The November 26, 2018, release by the Internal Revenue Service of proposed regulations (REG-106089-18) related to IRC § 163(j) has provided some clarity for federal income taxpayers. But the regulations’ treatment of federal consolidated groups gives rise to complexities and questions as to how the limitation will operate at the state level. In this Bottom Line videocast Eversheds Sutherland attorneys Todd Betor and Elizabeth Cha discuss:

  • an overview of IRC § 163(j)
  • key elements of the proposed regulations
  • important SALT considerations

In Kraft Foods Global, Inc. v. Director, Division of Taxation, 2018 WL 2247356 (May 17, 2018), the New Jersey Superior Court, Appellate Division, recently upheld a New Jersey Tax Court decision denying a taxpayer an exception to the state’s interest add-back requirement in determining the taxpayer’s corporate net income subject to New Jersey’s corporation business tax (CBT). This case highlights the unintended tax consequences that may result from financing arrangements between related entities.

Like many states, New Jersey uses federal taxable income as a starting point for the CBT and then has several modifications to federal taxable income to arrive at New Jersey taxable income. One of these modifications is the related party interest add-back provision, which provides that “[e]ntire net income shall be determined without the exclusion, deduction or credit of … [i]nterest paid, accrued or incurred for the privilege period to a related member….”  N.J.S.A. 54:10A–4(k)(2)(I).

There are five statutory exceptions to the interest add-back requirement. In Kraft Foods, the only exception relied upon by the taxpayer was the “Unreasonable Exception,” which requires the taxpayer to establish “by clear and convincing evidence, as determined by the director, that the disallowance of a deduction is unreasonable.” In support of its argument, the taxpayer argued that its parent company simply “pushed down” loans from bondholders because the parent company could secure a better interest rate on the open market than the taxpayer.

The appellate court upheld the determination of the Tax Court that the taxpayer did not qualify for the Unreasonable Exception. While acknowledging that legislative history supported the taxpayer’s contention that the Unreasonable Exception may apply to a “pushed down” loan, even in the absence of a guarantee of the third-party debt, the appellate court found that the taxpayer did not meet its evidentiary burden. According to the court, the taxpayer produced no document suggesting that it was ultimately responsible for the third-party debt. The taxpayer’s promise to pay its parent company did not contain a guarantee to the third-party bondholders, nor did the promissory notes the taxpayer signed on behalf of its parent contain payment terms or a schedule for principal payments. Thus, according to the appellate court, it was reasonable for the Director to determine that the parent’s debt to the bondholders “was not, legally or effectively, ‘pushed down’” to the taxpayer. Kraft Foods Global, Inc. v. Director, Division of Taxation, 2018 WL 2247356 (May 17, 2018).

On December 22, 2017, the largest overhaul of the nation’s tax code since 1986 was signed into law. While the reduction in the corporate income tax rate grabbed most of the headlines, in their article for the Summer 2018 edition of Partnering Perspectives, Eversheds Sutherland attorneys Jeffrey Friedman and Michael Resnick discuss several additional important considerations related to the Tax Cuts and Jobs Act.

View the full article.

On May 14, 2018, Indiana Governor Eric Holcomb signed into law H.B 1316 (the Bill). The Bill provides a number of changes to Indiana’s tax laws, including responding to provisions of the federal Tax Cuts and Jobs Act. Some notable provisions of the Bill include:

