Deducting related-party interest and intangible expenses.EXECUTIVE SUMMARY * State addback provisions limit a corporation's ability to use intercompany licensing and financing arrangements to reduce state income taxes. * Most states that have addback provisions grant exceptions for intercompany financing and licensing arrangements motivated mo·ti·vate tr.v. mo·ti·vat·ed, mo·ti·vat·ing, mo·ti·vates To provide with an incentive; move to action; impel. mo by legitimate business purposes. * Although state statutes have common themes, there are many variations and significant differences, particularly as to when exceptions will apply. ********** Over a dozen states have enacted laws disallowing deductions for interest and intangible expenses paid to related parties, and several other states have proposed such laws. This article provides an overview of various state interest and intangible expense addback provisions. In response to fiscal pressures and the perception that significant tax revenues are being lost to corporate tax shelter tax shelter: see tax exemption. activities, states have enacted laws that disallow To exclude; reject; deny the force or validity of. The term disallow is applied to such things as an insurance company's refusal to pay a claim. deductions for interest and intangible expenses paid to related parties. In 2004, Illinois Illinois, river, United States Illinois, river, 273 mi (439 km) long, formed by the confluence of the Des Plaines and Kankakee rivers, NE Ill., and flowing SW to the Mississippi at Grafton, Ill. It is an important commercial and recreational waterway. , Maryland Maryland (mâr`ələnd), one of the Middle Atlantic states of the United States. It is bounded by Delaware and the Atlantic Ocean (E), the District of Columbia (S), Virginia and West Virginia (S, W), and Pennsylvania (N). , Tennessee Tennessee, state, United States Tennessee (tĕn`əsē', tĕn'əsē`), state in the south-central United States. , Virginia Virginia, state, United States Virginia, state of the south-central United States. It is bordered by the Atlantic Ocean (E), North Carolina and Tennessee (S), Kentucky and West Virginia (W), and Maryland and the District of Columbia (N and NE). and the District of Columbia District of Columbia, federal district (2000 pop. 572,059, a 5.7% decrease in population since the 1990 census), 69 sq mi (179 sq km), on the east bank of the Potomac River, coextensive with the city of Washington, D.C. (the capital of the United States). enacted such "anti-passive investment company" provisions. Similar provisions were enacted in 2003 by Arkansas Arkansas, river, United States Arkansas (ärkăn`zəs, är`kənsô'), river, c.1,450 mi (2,330 km) long, rising in the Rocky Mts., central Colo. , Massachusetts Massachusetts (măsəch  `sĭts), most populous of the New England states of the NE United States. , New York New York, state, United StatesNew York, Middle Atlantic state of the United States. It is bordered by Vermont, Massachusetts, Connecticut, and the Atlantic Ocean (E), New Jersey and Pennsylvania (S), Lakes Erie and Ontario and the Canadian province of (as well as New York City New York City: see New York, city. New York City City (pop., 2000: 8,008,278), southeastern New York, at the mouth of the Hudson River. The largest city in the U.S. ) and Oregon Oregon, city, United States Oregon, city (1990 pop. 18,334), Lucas co., NW Ohio, a suburb adjacent to Toledo, on Lake Erie; inc. 1958. It is a port with railroad-owned and -operated docks. The city has industries producing oil, chemicals, and metal products. ; by New Jersey in 2002; by Alabama Alabama, indigenous people of North America Alabama (ăləbăm`ə), indigenous people of North America whose language belongs to the Muskogean branch of the Hokan-Siouan linguistic stock (see Native American languages). , Mississippi Mississippi, state, United States Mississippi (mĭs'əsĭp`ē), one of the Deep South states of the United States. It is bordered by Alabama (E), the Gulf of Mexico (S), Arkansas and Louisiana, with most of the border formed by and North Carolina North Carolina, state in the SE United States. It is bordered by the Atlantic Ocean (E), South Carolina and Georgia (S), Tennessee (W), and Virginia (N). Facts and Figures Area, 52,586 sq mi (136,198 sq km). Pop. in 2001; by Connecticut Connecticut, state, United States Connecticut (kənĕt`ĭkət), southernmost of the New England states of the NE United States. It is bordered by Massachusetts (N), Rhode Island (E), Long Island Sound (S), and New York (W). in 1998; and by Ohio in 1991. In recent years, similar legislation was also introduced in Indiana Indiana, state, United States Indiana, midwestern state in the N central United States. It is bordered by Lake Michigan and the state of Michigan (N), Ohio (E), Kentucky, across the Ohio R. (S), and Illinois (W). , Missouri Missouri, state, United States Missouri (mĭz  r`ē, –ə), one of the midwestern states of the United States. , Pennsylvania Pennsylvania (pĕnsəlvā`nyə), one of the Middle Atlantic states of the United States. It is bordered by New Jersey, across the Delaware River (E), Delaware (SE), Maryland (S), West Virginia (SW), Ohio (W), and Lake Erie and New York , Rhode Island Rhode Island, island, United StatesRhode Island, island, 15 mi (24 km) long and 5 mi (8 km) wide, S R.I., at the entrance to Narragansett Bay. It is the largest island in the state, with steep cliffs and excellent beaches. , Texas and West Virginia West Virginia, E central state of the United States. It is bordered by Pennsylvania and Maryland (N), Virginia (E and S), and Kentucky and, across the Ohio R., Ohio (W). Facts and Figures Area, 24,181 sq mi (62,629 sq km). Pop. . By requiring corporations to add back otherwise deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). interest