Court of Appeals (Mich.) Finds that Post-Repossession Debt Not Deductible as “Bad Debt” under State Income Tax Laws

In Ally Financial, Inc. v. State Treasurer, 2016 WL 5107138 (Mich.App.,2016), the Michigan Court of Appeals found that two auto finance companies could not deduct their post-repossession losses as bad debt under state tax law. The procedural history sets up the issue.

Plaintiffs are financing companies that financed the purchase of motor vehicles from various retailers (dealerships) around the state. Under the retail installment contracts, car purchasers agreed to pay the entire amount financed, including sales tax, over a period of time. The dealerships assigned all of their rights under the installment contracts to plaintiffs, which included the right to enforce the debt and repossess collateral. In exchange, plaintiffs paid the retailers the entire amount financed under the installment contracts, including the portion of the financed sales tax. The dealerships then remitted the sales tax due to the state. However, some purchasers would default on their retail installment contracts, meaning that they did not repay the full amount of the purchase price or sales tax. In some instances plaintiffs repossessed the vehicles and sold them, applying the sale proceeds to the remainder of the purchase price and sales tax. Still, there were times when the contracts had unpaid balances even after the sale. Once plaintiffs determined such installment contracts worthless, they claimed the remaining balances as “bad debts” under § 166 of the Internal Revenue Code, 26 USC 166, on their federal tax returns.   Plaintiffs sought refunds for bad debts and filed suit after the Department denied the refunds. The Department sought summary disposition in all three cases. It noted that claiming a debt as a bad debt under § 166 of the Internal Revenue Code was not the sole determining factor for whether a claimant was entitled to a bad debt deduction under MCL 205.54i; rather, an entity claiming a refund must satisfy the specific requirements set forth in § 54i. The Department denied that refunds were owed because plaintiffs had included repossessed property in its claim and repossessed property was specifically excluded under MCL 205.54i(1)(a), DaimlerChrysler Services of North America, LLC, unpublished opinion per curiam of the Court of Appeals, issued January 21, 2010 (Docket No. 288347), and Revenue Administrative Bulletin (RAB 1989–61). Additionally, the Department maintained that plaintiffs failed to submit proper documentation that the sales taxes had been paid in RD–108 forms (Application for Michigan Title & Registration–Statement of Vehicle Sale). Finally, specifically as to Ally, the Department argued that Ally’s elections forms were not sufficient to determine whether Ally or the dealerships were entitled to the refund. The Department noted that under MCL 205.54i, either a retailer or a lender could seek a refund for sales tax on bad debts, but that there had to be a clear election between the retailer and the lender as to who would be entitled to pursue the refund. The Department argued that although Ally had recently provided several documents purporting to be election agreements with retailers, those documents were signed and dated after the date Ally wrote off the bad debt for federal income tax purposes. Because the election forms applied only to “accounts currently existing or created in the future,” they were not applicable to the already written-off loans. Moreover, the Department argued that Ally could not simply rely on the written assignment of retail installment contracts between the retailers and Ally.   The Court of Claims entered three separate orders granting the Department summary disposition. In the Ally case, summary disposition was granted pursuant to MCR 2.116(C)(10) and in the Santander cases, summary disposition was granted pursuant to both MCR 2.116(C)(8) and (C)(10).   The Court of Claims first addressed whether Ally’s written elections with the retailers satisfied the statute and concluded that they did not because they applied only to “currently existing” loans and, therefore, did not cover the accounts for which Ally sought a deduction. The Court of Claims then went on to find that the Department could require a claimant to submit an RD–108 form where the legislature had empowered the Department to determine what evidence it needed. Finally, while recognizing it as a non-binding case, the Court of Claims cited to and relied upon the DaimlerChrysler case, when it concluded that repossessed property was excluded as bad debt.