  • updating Indiana’s conformity to the Internal Revenue Code from January 1, 2016 to February 11, 2018, effective for taxable years beginning on or after January 1, 2018;
  • specifying that any IRC amendments made by an act passed by Congress prior to February 11, 2018, other than the 21st Century Cures Act or the Disaster Tax Relief and Airport and Airway Extension Act, that is effective for a taxable year that begins before February 11, 2018 and affects corporate taxable income, is also effective for the same taxable year for purposes of determining Indiana adjusted gross income.
  • specifying that amounts under IRC 951A (GILTI) are treated as foreign source dividends for Indiana purposes, which means that Indiana’s Dividends Received Deduction for foreign source income under Ind. Code § 6-3-2-12 will apply to GILTI;
  • providing for similar treatment of amounts under IRC 965 Repatriation Transition Tax;
  • specifying that to the extent any amounts from the Repatriation Transition Tax or GILTI are included in Indiana income, these receipts will be included in the Indiana apportionment factor and sourced based on the rules for dividends from investments;
  • decoupling from the limitation on interest expenses under IRC 163(j); and
  • decoupling from the federal unlimited NOL carryforward period under IRC §172 and instead providing for a carryforward period of 20 years.
Eversheds Sutherland Observation: Indiana’s treatment of GILTI as a “foreign source dividend” puts GILTI on equal footing with Subpart F income (including the Repatriation Transition Tax) for Indiana corporate tax purposes. Under Indiana Code § 6-3-2-12, a 100% DRD is allowed for foreign source dividends from 80% owned corporations. The DRD is reduced to 85% for dividends from corporations in which the US shareholder owns a 50-80% interest, and further reduced to 50% for dividends from corporations in which the ownership percentage is 50% or less. Indiana’s treatment of GILTI under the Bill is similar to certain other states’ treatment of GILTI including Georgia, which exempts both GILTI and Subpart F income from state taxation, and Illinois, which has a foreign dividend subtraction that applies to both GILTI as well as Subpart F income.

Read more here: Indiana H.B. 1316

On April 10, 2018, and April 13, 2018, Oregon Governor Kate Brown signed into law S.B. 1529 and S.B. 1528 (the Bills), respectively, which provide a series of changes to Oregon’s income tax laws in response to recent federal tax changes as part of the federal Tax Cuts and Jobs Act. Most notably, the Bills: (i) update the state’s IRC conformity date to December 31, 2017; (ii) decouple from the federal temporary dividend received deduction with respect to the transition tax under IRC § 965 by requiring an addback of the federal deduction allowed under IRC § 965(c); (iii) provide relief from double taxation of repatriated income for taxpayers subject to Oregon tax under the state’s tax haven legislation by allowing a credit equal to the lessor of any taxes paid attributable to the tax haven addback for years beginning on or after January 1, 2014, and before January 1, 2017, or the amount of Oregon tax attributable to income reported under IRC § 965 for tax years beginning on or after January 1, 2017, and before January 1, 2018; and (iv) establish a state Opportunity Grant Fund and provide individual and corporate income tax credits for contributions made to this fund. Although taxpayers are required to addback the amounts deducted under IRC § 965(c), the Oregon Department of Revenue has issued guidance stating their position that the transition tax’s income inclusion is eligible for the state’s dividends received deduction under ORS 317.267(2)(b), which provides an 80% deduction for dividends received from a 20% owned corporation and a 70% deduction for all other dividends.

The Bills also repeal the tax haven addback found under Oregon Revised Statutes section 317.716 and require the Department of Revenue to evaluate the efficacy of including global intangible low-taxed income (GILTI) under IRC § 951A in the state tax base in comparison to Oregon’s now-repealed tax haven addback, with a report to be issued on or before December 1, 2020.

Read more here:  Oregon Senate Bill 1528; Oregon Senate Bill 1529; Oregon Corporation Excise/Income Tax Update

The Texas Comptroller ruled that, for Texas apportionment purposes, the sale for resale of mobile voice and data services, purchased from third-party mobile telecommunications carriers and sold to an out-of-state third-party retailer using the carrier’s network infrastructure, is characterized as the sale of telecommunications services and internet access services, respectively, not the sale of an intangible right to access a service. Accordingly, unlike receipts from the sale of an intangible asset which are sourced to the purchaser’s location, the taxpayer’s service receipts were sourced to the state to the extent that the Internet was accessed in Texas or the mobile voice services were provided in Texas. Private Letter Ruling No. 201711016L (Nov. 27, 2017).

