Court Approval of VW-Dealer Settlement Still Leaves Taxation Question Unanswered

On January 23, U.S. District Judge Court Breyer gave the Court’s final approval to the Volkswagen settlement, holding that “the settlement is fair, reasonable and adequate.”

The Court evaluated eight factors in considering the fairness and reasonableness of the proposed settlement.  Two discussions related to the impact of the emission scandal on VW franchise value.

In discussing the strength of the Class Members’ case, the Court noted that the dealers submitted expert testimony as to the lost profit exposure of Class Members which provided a “reliable estimate for either the present value of lost profit, or alternatively, a diminishment to the earnings capacity of Class Members’ franchises.”

In discussing the “experience and views of counsel” as a factor to be considered, the Court stated – in part – that “Class Counsel ‘strongly support this settlement’ because it ‘provides Franchise Dealer Class Members with genuine and substantial financial support to compensate them for the loss in the value of their dealerships’.”

Based on these statements, some CPAs might accept them as clear support for reducing previously capitalized VW franchise value or goodwill by the amounts of the payments (to be) received.

Let’s inject a note of caution here.  Language elsewhere in the Court’s opinion indicates that in evaluating various factors, “Courts need not ‘reach any ultimate conclusions on the contested issues of fact and law which underlie the merits of the dispute, for it is the very uncertainty of outcome in litigation and avoidance of wasteful and expensive litigation that induce consensual settlements’.”

It really comes down to this:  Now that we know that the terms of the settlement have been accepted, how should these payments be characterized for income tax purposes?  Are they ordinary income?  Or, are they basis reductions potentially resulting in long-term capital gain?

Viewing ratification by the Court as a foregone conclusion, Volkswagen paid almost 60% of the dealers in the Class (374 of 644 dealers) the initial 50% of their cash component in December 2016.  Another 155 dealers received their initial payment on January 13, 2017, and another 10 dealers received their initial payment a few days later.

Clearly, since almost all of the dealers have already accepted payments from VW, they now need some precedentially binding guidance (i.e., certainty) from the IRS on how these payments should be treated for tax purposes.  It’s now time for NADA to push the IRS to provide that guidance to insure uniform treatment across this broad spectrum of taxpayers.