and intangible expenses, states limit corporate taxpayers' ability to use intercompany licensing and financing arrangements to reduce state income taxes. This article provides an overview of the various state interest and intangible expense addback provisions. These provisions contain numerous special rules and exceptions; although the various state statutes share common themes, there are significant differences among the states. Thus, a thorough analysis of each state's provisions is required to ensure compliance. Background An example of the type of arrangement targeted by state addback provisions is the use of trademark holding companies. An operating company operating company A business that engages in transactions with outsiders. transfers its trademarks and other marketing intangibles Property that is a "right" such as a patent, Copyright, or trademark, or one that is lacking physical existence, such as good will. to a separately incorporated subsidiary organized in Delaware Delaware, state, United States Delaware (dĕl`əwâr, –wər), one of the Middle Atlantic states of the United States, the country's second smallest state (after Rhode Island). (which does not tax the income of intangible property intangible property n. items such as stock in a company which represent value but are not actual, tangible objects. companies) (1) or in a state like Nevada Nevada (nəvăd`ə, –vä–), far western state of the United States. It is bordered by Utah (E), Arizona (SE), California (SW, W), and Oregon and Idaho (N). (which has no corporate income tax). The subsidiary then licenses the intangibles back to the operating affiliate Affiliate Relationship between two companies when one company owns substantial interest, but less than a majority of the voting stock of another company, or when two companies are both subsidiaries of a third company. See: Subsidiaries, parent company. . This transaction gives the operating company a royalty Compensation for the use of property, usually copyrighted works, patented inventions, or natural resources, expressed as a percentage of receipts from using the property or as a payment for each unit produced. expense deduction deduction, in logic, form of inference such that the conclusion must be true if the premises are true. For example, if we know that all men have two legs and that John is a man, it is then logical to deduce that John has two legs. that reduces its state income tax in a separate-company reporting state. In contrast, the corresponding royalty income is tax free, because the payee's income is not subject to state income tax. In requiring the operating company to add back the royalty expense deductions, states deny the tax benefit of establishing an intangible property company. Such companies generally do not reduce taxes in states that require combined unitary unitary pertaining to a single object or individual. reporting, because the intercompany income and expenses offset each other when the operating company and the intangible property company are combined. If foreign affiliates are not included in the combination, however, any interest or intangible expenses that the unitary group's U.S. members pay or accrue To increase; to augment; to come to by way of increase; to be added as an increase, profit, or damage. Acquired; falling due; made or executed; matured; occurred; received; vested; was created; was incurred. to an offshore intangible property company might reduce state taxable income Under the federal tax law, gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual or entity's tax liability. The essence of taxable income is the accrual of some gain, profit, or benefit to a taxpayer. . Expenses Targeted by Addback Provisions The states that disallow deductions for related-party payments generally require a corporation to add back to Federal taxable income, any otherwise deductible intangible and interest expenses directly or indirectly paid or accrued ac·crue v. ac·crued, ac·cru·ing, ac·crues v.intr. 1. To come to one as a gain, addition, or increment: interest accruing in my savings account. 2. to a related member (see Exhibit 1 on p. 288). All of the state addback provisions apply to intangible expenses (e.g., royalties Not to be confused with Royal family. Royalties (sometimes, running royalties) are usage-based payments made by one party (the "licensee") to another (the "licensor") for ongoing use of an asset, most typically an intellectual property (IP) right. ); most also apply to interest expense. In recognizing that intercompany financing and licensing arrangements are often motivated by valid business purposes and not tax avoidance The process whereby an individual plans his or her finances so as to apply all exemptions and deductions provided by tax laws to reduce taxable income. Through tax avoidance, an individual takes advantage of all legal opportunities to minimize his or her state or federal , each state provides some relief from the automatic disallowance dis·al·low tr.v. dis·al·lowed, dis·al·low·ing, dis·al·lows 1. To refuse to allow: "[The government] of such deductions, through statutory exceptions. Interest Expenses In most states, the addback requirement applies to any otherwise deductible interest expense paid or accrued to a related member, unless a statutory exception applies. For example, Maryland's and New Jersey's addback provisions apply to any "otherwise deductible interest expense" paid or accrued to a related member. (2) For this purpose, both states define interest expense as amounts deductible under Internal Revenue Code The Internal Revenue Code is the body of law that codifies all federal tax laws, including income, estate, gift, excise, alcohol, tobacco, and employment taxes. These laws