By Chelsea Marmor and Charlie Kearns

The New Mexico Administrative Hearings Office affirmed the Taxation and Revenue Department’s assessment to Agman Louisiana Inc. based on the taxpayer’s gain from the sale of stock of a corporation in which the taxpayer owned less than a 50% interest. The Hearings Office ruled that such gain was apportionable business income subject to New Mexico corporate income tax. Agman argued that the gain was non-business income and must be allocated to its commercial domicile. The Hearings Office disagreed and determined that Agman met New Mexico’s three-prong business income test in NMSA 1978 § 7-4-2(A). Under the first prong of that statutory test, the Hearings Office summarily concluded that Agman met the threshold “transactional test” because the sale arose from “transactions and activity” in the “regular course of the taxpayer’s trade or business.” Agman met the second prong “disposition test” because the income from the stock sale arose from the disposition of a business. The company also met the third prong “functional test” because the income from the sale of the stock provided the taxpayer with an “operational benefit integral to [its] business.” Finally, the Hearings Office ruled that characterizing the gain as apportionable business income did not offend the US Constitution because the stock that generated the gain served an “operational rather than investment function,” as explained in the Supreme Court’s Allied Signal and MeadWestvaco decisions. In the Matter of the Protest of Agman Louisiana Inc. v. Taxation & Revenue Dep’t, N.M. Admin. Hearings Office, Decision and Order No. 17-47 (Dec. 5, 2017).

By Dmitrii Gabrielov and Andrew Appleby

The New York State Department of Taxation and Finance issued an advisory opinion determining that non-US unauthorized life insurance companies’ premiums were not includable in the New York State insurance franchise tax apportionment factor. The Department reasoned that the apportionment statute requires a life insurance company to report its premiums on a basis “consistent with” the Insurance Law filing requirements for authorized insurers. The applicable Insurance Law statute: (1) does not apply to unauthorized insurers; and (2) requires (authorized) non-US insurers to report only their US business and assets. Therefore, the Department concluded that a non-US unauthorized life insurance company’s premiums were neither “New York premiums” nor “total premiums” (the premium factor numerator and denominator, respectively). Notably, the Department relied on Insurance Law filing requirements to determine the insurance companies’ tax treatment. N.Y. Advisory Opinion TSB-A-17(2)C (Oct. 4, 2017).

By Dmitrii Gabrielov and Andrew Appleby 

The New York State Supreme Court, Appellate Division, affirmed the New York City Tax Appeals Tribunal’s (Tribunal) decision that Aetna’s subsidiary health maintenance organizations (HMOs) were subject to the New York City General Corporation Tax (GCT) for 2005 and 2006. The Appellate Division determined that the Tribunal’s reasoning was not arbitrary and capricious. The Tribunal reasoned that the GCT exemption for companies doing an insurance business in New York State did not apply because the HMOs were regulated almost entirely under New York’s Public Health Law, not the Insurance Law, and therefore were not doing an insurance business in the state. Aetna, Inc. v. N.Y.C. Tax App. Trib., No. 70/16-4533 (N.Y. App. Div., 1st Dep’t Oct. 19, 2017).

By Ted Friedman and Eric Coffill

On August 30, 2017, the Indiana Department of Revenue determined that an out-of-state corporation doing business in Indiana and worldwide was entitled to a reduction of its Indiana sales factor because certain sales in foreign jurisdictions should not have been sourced to Indiana under the state’s “throwback rule.” In a prior audit, the Department had required the corporation to include in its income royalties received by subsidiaries for licensing intellectual property in order to “fairly reflect” the corporation’s income. The Department explained that “[b]y allocating the royalty income to [the corporation], the Department’s prior audit implicitly considered that [the corporation’s] subsidiaries’ nexus could be attributable to [the corporation],” and that, for the current years at issue, the Department will consider the subsidiaries’ nexus for purposes of the corporation’s apportionment computation “as a matter of equity under these particular set of facts.” The Department concluded that the corporation demonstrated that its subsidiaries’ activities in certain foreign countries exceeded the protection of P.L. 86-272 and that the corporation would be subject to a net income tax in those countries. Therefore, the Department determined that the throwback rule should not apply to the corporation’s receipts from sales in those countries. Mem. of Decision 02-20160336R (Ind. Dep’t of State Revenue Aug. 30, 2017).