WEIGH RISK, BENEFIT OF USING INFLATED MACHINERY TRADE-IN VALUE
Originally published on March 25, 2010
Last week, one of our clients bought two new tractors and traded in two used tractors.
The dealer’s trade-in values for the used tractors were considerably higher than what our client had originally paid, which prompted a call to our office.
Our client had agreed to pay $160,000 for one of the tractors after the trade-in. The dealer then offered to inflate the trade-in value of the used tractor, which would increase the cost of the new tractor for tax purposes. Our client would compute his annual capital cost allowance on the inflated cost.
Our client was concerned that the Canada Revenue Agency (CRA) might reassess the trade-in figure on the used tractor to one closer to its fair market value, specifically since the dealer’s contract listed its market value to be $45,000 and its trade-in value to be $163,000.
What are the tax costs and benefits of using an inflated trade-in value?
In this case, the client recognized that a capital gain would have to be reported on his corporate tax return in the amount of $90,500.
He also understood that this same gain would translate into a “bump” in the capital cost of the new tractor for tax purposes. This inflated cost would result in a higher claim for tax depreciation or capital cost allowance over the life of the tractor.
Does the increased tax shield or claim for capital cost allowance exceed the corporate taxes, which will be triggered when we dispose of the used tractor? In table two, we show the bump advantage in row E. The advantage is lowest in Manitoba and highest in Saskatchewan.
For our client, who lives in Saskatchewan, using the dealer’s “trade-in value,” even after including the corporate taxes on the capital gain, yield’s an overall tax advantage of $4,978.
Our farmer will be motivated to report the disposition of his used tractor at the dealer’s trade-in allowance of $163,000, resulting in an inflated cost bump of $90,500.
For Saskatchewan farmer Tom Zeiben, a reassessment took him all the way to the Tax Court of Canada.
The CRA reassessed his 1984-87 income tax returns on the grounds that his trade-in values used in the acquisition of a tractor and combine were considerably more than what he had originally paid for the items.
Zeiben argued that he found the dealers’ prices on his trade-in attractive, which is why he traded. How the dealers recovered these prices was of no concern to him.
At the trial, Zeiben said he had negotiated a cash difference from a dealer “list price,” which they had both known in advance.
Zeiben’s dealer testified that his list price was based on the prospect of discounts, reductions and special sales attractions from his supplier, which accounted for his ability to sell for cash at a much lower figure.
The CRA argued that generally accepted accounting principles required the recording of trade-ins at their true fair market value. The Tax Court judge ruled in favour of Zeiben. He concluded that the deal between Zeiben and his dealer was negotiated in good faith and on a rationale that did not warrant the court’s rejection.
He also said the Income Tax Act contained no definition of the word “cost” for purposes of computing capital cost allowance.
We explained to our client the tax consequences, and the client decided to sign the contract of purchase and sale based on the inflated trade-in allowance realized when the dealer based the cash difference off his list price.
There remains a risk that the CRA could, under audit, re-examine the “true substance” of the contracts to arrive at a different conclusion about the true proceeds of disposition of the trade-ins as opposed to what the contracts showed them to be.
Tax implications vary from province to province. Producers should be sure that their trade-in allowance is based on a dealer “list price” that is relevant to the dealer’s place of business.
If the price is considered a sham and not negotiated in good faith, the CRA could reassess and impose interest and penalties, which would negate any advantage in a hurry.
Allyn Tastad, chartered professional accountant, is a partner in the accounting firm of Hounjet Tastad Harpham in Saskatoon at 306-653-5100, e-mail at firstname.lastname@example.org or website www.hth-accountants.ca. All data and information provided is for informational purposes only. Readers are cautioned that laws and regulations are subject to change. Consult your accountant for current professional advice tailored to your situation.