constitute title 26 of the U.S. Code (26 U.S.C.A. § 1 et seq. (IRC (Internet Relay Chat) Computer conferencing on the Internet. There are hundreds of IRC channels on numerous subjects that are hosted on IRC servers around the world. After joining a channel, your messages are broadcast to everyone listening to that channel. ) Sec. 163. (3) Some states, such as Mississippi and New York, require an addback only of interest expense related to the acquisition, ownership or disposition Act of disposing; transferring to the care or possession of another. The parting with, alienation of, or giving up of property. The final settlement of a matter and, with reference to decisions announced by a court, a judge's ruling is commonly referred to as disposition, regardless of of intangible assets Intangible Asset An asset that is not physical in nature. Notes: Examples are things like copyrights, patents, intellectual property, and goodwill. These are the opposite of tangible assets. . (4) For example, if a parent pays a royalty to a subsidiary intangible property company, and the subsidiary lends lend v. lent , lend·ing, lends v.tr. 1. a. To give or allow the use of temporarily on the condition that the same or its equivalent will be returned. b. the funds back to the parent, the parent's interest paid on the loan must be added back. Intangible Expenses State addback provisions also generally apply to any otherwise deductible "intangible expenses" paid or accrued to a related member, unless a statutory exception applies. Although the principal target of these provisions is related-party royalties, the concept of intangible expenses in most states is broader. For example, the Virginia addback provision defines intangible expenses and costs to include (1) otherwise deductible expenses, losses and costs related to the acquisition, ownership or disposition of intangible property; (2) losses related to factoring transactions; (3) royalty, patent, technical and copyright fees; (4) licensing fees; and (5) other similar expenses and costs. For this purpose, "intangible property" means patents, patent applications, trade names, trademarks, service marks, copyrights and similar types of intangible assets. (5) North Carolina has a narrowly drawn addback provision that applies only to deductions for a "North Carolina royalty," which is a royalty, technical fee, licensing fee or similar charge for the use in the state of a trademark, trade name, service mark or similar type of intangible asset. (6) For example, at the taxpayer's election, if a corporation that operates retail stores in North Carolina pays a royalty to a related member for the use of trademarks at its retail locations in the state, the taxpayer must either add back the royalty in computing computing - computer its North Carolina taxable income, or the related payee The person who is to receive the stated amount of money on a check, bill, or note. payee n. the one named on a check or promissory note to receive payment. PAYEE. The person in whose favor a bill of exchange is made payable. must include the royalty income on a North Carolina income tax return filed for the same tax year in which the taxpayer deducts the royalty expense. Related Members State addback provisions apply to certain expenses paid or accrued to a related member. A "related member" generally includes, among other things, a component member of a controlled corporate group (as defined in Sec. 1563(b)) of which the taxpayer is a member. (7) The control test in IRC Sec. 1563(b) is 80%-or-more stock ownership; thus, members of an affiliated af·fil·i·ate v. af·fil·i·at·ed, af·fil·i·at·ing, af·fil·i·ates v.tr. 1. To adopt or accept as a member, subordinate associate, or branch: group (as defined in IRC Sec. 1504(a)) that elect to file a Federal consolidated con·sol·i·date v. con·sol·i·dat·ed, con·sol·i·dat·ing, con·sol·i·dates v.tr. 1. To unite into one system or whole; combine: return are generally deemed related for purposes of state addback provisions. State definitions of a related member also generally include a related entity, such as an individual who directly or indirectly owns at least 50% of the value of the taxpayer's outstanding stock. New York's definition is broader and includes any corporation or other entity, when one such entity (or a set of related entities) owns or controls at least 30% of the combined voting power or at least 30% of the capital, profits or beneficial interests in the other entity. (8) When Addback Not Required States that require taxpayers to add back interest and intangible expenses paid or accrued to related members generally offer some relief from the automatic disallowance of such deductions. These exceptions reflect the reality that many intercompany financing and licensing arrangements are motivated by legitimate business purposes, rather than tax avoidance. The exceptions are quite complex and often apply to one type of related-party payment, interest expense or intangible expense, but not the other. The exceptions are summarized below. Conduit Payment Exception Some states do not require related-party interest or intangible expense addbacks if the taxpayer establishes that (1) the related-income recipient One who receives. The person to whom an e-mail message is sent is the recipient. (communications) recipient - One who receives; receiver. E.g. "No recipient of the e-mail message will know about the other addressees who were listed in the BCC header." paid the expense to an unrelated person during the same year and (2) tax avoidance was not a principal purpose of the related-party transaction Related-Party Transaction A business deal or arrangement between two parties who are joined by a special relationship prior to the deal. For example, a business transaction between a major shareholder and the corporation, such as a contract for the shareholder's company to perform that gave rise to the expense (see Exhibit 2 on pp. 290-293, Column A). This exception reflects the view that the related payee is merely a conduit for the taxpayer's payment of legitimate interest or intangible expenses to an unrelated third party. Examples of nontax business purposes for related-party interest payments include centralized cen·tral·ize v. cen·tral·ized, cen·tral·iz·ing, cen·tral·iz·es v.tr. 1. To draw into or toward a center; consolidate. 