Washington Governor Christine O. Gregoire has signed into law a bill reversing the effects of Puget Sound National Bank v. Department of Revenue, 868 P.2d 127 (Washington 1994), the 16-year old seminal case that established the right of an assignee of a debt instrument to recover sales tax paid to the state when the debtor defaults.
The Washington State Legislature passed the bill, Second Engrossed Substitute Senate Bill 6143, on April 19, 2010, which was signed by the Governor April 23, 2010. It amends RCW 82.08.037 and 82.12.037 to provide that, for sales tax purposes, a “bad debt” does not include “debts sold or assigned by the seller to third parties, where the third-party is without recourse against the seller.” The bill does provide that an original seller may seek a refund of the tax after a debt instrument has been reassigned to it by the third-party lender.
The change is effective for refunds or credits filed with the Department of Revenue after June 30, 2010. By limiting sales tax bad debt recovery to sellers only, the state expects to gain $1.7 million in new revenue in the 2011 fiscal year.
The Washington Supreme Court’s 1994 decision in the Puget Sound National Bank v. Department of Revenue (“Puget Sound”) case laid the legal groundwork for a nationwide effort to establish the right to a bad debt refund of taxes paid on credit transactions where the original seller had assigned the receivable to a third-party lender.
The case involved a Washington bank that purchased automobile loan contracts on a nonrecourse basis from local auto dealers. Under Washington law, the full amount of sales tax on the purchase price of an automobile became due at the time of the sale (Wash. Adm. Code § 458-20-198). When purchasing the sales contracts, the bank paid each dealer the balance due on the sale and the applicable uncollected portion of the state sales tax. In return, the dealer assigned to the bank all of the rights in the installment contract. When buyers subsequently defaulted on their payments, the bank repossessed the cars, sold them at a loss, and wrote the losses off as worthless debts for federal tax purposes. The bank then sought a refund for the sales tax under RCW 82.08.037, which limited the refund to a person “making a sale at retail” who had paid the sales tax on debts that were deductible as worthless for federal income tax purposes.
Although the bank was not the entity that made the sale at retail, the Washington Supreme Court reasoned that the dealerships’ assignments of the installment contracts to the bank put the bank “in the shoes” of the dealerships and ruled that the bank was thus itself entitled to the refund. It found no statutory or public policy prohibition against the assignment of a sales tax refund.