State laws and legislation disallowing certain intercompany expenses.

• Author: Boucher, Karen J.

Editor's note: Ms. Naghavi chairs the AICPA Tax Division's State and Local Tax Technical Resource Panel (TRP). Ms. Boucher is a former chair of that TRIP.

For more information about this column, contact Ms. Boucher at kboucher@deloitte.com.

Over the past several years, a number of states not requiring unitary corporations to use a combined reporting method, have enacted legislation to limit (or eliminate) common state tax planning strategies for paying royalties or interest to affiliated trademark, tradename or finance companies. This article identifies the six states that enacted such laws prior to 2003 and summarizes the 2003 state legislative activity (through June 2003) for limiting such intercompany deductions.

Laws Enacted Prior to 2003

Alabama: For tax years beginning after 2000, corporations must add back to Federal taxable income interest and intangible expenses/costs directly or indirectly paid to a related member, unless: (1) the corresponding income item was subject to net income tax by Alabama, another state or foreign income tax treaty country in the same tax year; (2) the corporation and the revenue commissioner agree in writing to the application or use of alternative adjustments and computations; (3) the corporation establishes that the adjustments are unreasonable; or (4) the corporation can establish that the transaction giving rise to the expenses/costs did not have as a principal purpose the avoidance of Alabama tax and the related member is not primarily engaged in the acquisition, use, licensing, maintenance, management, ownership, sale, exchange or other disposition of intangible property, or in the financing of related entities; see Act 1088 (HB 2), Laws 2001 (4th Sp. Sess.); Ala. Code [section] 40-18-35(b).

Connecticut: For tax years beginning after 1998, corporations must add back to Federal taxable income interest and intangible expenses/costs directly or indirectly paid to related members, unless the corporation: (1) establishes by clear and convincing evidence that the adjustments are unreasonable; (2) establishes by a preponderance of the evidence that the transaction did not have as a principal purpose the avoid ante of tax and during the same tax year, the related member paid the expense to an unrelated person; or (3) agrees in writing with the commissioner to the use of an alternative apportionment method; see P.A. 98-110, Laws 1998; Conn. Gen. Stat. [section] 12-218c(b) and (c).

The addback is also not required to the extent that increased tax attributable to such adjustments would have been avoided had the corporation and related member timely elected to file a Connecticut combined return.

Mississippi: For tax years beginning after 2000, taxpayers must add back to Federal taxable income interest and intangible expenses/costs directly or indirectly paid to related members, unless the taxpayer can establish: (1) the transaction giving rise to the expense was done primarily for a valid business purpose other than tax avoidance and the related party is not primarily engaged in the acquisition, use, maintenance or management, ownership, sale, exchange or other disposition of intangible property; or (2) the related party paid such expense to an unrelated party; see Ch. 586 (HB 1695), Laws 2001; Miss. Code Ann. [section] 27-7-17(2). The June 30, 2003 sunset for this provision was removed by recent legislation; see SB 2354, Laws 2003.

New Jersey: For tax years beginning after 2001, corporations generally...