2. borrowing from public capital markets followed by intercompany loans Intercompany loan Loan made by one unit of a corporation to another unit of the same corporation. to operating units operating unit A type of operating company that engages in transactions with outsiders and that is owned by another business. For example, in 1995 the stockholders of Capital Cities/ABC approved a $19 billion merger with the Walt Disney Company, whereupon , and centralized cash management transactions, in which surplus cash generated by some affiliates is pooled and used to pay other affiliates' expenses. For New York tax purposes, the conduit exception applies only if the taxpayer also establishes that the related-party payment was arm's length arm's length adj. the description of an agreement made by two parties freely and independently of each other, and without some special relationship, such as being a relative, having another deal on the side or one party having complete control of the other. , and the transaction had a "valid business purpose." A valid business purpose is "one or more business purposes, other than the avoidance or reduction of taxation, which alone or in combination constitute the primary motivation for some business activity or transaction, which activity or transaction changes in a meaningful way, apart from tax effects, the economic position of the taxpayer." (9) In contrast, for Mississippi and North Carolina tax purposes, the taxpayer need not establish the lack of a tax avoidance motive motive or motif (mōtēf`), in music, a short phrase or passage of two or more notes and repeated or elaborated throughout the composition. The term is usually used synonymously with figure. for the conduit exception to apply. Taxation of Corresponding Income Exception Some states do not require an addback if the corresponding income is taxed to the related payee, in which case the transaction does not necessarily reduce the related parties' combined state tax burden (see Exhibit 2, Column B). For example, under Alabama's provision, no addback is required if the "corresponding item of income was in the same taxable year Taxable year The 12-month period an individual uses to report income for income tax purposes. For most individuals, their tax year is the calendar year. subject to a tax based on or measured by the related member's net income in Alabama or any other state of the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. , or by a foreign nation which has in force an income tax treaty with the United States." (10) This exception does not apply if the related payee's income is offset or eliminated in a combined or consolidated return. In addition, the exception applies only to the extent the corresponding item of income is included in the related payee's post-apportionment taxable income. An example is provided by the Alabama Department of Revenue (DOR Dor or Dora, Canaanite seaport, ancient Palestine (modern Israel), N of Caesarea Palestinae. It was never a Jewish city but rather a Phoenician outpost. It was rebuilt by the Romans; still visible are the ruins of a temple and a theater. ): A Corp. pays a $100 royalty to B Corp., a related member. B files an income tax return only in State B, to which it apportions 5% of its income. A must add back $95 of the $100 in royalties; the other $5 qualifies for the exception. (11) In many states, the "subject to tax" exception applies only if the related payee's corresponding income bears a certain type or level of taxation. For example, the North Carolina exception applies only if the related payee includes the corresponding income in that state's return filed for the same tax year. The New York exception applies only to income paid to a corporation organized in a foreign country that has an income tax treaty with the U.S., and is taxed in the foreign country at a rate at least equal to New York's. The Connecticut, Massachusetts and New Jersey exceptions apply only to interest (not royalties), and only if the effective (or, in some cases, aggregate) state tax rate on the related payee's income is within three percentage points of the state's effective (or, in some cases, statutory) tax rate. Example: O Corp. is subject to Massachusetts tax at a 9.5% statutory rate. It makes interest payments to P Corp., a related member. P apportions 25% of its income to each of the following four states and is subject to tax at the rates noted: Connecticut (7.5%), Kentucky Kentucky, state, United States Kentucky (kəntŭk`ē, kĭn–), one of the so-called border states of the S central United States. It is bordered by West Virginia and Virginia (E); Tennessee (S); the Mississippi R. (8.25%), Louisiana Louisiana (ləwē'zēăn`ə, l ē'–), state in the S central United States. It is bounded by Mississippi, with the Mississippi R. (8%) and Maryland (7%). P's effective tax rate
in each state equals 25% of the statutory rate (i.e., 1.875%, 2.063%, 2%
and 1.75%, respectively). Its total effective state tax rate is the sum
of the four rates, or 7.69%. Thus, O need not add back its deductions
for interest paid to P, because its 7.69% effective state tax rate is
within three percentage points of O's 9.5% Massachusetts tax rate.
