On February 26, 2024, the Alabama Tax Tribunal (Tribunal) held that Huhtamaki Inc. (Huhtamaki), a packaging manufacturer, is not required to add back interest payments indirectly made to foreign affiliates through a U.S. parent company.

Under Alabama’s add-back statute, a corporation must add back otherwise deductible interest expenses directly or indirectly paid to a related member unless an exception applies. One such exception is the subject-to-tax exception, which allows a corporation to avoid adding back income if the corresponding item of income is subject to tax based on the related member’s net income by a foreign nation that has an income tax treaty with the United States. The statute further provides: “[t]hat portion of an item of income which is attributed to a taxing jurisdiction having a tax on net income shall be considered subject to a tax even if no actual taxes are paid on such item of income in the taxing jurisdiction by reason of deductions or otherwise.” Ala. Code § 40-18-35(b).

During the tax years at issue, Huhtamaki made several interest payments to its U.S. parent company, which then made payments to foreign affiliates in countries with an income tax treaty with the United States—a portion of such interest income was deductible in the foreign counties. The Alabama Department of Revenue (DOR) argued Huhtamaki failed to prove the exclusion to the add-back statute claimed for the interest deductions taken for the foreign affiliates on the Alabama return.

Citing to its 2022 decision in State of Alabama v. Pfizer., CV.-2022-901481-00, in which the Tribunal held that a corporation is not required to add back interest paid to a related entity as the recipient was subject to tax on that income in a foreign nation, the Tribunal rejected the DOR’s argument. Agreeing with Huhtamaki, the Tribunal held that the fact the foreign affiliates were allowed to deduct a portion of the interest payments in calculating their net income does not defeat Huhtamaki’s entitlement to the subject-to-tax exception. The Tribunal further noted that the DOR did not cite any legal authority, other than a European Commission letter, to dispute Huhtamaki’s entitlement to the exception. The Tribunal also rejected the DOR’s request to reconsider the holding in Pfizer.

Huhtamaki Inc. v. Ala. Dept. Rev., Ala. Tax Tribunal,Dkt. No. BIT. 19-890-JP (Feb. 26, 2024).