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This is a hypothetical situation. John owns a vehicle worth $5000. John gave this vehicle to his friend David for free and one week later, David gave John a $5000 monetary gift for John's birthday.
In this scenario, is it lawful for David not to pay sales tax for this vehicle as they both agree that the selling price for the vehicle is $0?
First, let's deal with the implicit assumption that sales tax is not payable on gifts. Whether that is true or not depends on the law in your jurisdiction.
For example, in australia there is no Goods and Services Tax (GST) payable on a gift because a gift is not a "supply" under the law. Technically, a value-added tax like the GST is not a sales tax but close enough.
However, exchanging a "gift" for something of value (airline points, for example) is not a gift.
Of course, Australian States and Territories levy Stamp Duty on the transfer of a vehicle's registration, and this is calculated on the sale price or the market price whichever is the greater. Also, technically, that's not a sales tax either.
Assuming that there is no sales tax payable on a gift; if John and David entered into this arrangement (not a contract because of its illegal purpose) to avoid tax, then tax is payable and they are now criminals.
If the relevant tax authority learns what happened and decides to investigate, then John and David might have some explaining to do. If David can show that he has routinely given John large cash gifts on John's birthday, then they may convince the authority not to prosecute. If they can't, then they get to try to convince a judge.
It is not atypical for tax law to reverse the onus of proof: the government doesn't have to prove tax is payable, John and Dave have to prove it isn't.
If you receive a vehicle as a gift you must pay [provincial sales tax] on the fair market value of the vehicle, unless a specific exemption applies.
(British Columbia, "PST on Vehicles", p. 10)
There are exemptions for inheritance, relatives, charities, lotteries, and transfers during property division during dissolution of a marriage or marriage-like relationship.
Since the vehicle is worth $5,000 or less, the transfer is exempt from taxation (Saskatchewan, "Information Bulletain: PST-58").
If you receive a vehicle as a gift, you will generally have to pay tax based on the fair value of the vehicle determined using the Canadian Red Book listing or a review by the Provincial Tax Commission (Nova Scotia, "Tax on Privately Purchased Vehicles").
As you likely expect, most locales have laws to handle these sorts of attempted workarounds. In texas for example (source), transferring a motor vehicle for $0 is considered a "gift" if the recipient is an immediate family member, estate, or non-profit organization. Such a gift is subject to a gift tax (currently $10). The recipient is merely a friend in your scenario, so the following rule would apply:
The transfer of a motor vehicle for no consideration, that does not qualify as a gift, is taxed as a sale and SPV procedures may apply.
SPV is the "Standard Presumptive Value". You can think of this as the average selling price for that specific vehicle. So in other words, you'll have to pay the same taxes as if the car was sold for a fair price.
"Hey, that's easy to get around as well. I'll sell it for $10, that way it's not a transfer 'for no consideration'!"
When you buy a vehicle, the law says you pay tax on "the greater of the sales price or 80 percent of the vehicle’s SPV". If you try to cheat the tax man by selling the vehicle for an unreasonably low price, you'll be taxed based on the SPV instead. If the car you're buying is in awful condition and its actual value is much less than the SPV, you can avoid being taxed on the greater amount by presenting "a valid certified appraisal" that confirms the vehicle's fair market price.
The IRS has "gift taxes". Generally the donor pays, but there are fairly large exemptions.
However, you are using reciprocal gifts to conceal what's actually a barter. (well a barter with money on one leg is technically a sale). IRS casts a wide net looking for such transactions: to show the extremes to which they go, consider three brothers each with a trust fund for their children. The brothers wanted to gift six times the legally exempt amount for in-family giving... so they made a pact for each brother to give to all three trust funds, and their spouses to do the same. IRS objected and tax court sided with IRS. So no, the illusionary gifts will not be treated as such, and will be treated as a barter or sale.
At the Federal level, the sale would not be a taxable event: First, buying things doesn't create income tax. The seller would only need to pay income tax on the net profits, meaning sale price minus what they paid for it. And since cars generally decline in value, they probably have a higher cost basis than they sold it for, so no tax owed.
As such, it is unlikely that the IRS would take an interest in this transaction - the juice isn't worth the squeeze... But don't confuse "no penalty" with "lawful". The "fake gifts" equating to a barter or sale is absolutely not lawful.
It will matter to the state on a couple of levels. First, most states will want to collect sales tax, and this process is generally built right into the vehicle titling and registration system. Second, in many states the registration fee is based on the sales price. In both these cases, the state will have a stake, and will see things the same way the IRS does. So they certainly will see this as an attempt at tax fraud, and they will consider the juice to be worth the squeeze.
