The manufacturers did not have the proper intent or motive because the motive is not to obtain advantage for the general community.
  • The payments are for the direct benefit of the manufacturers.
  • A customer relationship exists between the manufacturers and the dealerships.
  • The manufacturers want the dealerships to buy more vehicles.
  • The payments provide an incentive for the dealerships to upgrade their facilities, which may result in an increase in dealership sales of vehicles for the benefit of the manufacturers.

After determining that none of the exclusions from income apply, the IRS determined that the payments received by the dealerships from the manufacturers are includable in the gross income of the dealerships under Section 61. Automobile dealerships and other retail establishments that receive payments similar to those received by the taxpayers in the GLAM should be aware of the IRS position.

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