T H E B E N E F I T S F O R T H E D E A L E R , R F C A N D T H E C U S T O M E R A R E R E A L LY C O M P E L L I N G .
LHPH vs. BHPH: Should My Dealership Switch? In recent years, the Lease Here-Pay Here (LHPH) model has generated some buzz in the world of subprime auto sales – and for good reason. LHPH is an offshoot of the Buy Here-Pay Here (BHPH) concept, but it involves a dealer retaining the title to each vehicle and charging usage fees to customers. While the difference might seem subtle at first, it can radically change how the vehicle transaction is managed, taxed and regulated. Among the advantages of LHPH: •Deferred sales tax. • A federal income tax deduction for depreciation of your assets. • It doesn’t require a related finance company (RFC). •Less burdensome regulations. •Faster repossession times. • Vehicles can’t be claimed in a bankruptcy. Probably the most commonly cited advantage of switching to a lease program is the ability to defer sales tax payment on your vehicles. Instead of paying sales tax up front – long before you’ve received all of the customer’s money – you’re allowed to pay the sales tax in installments, every time your customer pays you. That lessens your risk of losing money when a customer defaults, and it makes cash flow more even and manageable. George Klinke, vice president of business development for the San Diegobased company LHPH, LLC, called that the greatest advantage of the model. “There are 32 states where there’s a real cash flow incentive,” Klinke said. “When you buy a car in California, you pay an 8.75 percent sales tax on that vehicle. On a $20,000 car, you’re paying $1,750. That’s money that comes out of the dealer’s or the consumer’s pocket today.” But in California and 31 other states, dealerships can pay the sales tax on
each vehicle as payments are collected, rather than at the lease’s inception. Additionally, lessors can collect a security deposit, which is not subject to taxation. “This is a pool of money where if there are other expenses that come up in the lease, the security deposit can be applied against those,” Klinke said. Unless state law mandates otherwise, the only up-front tax on a lease is paid on the cap cost reduction. For years, BHPH dealers have avoided income taxes on “phantom income” through the use of a related finance company. An RFC is a legally separate corporation an auto dealership establishes to handle financing, often for customers who have difficulty obtaining credit from traditional lenders. Usually, the dealership sells the note from each vehicle transaction to its RFC at a discount, eliminating most of the dealership’s profit on the sale, which would have been taxable income even though no payments had yet been collected from the consumer. The RFC’s income on the note purchase, however, is taxed as the payments are collected, avoiding a large income tax on profits that haven’t been earned yet and creating a substantial cash flow advantage. If executed correctly, this setup is entirely legal. The IRS has even written a guide for it, available at www.irs.gov/ businesses/article/0,,id=137739,00. html. But the IRS also examines RFCs carefully for evidence that they’re substantive businesses that remain at “arm’s length” from dealerships, rather than thinly disguised shell corporations. One small misstep could place you in line for an audit. For dealers wanting to avoid this compliance headache and the difficulty of establishing a legitimate RFC, LHPH is an attractive option.
Because of the inherent tax advantages of leasing, it is not necessary to have a related finance company to handle LHPH deals – though dealers may still choose to keep their RFCs as a buffer against bad publicity, lawsuits and financial risk. Because the dealer is the lessor and therefore the owner of the asset (vehicle), he can claim depreciation over the term of the lease based on IRS guidelines and use it as an income tax deduction, reducing the overall tax bill. Jason Berger, managing partner of AK Acceptance, an RFC in Pittsburgh, said LHPH deals are not constrained by the tougher regulatory requirements that affect BHPH dealers. At the federal level, LHPH deals fall under the less restrictive Regulation M rules that govern auto leasing, rather than the notoriously tough Regulation Z rules that govern auto sales. Under Reg M, a dealer is not obligated to disclose an annual percentage rate because there is no interest rate in a lease – just a “rent” or “lease” charge. The lack of an interest rate also means you are is not encumbered by state usury limits. You can impose mileage overage charges to protect the value of the vehicle. And if the lessee declares bankruptcy after starting an LHPH deal, he won’t be able to avoid repossession because he never had ownership of the vehicle. For the same reason, if a lessee breaches the contract, there’s no mandatory grace period to comply with for repossessions. “We pull the trigger faster,” Berger said, noting dealerships can technically repossess a vehicle if a payment is even one day late – though that might not be a great way to build goodwill in the community. “My target turnaround time is 21 days from the time of default [to when the car is available to lease again]. C O N T I N U E D O N PA G E 2 6
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