(12) The calculation of effective tax rates to determine whether a
corporation is entitled en·ti·tle tr.v. en·ti·tled, en·ti·tling, en·ti·tles 1. To give a name or title to. 2. To furnish with a right or claim to something: to the "subject to tax" exception differs significantly among the states. Unreasonable Addback Exception A third common exception applies if the addback of related-party expenses produces an unreasonable result (see Exhibit 2, Column C). For example, according to according to prep. 1. As stated or indicated by; on the authority of: according to historians. 2. In keeping with: according to instructions. 3. Connecticut law, (13) an addback adjustment is not required "if the corporation establishes by clear and convincing evidence clear and convincing evidence n. evidence that proves a matter by the "preponderance of evidence" required in civil cases and beyond the "reasonable doubt" needed to convict in a criminal case. (See: beyond a reasonable doubt) that the adjustments are unreasonable." For Alabama tax purposes, an adjustment is unreasonable if it has "increased the taxpayer's Alabama income tax liability to an amount that bears no fair relation to the taxpayer's Alabama presence." (14) The New Jersey Division of Taxation identifies two potential situations in which adding back interest expense may produce an unreasonable result: (1) interest paid on intercompany payables/receivables created by cash sweeps from some affiliates and paying the expenses of other affiliates, when interest is credited to the entity relinquishing re·lin·quish tr.v. re·lin·quished, re·lin·quish·ing, re·lin·quish·es 1. To retire from; give up or abandon. 2. To put aside or desist from (something practiced, professed, or intended). 3. the funds, and each party profits from the transactions; and (2) interest paid on debt incurred to acquire a company, when the debt was pushed down to the acquired company without a guarantee by the taxpayer, and the taxpayer supplies appropriate documentation. (15) Alternative Adjustment Exception A fourth common exception provides relief if a taxpayer and state tax authorities agree to an alternative adjustment (see Exhibit 2, Column D). For example, under Massachusetts law, (16) an addback is not required if "the taxpayer and the commissioner agree in writing to the application or use of an alternative method of apportionment The process by which legislative seats are distributed among units entitled to representation; determination of the number of representatives that a state, county, or other subdivision may send to a legislative body. The U.S. ." The New Jersey Division of Taxation will allow an alternative method of apportionment "if the taxpayer is taxed upon more than 100% of its income." (17) Under Virginia law, the taxpayer must petition petition Written instrument directed to an individual, government official, legislative body, or court in order to seek redress of grievances or to request a favour. the tax commissioner for relief after filing its income tax return for the year and demonstrate by clear and convincing evidence that the related-party transaction had a valid business purpose other than tax avoidance. (18) Other Circumstances CIRCUMSTANCES, evidence. The particulars which accompany a fact. 2. The facts proved are either possible or impossible, ordinary and probable, or extraordinary and improbable, recent or ancient; they may have happened near us, or afar off; they are public or Exhibit 2, Column E, details other circumstances in which a taxpayer need not add back related-party interest or intangible expenses. For example, Connecticut, Massachusetts and New Jersey all provide exceptions for certain payments to a related member that is a resident of a foreign country having an income tax treaty with the U.S. The details vary from state to state. Ohio provides an exception when the increased tax attributable attributable emanating from or pertaining to attribute. attributable proportion see attributable risk (below). attributable risk to the addback would have been avoided had the taxpayer and the related member, to which it paid the expense, filed a combined return. Alabama and Mississippi do not require an addback when the related-party transaction was not tax-motivated, and the related payee is not primarily engaged in activities relating to relating to relate prep → concernant relating to relate prep → bezüglich +gen, mit Bezug auf +acc intangible assets. For Alabama tax purposes, "primarily engaged" means the related payee's receipts from intangibles activities exceed any other category of receipts. For example, if a company derives $400 of receipts from licensing intangibles, and $300 each from selling and repairing widgets, it is primarily engaged in intangibles activities, because its royalties exceed its receipts from either selling goods or rendering See render. (graphics, text) rendering - The conversion of a high-level object-based description into a graphical image for display. For example, ray-tracing takes a mathematical model of a three-dimensional object or scene and converts it into a bitmap image. services. (19) As a final example, Tennessee allows a deduction for related-party intangible expenses if the taxpayer discloses the expenses on its return and completes the schedule required by the commissioner. In addition, any taxpayer that claims a deduction without making the requisite disclosures is subject to a negligence negligence, in law, especially tort law, the breach of an obligation (duty) to act with care, or the failure to act as a reasonable and prudent person would under similar circumstances. penalty in addition to the tax assessment. (20) Combined Reporting States As noted above, intangible property company planning strategies generally do not erode Erode (ĕrōd`), city (1991 urban agglomeration pop. 361,755), Tamil Nadu state, S India, on the Kaveri River. The city is located in a cotton-growing region, and its industries include cotton ginning and the manufacture of transport equipment. the tax base of a state that requires combined unitary reporting, because the intercompany income and expenses offset one another when the operating and intangible property companies are combined. If foreign country affiliates are not included in the combination, however, any interest or intangible expenses paid or accrued to an offshore intangible property company might reduce state taxable income. For example, for Illinois combined reporting purposes, a unitary business group does not include an otherwise unitary member whose business activity outside the U.S. is 80% or more of the member's total business activity (21) (generally referred to as 80/20 companies). Effective for tax years ending after Dec. 30, 2004, unitary groups In mathematics, the unitary group of degree n, denoted U(n), is the group of n×n unitary matrices, with the group operation that of matrix multiplication. The unitary group is a subgroup of the general linear group GL(n, C). filing an Illinois tax return must add back otherwise deductible interest and intangible expenses paid or accrued to 80/20 companies, subject to numerous exceptions. (22) In 2003, the Oregon DOR promulgated prom·ul·gate tr.v. prom·ul·gat·ed, prom·ul·gat·ing, prom·ul·gates 1. To make known (a decree, for example) by public declaration; announce officially. See Synonyms at announce. 2. a similar regulation to require the addback of related-party intangible expenses in particular circumstances. (23) An addback is required if (1) the owner and user of an intangible asset (e.g., a trademark) are owned by the same interests; (2) the owner and user are not included in the same Oregon return; and (3) the separation of the ownership and the use of the intangible asset either (i) has no effect on the user's operations other than payment of the royalty (resulting in tax evasion The process whereby a person, through commission of Fraud, unlawfully pays less tax than the law mandates. Tax evasion is a criminal offense under federal and state statutes. A person who is convicted is subject to a prison sentence, a fine, or both. ) or (ii) affects Oregon taxable income so that it does not clearly reflect the business activity conducted in the state in comparison to business activity as a whole. The regulation provides an example of a retailer paying royalties for the use of a trademark held by a subsidiary incorporated in Bermuda Bermuda (bûrmy `də), British dependency (2005 est. pop. 65,400), 21 sq mi (53 sq km), comprising some 150 coral rocks, islets, and islands (of which some 20 are inhabited), in the .Conclusion Over a dozen states have enacted related-party interest and intangible expenses addback provisions designed to limit corporate ability to use intercompany licensing and financing arrangements to reduce state income taxes. In recent years, other states have introduced similar legislation. Although the various state statutes share common themes, there are significant differences among them, relating mostly to the circumstances under which an exception applies and an addback is not required. As a result, these provisions have significantly increased the compliance burden for multistate mul·ti·state adj. Of, relating to, or involving several states: a multistate environmental campaign. corporate taxpayers.
