By Stephen Burroughs, Jonathan Feldman and Open Weaver Banks

In a significant taxpayer win, the Massachusetts Appellate Tax Board (ATB) held that intercompany interest payments from a wholly owned subsidiary to Massachusetts Mutual Life Insurance Company (MassMutual) were bona fide loans and were deductible for excise tax purposes. The subsidiary (HoldCo) was a holding company for MassMutual’s non-insurance subsidiaries. The Department of Revenue argued that HoldCo’s interest payments to MassMutual and subsequent deductions did not arise from true debt because a commercial bank would not lend money to an unrelated debtor on the terms evidenced by the notes at issue. The Department also contended that the convertibility of HoldCo’s notes to equity evidenced a relationship inconsistent between that of an unrelated creditor and debtor. MassMutual claimed that its loans to HoldCo were not motivated by tax considerations, but primarily for the valid business purpose of boosting its risk-based capital score (RBC Score) and providing financing for HoldCo’s investments. 

The ATB first determined that the notes satisfied Massachusetts’ definition of bona fide debt, based on a 17-part test established under prior law. HoldCo issued the notes for a valid business purpose; improving MassMutual’s RBC Score allowed it to carry a lower regulatory reserve. Further, MassMutual was active in the credit markets as a third-party lender but operated under a different lending model than commercial banks, thus rendering comparisons to them irrelevant. 

Next, the ATB held that HoldCo’s interest payment deductions satisfied Massachusetts’ “unreasonable” exception to its related party interest add-back requirement. Already finding that the notes constituted bona fide debt, the ATB further found that the notes were entered into for a valid, non-tax business purpose, were supported by economic substance, and the interest deducted reflected fair value and consideration. Although the interest paid on the notes provided a tax benefit to HoldCo, the ATB stated that the lending arrangement was not entered into as part of a tax avoidance scheme, and it was appropriate for MassMutual to finance the expansion of HoldCo’s subsidiaries in a manner that benefitted the MassMutual business as a whole. Massachusetts Life Ins. Co. v. Comm’r of Revenue, Docket Nos. C305276, C305277 (Mass. App. Tax Bd. June 12, 2015).