On April 1, 2019, the Arkansas Office of Hearings and Appeals held that a taxpayer could not deduct interest expense for long-term debt used to finance a cash dividend as a non-business expense allocable to Arkansas because there was no corresponding non-business income allocable to the state.
The taxpayer was a corporation based in Arkansas that separated from its parent company. In connection with the separation, the taxpayer obtained third-party long-term debt to finance a cash dividend, which resulted in interest expense for the taxpayer. The taxpayer argued the interest expense should be classified as non-business expense allocable to Arkansas because it satisfied the transactional and functional tests under the Uniform Division for Income Tax Purposes Act (UDITPA). The administrative law judge held, however, that UDITPA’s business and non-business classifications only apply to income and there is no independent characterization of expenses apart from income. Thus, parsing of expenses occurs only after business and non-business income is determined. Here, because the interest expense was not linked to the generation of non-business income directly sourced to Arkansas, the interest expense could not be characterized as a non-business expense allocated to the state. Administrative Decision Nos. 19-185 & 19-186, Ark. Dep’t of Fin. & Admin. (Apr. 1, 2019).