Exhibit 1: Expenses added back if arising
from a transaction with a related member
Expense
Royalties and other
State Interest expense intangible expenses
Alabama X X
Arkansas X X
Connecticut X X
District of X X
Columbia Only interest related to
trademarks, patents
and similar intangibles
Illinois X X
Applies to payments to Applies to payments to
80/20 companies 80/20 companies
Maryland X X
Massachusetts X X
Mississippi X X
Only interest related to
trademarks, patents
and similar intangibles
New Jersey X X
New York X X
Only interest related to
trademarks, patents
and similar intangibles
North Carolina X
Only royalties for use of
trademarks in the state
Ohio X X
Oregon X
Tennessee X X
Only interest related to
trademarks, patents
and similar intangibles
Virginia X X
Effective for tax
State years beginning after Special Form
Alabama 2000 Schedule AB, Add-Back Form
Arkansas 2003
Connecticut 2002 (interest) Form CT-1120AB, Add Back
1998 (royalties) and Exceptions to Add Back
of Interest and Intangible
Expenses
District of Aug. 1, 2004
Columbia
Illinois Dec. 30, 2004
Maryland 2003
Massachusetts 2001 Schedules ABI, Exceptions
to the Add Back of Interest
Expense and ABIE,
Exceptions to the Add Back
of Intangible Expenses
Mississippi 2000
New Jersey 2001 Schedule G-2, Interest
Expenses and Intangible
Expenses and Costs
New York 2002
North Carolina 2000
Ohio 1997 (tax reports Schedule B-3, Related
for 1999 tax year); Entity/Member Adjustments
predecessor enacted
in 1991
Oregon Dec. 30, 2003
Tennessee 2003
Virginia 2003
State Applicable statute
Alabama AL Rev. Stat. [section] 40-18-35(b)
Arkansas AK Code Ann. [section] 26-51-423(g)
Connecticut CT Gen. Stat. [section] 12-218c
District of DC Code Ann. [section] 47-1803.03
Columbia
Illinois IL Comp. Stat. Ch. 35, [section] 203
Maryland MD Code Ann. [section] 10-306.1
Massachusetts MA Gen. Laws, Ch. 63, [subsection] 311-31 K
Mississippi MS Code Ann. [section] 27-7-17(2)
New Jersey NJ Stat. Ann. [subsection] 54:1OA-4 and
-4.4
New York NY Tax law [section] 208.9(o)
North Carolina NC Gen. Stat. [section] 105-130.7A
Ohio OH Rev. Code [subsection] 5733.04(1)(12),
.042, and .055(B)
Oregon OAR [section] 150-314.295
Tennessee TN Code Ann. [section] 67-4-2006
Virginia VA Code Ann. [section] 58.1-402(8)(8)
and (9)
Exhibit 2: Circumstances not requiring an addback
Circumstance
(B)
(A) Taxation of corresponding
Conduit payment exception: income exception: Related-
Related-income recipient member's income that
pays the amount to an corresponds to the expense
unrelated person during is, in the same year,
the same year; tax subject to tax in a U.S.
avoidance is not a state or foreign country
principal purpose of the that has an income tax
State related-party transaction. treaty with the U.S.
Alabama X
Arkansas X
Connecticut X X
Applies to (1) royalties Applies to interest if (1)
and other intangible (i) tax avoidance is not
expenses and (2) interest a principal purpose of
related to trademarks, the transaction, (ii) the
patents and similar interest is paid pursuant
intangible assets. to a contract that
reflects an arm's-length
interest and terms and
(iii) the effective tax
rate on the related-
payee's income is within
three percentage points
of the taxpayer's
statutory Connecticut
rate; or (2) the related
payee is subject to
Connecticut's insurance
premium tax or a
comparable tax in another
state.
