The Benefits and Tips to Creating a Related Finance Company

October 1, 2019 | Branden Wilson

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By Branden Wilson, CPA

Co-Authored By Chelsea O’Shields

Many dealership owners have found that the use of a related finance company, or a “buy-here, pay here” business, is extremely beneficial for their dealership, if operated correctly.  As a dealer, here is why you might consider establishing a related finance company and a few things to be aware of during the process.

What is a related finance company and its associated benefits?

A related finance company or “RFC” for used car dealerships is a company that finances contracts for customers purchasing an automobile. While it is a separate legal entity, it will have similar ownership to the dealership that it services.

The two key benefits to setting up an RFC are income tax and financing related. Accrual based taxpayers must pay tax on the sale of inventory in the current year, even if no cash was received until the following taxable year. RFCs essentially allow the taxpayer to convert the sale to the cash basis method and actually pay taxes as they collect the money.

Another benefit is the ease of obtaining financing. If a dealer decides to take financing against the receivables on their books, it may cause conflict with floorplan lender since both may want to use the receivables as collateral. By moving these receivables to a related finance company, it alleviates this conflict and makes obtaining financing easier.

When should you consider a related finance company?

We encourage dealers to consider setting up a RFC around the time they reach approximately $1 million or more in receivable portfolio size, while also considering the average number of sales transaction each month and expected growth. Due to additional expenses involved in setting one up, such as additional filing requirements and hiring new staff and collections personnel, they are not the perfect fit for everyone.

How do I set one up?

Upon deciding that this strategy makes sense for your business, there are certain steps one must take. The RFC must be established as a separate legal entity which involves filing for state and local licenses, occupational licenses, separate mailing address and phone number, and other guidelines as set out by the Internal Revenue Service. Most importantly, funds and accounting records between the RFC and the dealership must be kept separate, so a new bank account and accounting software will need to be set up. 

What do I do after I set one up?

A Master Dealer Agreement will need to be drafted between the dealership and the RFC. It needs to outline the terms between the two parties that states the RFC may from time to time decide to purchase retail contracts from the dealership at fair market value without recourse. The IRS prefers cash funding of these purchases; however, if this is not an timely option for the dealer, a promissory note can be formed. Regular payments must be made in accordance with the note, including interest.

The RFC must also comply with state title and lien recording rules. The RFC will need to be set up as the lienholder of the titles and the sales agreement will show that the dealership sold the vehicle. There should also be a retail installment contract entered into in the name of the dealer and the assigned or shown as assignable by the dealer to the RFT. Customers will need to be notified that their contracts were sold to the separate entity and notify them of where to send their future payments.

If you are interested in learning more about related finance companies or need help deciding if one if the perfect fit for your business, please call us.

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