Intercompany Transactions Add-back Provisions
Transcription
Intercompany Transactions Add-back Provisions
4/17/2015 Intercompany Transactions Add-back Provisions Where Are We Now? April 23, 2015 Presented By Andres Vallejo and Brian Kirkell Presenters • Andres Vallejo • Brian Kirkell • • • • Morrison Foerster [email protected] McGladrey LLP [email protected] 2 1 4/17/2015 Background • Legislative Responses to Tax-Motivated Transactions • Separate v. Combined Reporting • Disallowance of related-company expense deductions 3 Statutory Issues • Requires a taxpayer to add-back certain expenses directly or indirectly paid to a related member that is not itself subject to tax within the taxing state, provided that a specific safe harbor is not met • Expenses subject to add-back • Intangible interest expenses • Intangible expenses (e.g., patents, copyrights, trademarks, etc.) • Embedded intangibles • Management fees • Definition of related member • Generally expansive, direct or indirect common ownership of 50% of value 4 2 4/17/2015 Statutory Issues • Common safe harbors • Transaction has a valid business purpose and economic substance, and is undertaken at arm’s length rates & terms • Principal purpose for the transaction was not tax avoidance • Recipient pays an income-based tax to one or more other states on the income received from the related party taxpayer • Recipient not “primarily engaged” in maintenance and management of intangibles • Recipient is located in a foreign country that has a comprehensive tax treaty with the U.S. • Expense has a valid business purpose and is ultimately passed through to an unrelated party • Taxpayer and state enter into alternative apportionment agreement • Taxpayer and recipient are included in a combined or consolidated report 5 Significant Cases • Surtees v. VFJ Ventures, Inc., 8 So. 3d 950 (Ala. Civ. App. 2008) • Taxpayer jeans manufacturer licensed trademarks from related member Delaware intangibles management company • Alabama Court of Civil Appeals required that the Taxpayer add back the income that it paid to the related member for the trademark licenses and denied that any exception to the add back statute applied • Alabama Supreme Court Affirmed 6 3 4/17/2015 Significant Cases (Cont’d) • Beneficial New Jersey, Inc. v. Division of Taxation, N.J. Tax. Docket No. 009886-2007 (Aug. 31, 2010) (unpublished) • Taxpayer consumer lending company took loan from its parent (on which the parent charged interest) • Tax Court did not apply New Jersey’s add back statute and allowed the Taxpayer to deduct its interest payments to payment because the Tax Court felt that the Taxpayer satisfied the “unreasonable” exception to the add back statute 7 Significant Cases (Cont’d) • Wendy’s v. Virginia Dep’t of Taxation, 84 Va. Cir. 398 (2012) • Taxpayer licensed trademarks from related entity and then sub-licensed the trademarks to both related and unrelated companies • Circuit Court did not apply the add back statute and allowed the Taxpayer to deduct the royalties paid for the license. The court felt that the Taxpayer satisfied one of the “safe harbors” to the add back statute: the related entity derived at least one third of its gross revenues from unrelated companies as a result of the Taxpayer’s pass through to the related entity of the royalties paid to the Taxpayer by unrelated sub-licensees 8 4 4/17/2015 Significant Cases (Cont’d) • Kimberly-Clark Corp. v. Comm’r of Revenue, 981 N.E.2d 208 (Mass. App. Ct. 2013) • Taxpayer made a number of payments to related entities as part of a restructuring that aimed to centralize operational functions amongst the entity family • The Appeals Court applied the add back statute, and denied the Taxpayer’s deductions for such expenses. The court declined to apply the “unreasonable” exception because there was substantial evidence that the Taxpayer’s principal purpose for the transactions was tax avoidance 9 Significant Cases (Cont’d) • Morgan Stanley & Co. v. Division of Taxation, N.J. Tax Court Docket No. 007557-2007 (Oct. 29, 2014) • Taxpayer made interest payments to a related entity • The Tax Court allowed the Taxpayer to claim deductions for the interest payments. The Court declined to apply the add back statute. The Court thought that the Taxpayer satisfied the “unreasonable” exception because the taxing authority failed to consider the Taxpayer’s evidence for why it met the exception. 10 5 4/17/2015 Constitutional Challenges • Complete Auto Transit Inc. v. Brady, 430 U.S. 274 (1977) • Substantial Nexus • Fair Apportionment • Discrimination • Fairly Related 11 Constitutional Challenges (Cont’d) • Nexus • Disallowance of a deduction is functionally equivalent to taxing income • Hunt-Wesson Inc. v. Franchise Tax Board, 528 U.S. 458 (2000) 12 6 4/17/2015 Constitutional Challenges (Cont’d) • Fair Apportionment • Internal Consistency Test • External Consistency Test 13 Constitutional Challenges (Cont’d) • Discrimination • Foreign Commerce Clause • Discrimination between Separate and Combined filing states 14 7 4/17/2015 Legislative and Administrative Developments • Not much legislative or regulatory action so far in 2015, but 2013 and 2014 were interesting in select states • New York SB 2609D (3/28/2013) • Existing royalty expense add-back exception substantially modified • The royalty expense add-back will not be required if: • The taxpayer can establish by clear and convincing evidence that it meets the new “subject to tax” exception or the amended “conduit” and “treaty” exceptions, or • The taxpayer and the Commissioner of Taxation and Finance agree in writing to the application or use of alternative adjustments or computations 15 Legislative and Administrative Developments • Pennsylvania HB 465 (7/9/2013) • Creates intangible and interest add-back • Exceptions available: (1) subject to tax; (2) business purpose; (3) treaty; (4) conduit • Effective 1/1/2015 • Virginia Document No. 13-140 • Franchise fees characterized as management fees were not subject to addback 16 8 4/17/2015 Legislative and Administrative Developments • Virginia Document No. 13-195 (10/23/2013) • Ruled that selling receivables to a bankruptcy-remote special purpose entity in order to obtain financing qualified for the valid business purpose exception from the add-back statute • Virginia Document No. 13-211 (11/12/2013) • Ruled that a single-member limited liability company treated as a disregarded entity for federal income tax purposes that seeks to exclude the add-back of factoring fees on the basis that they were incurred for a valid business purpose must file a state income tax return reporting the addition and petition for a refund on an amended return 17 Legislative and Administrative Developments • Virginia Document No. 13-239 (12/19/2013) • Denied a franchise operation company's request to amend corporate tax returns to exempt royalties paid to a related party from the add-back requirement because the licensing agreement between the taxpayer and the related party and the agreements between the taxpayer and its franchisees were substantially different • Virginia SB 5001 (4/1/2014) • Subject to tax exception is computed on a post-apportionment basis (state issuing rulings against taxpayers, see VA Document No. 14-71) • To claim unrelated transaction exception, related party must actually engage in transactions with unrelated third-parties • Retroactive to 1/1/2014 18 9 4/17/2015 Legislative and Administrative Developments • Virginia Document No. 14-60 (4/30/2014) • Upheld apportionment adjustment to taxpayer’s “subject to tax” add-back exception, but denied adjustment for portion of fees paid for management services • Virginia Document No. 14-71 (5/27/2014) • Upheld apportionment adjustment to taxpayer’s “subject to tax” add-back exception 19 Practical Tips • Variations, inconsistencies, and multiple taxation • Watch out for the switcheroo • Filing requirements • To add-back or not to add-back • Add-back exceptions, common challenges and building an audit ready file • Dealing with embedded royalties 20 10 4/17/2015 Questions? 11