District of X X
Columbia Applies if the related- Applies to payments
party expense is an arm's- subject to tax in a U.S.
length amount, and the state or possession at a
transaction has a valid statutory rate of at least
business purpose other 4.5%, provided that the
than tax avoidance. related payee is not
subject to tax merely
because of its inclusion
in a combined or
consolidated return.
Illinois X X
Applies to payments to
a foreign person who is
subject to a tax on or
measured by net income
with respect to such
interest by a foreign
country or U.S. state
(other than a state that
requires mandatory unitary
reporting).
Maryland X X
Applies if the related- Applies if (1) tax
party expense is paid avoidance is not a
pursuant to an arm's- principal purpose of
length contract and rate. the transaction, (2)
the related-party expense
is paid pursuant to an
arm's-length contract and
rate and (3) the effective
state tax rate on the
related payee's income
is at least 4%.
Massachusetts X X
Applies to (1) royalties Applies to interest if
and other intangible (1) tax avoidance is not
expenses and (2) interest a principal purpose of
related to trademarks, the transaction, (2) it
patents and similar is paid pursuant to a
intangible assets. contract that reflects
an arm's-length rate
and terms and (3) the
effective tax rate on the
related payee's income is
within three percentage
points of the taxpayer's
statutory Massachusetts
rate.
Mississippi X
Taxpayer need not
establish the lack of
a tax avoidance motive
for exception to apply.
New Jersey X X
Applies to (1) royalties Applies to interest if
and other intangible (1) tax avoidance is not
expenses and (2) interest a principal purpose of
related to trademarks, the transaction, (2) it
patents and similar is paid pursuant to a
intangible assets. contract that reflects
an arm's-length rate
and terms and (3) the
effective tax rate on
the related payee's
income is within three
percentage points of the
taxpayer's statutory New
Jersey rate.
New York X X
Applies if the related- Applies if (1) the related
party expense is an arm's- payee is organized under
length amount, and the the laws of a foreign
transaction has a valid country that has an income
business purpose other tax treaty with the U.S.
than tax avoidance. and (2) the related
payee's income is taxed
in the foreign country
at a rate at least equal
to the New York tax rate.
North Carolina X X
Taxpayer need not Applies if the related
establish the lack of payee reports the income
a tax avoidance motive on a North Carolina return
for exception to apply. filed for the same tax
year in which the amount
is deducted by the
taxpayer.
Ohio X X
Oregon
Tennessee
Virginia X X
Applies to royalties and Applies to royalties and
other intangible expenses. other intangible expenses.
(C) (D)
Unreasonable addback Alternative adjustment
exception: Taxpayer exception: Taxpayer and
establishes that the commissioner agree to an
State addback is unreasonable. alternative adjustment.
Alabama X X
Arkansas X
Connecticut X X
District of
Columbia
Illinois X
Maryland
Massachusetts X X
Mississippi
New Jersey X X
New York
North Carolina
Ohio X X
Oregon
Tennessee
Virginia
Circumstance
(E)
State Other circumstances
Alabama The avoidance of Alabama
tax was not a principal
purpose of the related-
party transaction, and
the related payee is not
primarily engaged in
intangibles activities.
Arkansas 1. Related-payee's income
is received pursuant to an
arm's-length contract or
interest rate, and was
received in a transaction
not intended to avoid
Arkansas tax.
2. In a nontax location,
the related payee operates
an active business that
has at least 50 employees,
$1 million of tangible
property and $1 million
of revenue.
Connecticut 1. Interest is paid to a
related member located in
a foreign country that has
an income tax treaty with
the U.S.
2. Taxpayer elects to
calculate its tax on a
combined basis (for
intangible expenses)
or a unitary basis (for
interest expense).
District of 1. Related payee acquired
Columbia the intangible assets from
an unrelated person, the
transaction was done for
a valid business purpose
other than tax avoidance,
and the related-party
payments are made at
arm's length.
2. Related payee is
located in a foreign
country that has an
income tax treaty with
the U.S.
Illinois 1. Related-party expense
relates to an arm's length
contract and was not paid
to avoid Illinois or
Federal tax.
2. Addback is reduced by
dividends from a related
payee that are included
in the taxable income of
the unitary group for the
same tax year.
Maryland Interest payment made to
a related member that is
a bank, if tax avoidance
is not a principal purpose
of the transaction, and
the interest is paid
pursuant to an arm's-
length contract and rate.
Massachusetts Massachusetts-based
company with a foreign
parent may deduct expenses
paid to a related member
that is not a controlled
foreign corporation under
IRC Sec. 957, and is a
resident of a foreign
country that has an income
tax treaty with the U.S.
The transaction must have
a valid business purpose
other than tax avoidance.
Mississippi Related-party transaction
was done primarily for a
valid business purpose
other than tax avoidance,
and the related payee is
not primarily engaged in
intangibles activities.
New Jersey 1. Related payee is
located in a foreign
country that has an
income tax treaty with
the U.S.
2. Certain types
of cash sweeps.
New York
North Carolina
Ohio Tax attributable to addback
would be avoided if the
related members had filed
a combined return.
Oregon 1. Related payer and payee
are included in the same
Oregon tax return.
