A recent letter ruling from the Tennessee Department of Revenue concludes that the ownership of mortgages backed by Tennessee property was insufficient to subject a foreign investment fund (“Fund”) to the state’s franchise and excise taxes.

Tennessee broadly applies its franchise and excise tax to the extent permitted by the U.S. and state constitutions.  A limited partnership is subject to franchise and excise taxes if it is doing business in Tennessee and has a substantial nexus with the state.  Further, Tennessee has a rebuttable presumption that a financial institution is doing business in Tennessee if the sum of its assets and the absolute value of its deposits attributable to Tennessee sources equals or exceeds $5 million.

There are a variety of exceptions to Tennessee’s broad statutory definition of “doing business in Tennessee” for financial institutions. Specifically, a financial institution is not considered to be “conducting the business of a financial institution” in Tennessee if:

  1. the only activity of the financial institution in Tennessee is holding an ownership interest in a loan, lease, note or other assets attributed to Tennessee, and,
  2. the payment obligations were solicited and entered into by a person that is independent and not acting on behalf of the owner.

The Fund was a limited partnership formed and domiciled outside of the U.S. The Fund’s general partner was also domiciled outside of the U.S. and did not have any presence in the country. The Fund’s only activity was receiving payments from the mortgages it owned, which qualified it as a “financial institution” for Tennessee purposes. The Fund’s mortgages were obtained through a third-party investment manager and the Fund’s only involvement in the mortgage procurement process was the closing, which took place outside of Tennessee. Additionally, the Fund’s sole connection with Tennessee was that occasionally some of the mortgages owned by the Fund were located in Tennessee and some of the borrowers could possibly also be located within the state.

The Department of Revenue determined that the Fund’s activities squarely fell within the statutory safe harbor whereby a financial institution is not considered to be “conducting the business of a financial institution” within the state. The Fund was therefore not subject to Tennessee franchise and excise taxes despite otherwise satisfying other elements of the state’s economic nexus test.

Tenn. Dept. Rev. Ruling No. 20-07 (Oct. 8, 2020).