Large US corporate developers of timeshares and other forms of vacation ownership interval projects typically sell them to individual customers in exchange for installment obligations. The Internal Revenue Code provides such VOI sellers with special US regular corporate tax deferral benefits on those installment obligations.
VOI Deferral Rules
Section 453(l)(2)(B) generally permits US VOI sellers to treat installment obligations arising from VOI transactions as nondealer installment obligations. Such installment obligations thus favorably fall outside the scope of the Section 453(b)(2)(A) tax rule that disallows installment sale deferral on dealer sales.
Section 453(l)(2)(B) deferral of VOI installment obligations also favorably differ from generally accepted accounting principles (GAAP) timing rules, which generally include VOI installment gain at the time of sale. Section 453(l)(2)(B) thereby creates a timing difference of GAAP income in excess of corporate taxable income in the year the obligation is created. This timing difference is reversed about ratably over time, as the corporate income taxable, but GAAP excludable, installments are received.
But under Section 453(l)(3), as illustrated in TAM 9133002, when principal payments are received, the VOI seller is subject to a corporate tax deductible interest charge on such previously deferred corporate tax in addition to the regular corporate income tax. This effectively provides some compensation to the government for Section 453(l)(2)(B), allowing the installment gain to be deferred until collection.
The interest charge is determined by applying to the corporate tax payment upon the collection of the note, based on the applicable federal rate in effect at the date of sale. Section 453(l)(2)(C) provides that any interest income on VOI installment obligations added on the books of the seller to the established cash selling price of the VOI is deferrable, as if included in the total contract price.
Section 453A(b)(4) favorably excepts VOI installment obligations from the application of the Section 453A(c) interest charge rules. Section 453A(c) generally imposes a corporate tax-deductible interest charge on the expected future corporate tax attributable to the uncollected balance of non-VOI installment obligations in excess of $5 million. However, Section 453A(b)(4) restates that the Section 453(l)(3) interest charge on the triggered corporate tax attributable to the collected balance of installment obligations applies to VOI installment obligations. Section 453A(b)(4) also favorably excepts VOI installment obligations from the application of the pledge rules in Section 453A(d), which triggers gain to the extent a non-VOI installment obligation is pledged by the corporate payee to secure a loan.
A 2021 Congressional Research Report listed “deferral of gain on nondealer installment sales” as the ninth-largest corporate tax preference overall. It is the second-largest deferral corporate tax preference listed behind “depreciation of equipment in excess of the alternative depreciation system.” Since excess tax depreciation generally isn’t subject to the CAMT, nondealer installment gain may well be the largest potential timing difference that could be the subject of the CAMT.
Hilton Global Vacations
Hilton Global Vacations Inc., a New York Stock Exchange-traded company, is one of the major US timeshare sellers. HGV is incorporated in Delaware and headquartered in Florida and has domestic and international operations. According to its 2021 Form 10-K, HGV has two major business segments: real estate sales and financing, which includes selling VOIs and managing and pledging the resulting VOI obligation portfolio; and resort operations, which includes operating the timeshare resorts, typically under cost plus 10% to 15% markup contracts with the resort owners’ associations.
In 2021, HGV’s real estate and sales and financing segment produced $1.5 billion in revenue consisting mainly of VOI obligations secured by the VOIs sold. Less an allowance for collectability, these obligations were immediately recognized for GAAP purposes upon completion of the resort construction. HGV’s resort operations segment produced $700 million in revenue. Its total 2021 GAAP income before taxes was $300 million—a sharp recovery from the $300 million pretax GAAP loss during 2020, which was heavily marked by Covid-19. First half 2022 annualized 2022 GAAP net income was $400 million.
During 2021, about 75% of HGV’s VOI sales were financed. Each of HGV’s $2.4 billion VOI obligations on hand on Dec. 31, 2021, typically constituted about 90% of the selling price of the VOI, reflecting a 10% down payment. The average VOI loan outstanding during 2021 was about $22,000. The original term of the VOI obligations was generally 10 years, and their weighted average interest rate was about 14%. The average default rate on VOI installment obligations during 2021 was about 9%. Shortly after their origination, most of HGV’s VOI obligations have been pledged by HGV as security for loans. As of year-end 2021, HGV’s deferred income tax liability account that was attributable to deferred income timing differences was $500 million.
Perhaps forthcoming IRS corporate alternative minimum tax guidance issued under the regulatory authority of Section 56A could provide some CAMT relief on timing differences in general and the VOI installment sales in particular. In the absence of such guidance, Part 2 of this article will look at how the CAMT and OECD Pillar Two may affect HGV and other VOI sellers.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Alan S. Lederman is a shareholder at Gunster, Yoakley & Stewart, P.A. in Fort Lauderdale, Fla.
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