2. The separation of the
ownership of the intangible
asset from the user of the
tangible asset does not
result in either (1)
evasion of tax or (2)
a computation of Oregon
taxable income that is not
clearly reflective of the
business activity conducted
in Oregon in comparison
to business activity as
a whole.
Tennessee Taxpayer discloses the
expenses on its return
and completes the schedule
required by the commissioner.
Virginia 1. Royalties and intangible
expenses are paid to a
related payee that derives
at least one-third of its
revenues from licensing
intangibles to unrelated
parties and the related-
party payments are made
at arm's-length rates and
terms.
2. The taxpayer may
petition the tax
commissioner for relief
after filing its income
tax return for the year,
and must demonstrate by
clear and convincing
evidence that the related-
party transaction had a
valid business purpose
other than tax avoidance.
3. Interest expense,
if: (1) the related payee
has substantial business
operations relating to
the interest-generating
activities, including at
least five full-time
employees; (2) the interest
is not related to intangible
property activities; (3)
the transaction has a valid
business purpose other than
tax avoidance and the
payments are made at arm's-
length rates and terms; and
(4) one of the following
applies: (i) the related
payee's income is subject
to tax in a state or foreign
country that has an income
tax treaty with the U.S.,
(ii) the payments are made
pursuant to a pre-existing
contract entered into when
the parties were not related
and the payments continue to
be made at arm's-length rates
and terms, (iii) the related
payee engages in transactions
with unrelated parties that
generate revenue in excess
of $2 million annually or
(iv) the transaction was
undertaken at arm's-length
rates and terms and (1) the
related member uses funds
either borrowed from or
paid by an unrelated party
or (2) the debt was incurred
for certain specified
business purposes.
For more information about this article, contact Dr. Schadewald at schade n. 1. Shade; shadow. @uwm.edu See .edu. (networking) edu - ("education") The top-level domain for educational establishments in the USA (and some other countries). E.g. "mit.edu". The UK equivalent is "ac.uk". . (1) See DE Code [section] 1902(b)(8). (2) See MD Code Ann ANN, Scotch law. Half a year's stipend over and above what is owing for the incumbency due to a minister's relict, or child, or next of kin, after his decease. Wishaw. Also, an abbreviation of annus, year; also of annates. In the old law French writers, ann or rather an, signifies a year. . [section] 10-306.1(b) and NJ Stat. Ann. [section] 54:10A-4.4(b). (3) See MD Code Ann. [section] 10-306.1(a)(7) and NJ Stat. Ann. [section] 54:10A-4.4(a). (4) See MS Code Ann. [section] 27-7-17 and NY Tax Law [section] 208.9(o). (5) VA Code Ann. [section] 58.1-302. (6) See NC Gen. Stat. [section] 105-130.7A. (7) See, e.g., MA Gen. Laws, Ch. 63, Code [section] 31I, and NJ Stat. Ann. [section] 54:10A-4.4(a). (8) NY Tax Law [section] 208.9(o)(1)(B). (9) NY Tax Law [section] 208.9(o)(1)(D). (10) AL Rev REV Revolution REV Reverse REV Reverend REV Revision REV Review REV Revised REV Revelations (bible) REV Reversal REV Revolver (Beatles album) REV Reverendo . Stat. [section] 40-18-35(b). (11) See AL DOR, Reg REG, n.pr See random event generator. . [section] 810-3-35-.02(3)(g), Ex. 1. (12) MA DOR TIR TIR International Road Transport [French Transports Internationaux Routiers] No. 03-19 (9/4/03). (13) CT Gen. Stat. [section] 12-218c. (14) See AL DOLL, Reg. [section] 810-3-35-.02(3)(h). (15) See NJ Division of Taxation, "Questions and Answers Regarding the Business Tax Reform Act of 2002," Question 9 (revised 1/6/04). (16) MA Gen. Laws, Ch. 63, Code [section] 31I. (17) See NJ Division of Taxation, note 15 supra A relational DBMS from Cincom Systems, Inc., Cincinnati, OH (www.cincom.com) that runs on IBM mainframes and VAXs. It includes a query language and a program that automates the database design process. , Question 12. (18) See VA Code Ann. [section] 58.1-402(B)(8) and (9). (19) See AL DOR, Rev. Reg. [section] 810-3-35-.02(3)(b). (20) See TN Code Ann. [section] 67-4-2006. (21) See IL Comp. Stat. Ch. 35, [section] 1501. (22) See IL Comp. Star. Ch. 35, [section] 203. (23) See OAR [section] 150-314.295. Michael Michael, archangel Michael (mī`kəl) [Heb.,=who is like God?], archangel prominent in Christian, Jewish, and Muslim traditions. In the Bible and early Jewish literature, Michael is one of the angels of God's presence. S. Schadewald, Ph.D., CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. Associate Professor School of Business Administration University of Wisconsin--Milwaukee Milwaukee Milwaukee (mĭlwŏk`ē), city (1990 pop. 628,088), seat of Milwaukee co., SE Wis., at the point where the Milwaukee, Menominee, and Kinnickinnic rivers enter Lake Michigan; inc. 1846. , WI |
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