Current through Register Vol. 42, No. 11, August 30, 2024
(1) In accordance with the terms of §
40-18-35(b)(1),
Code of Ala. 1975, (hereafter "Ala. Code") for
purposes of computing its taxable income, a corporation shall add back
otherwise deductible interest expenses and costs and intangible expenses and
costs directly or indirectly paid, accrued or incurred to, or in connection
directly or indirectly with one or more direct or indirect transactions, with
one or more related members.
(2)
The corporation shall make the adjustments required in paragraph (1), unless:
(a) The corporation establishes, to the
Department's satisfaction, in a writing attached to the corporation's Alabama
corporate income tax return, that the adjustments are unreasonable, (See (3)(h)
below)
(b) The corporation and the
Commissioner of Revenue agree in writing to the application or use of
alternative adjustments and computations, (See (3)(i) below)
(c) The corporation establishes, to the
Department's satisfaction, in a writing attached to the corporation's Alabama
corporate income tax return, that the transaction giving rise to the interest
expenses and costs or the intangible expenses and costs between the corporation
and the related member did not have as a principal purpose the avoidance of any
Alabama tax and the related member is not primarily engaged in the acquisition,
use, licensing, maintenance, management, ownership, sale, exchange, or any
other disposition of intangible property, or in the financing of related
entities, (See (3)(b) and (c) below) or
(d) The corporation establishes, to the
Department's satisfaction, in a writing attached to the corporation's Alabama
corporate income tax return, that the item of income corresponding to the
taxpayer's expense was in the same taxable year subject to a tax based on or
measured by the related member's net income in Alabama or any other state of
the United States, or a foreign nation which has in force an income tax treaty
with the United States, if the recipient was a "resident" (as defined in the
income tax treaty) of the foreign nation. (See (3) (e), (f) and (g)
below).
(e) The attachment(s)
required by (2)(a), (c) and (d) above shall be in a format to be prescribed by
the Department of Revenue.
(3) Definitions and Operating Rules
(a) "Specified Intangible Activities" means,
for purposes of this regulation, the intangible related activities referred to
in Ala. Code §
40-18-35(b)(3) specifically including the acquisition, use, licensing, maintenance,
management, ownership, sale, exchange, or any other disposition of intangible
property.
(b) "Primarily Engaged"
means that as a percentage of total receipts, receipts from the specified
intangible activities or the receipts from financing related entities exceeds
the receipts from any other readily identifiable category of receipts.
1. EXAMPLE. Related member has $1,000 of
total receipts: $400 of royalty receipts from the licensing of intangibles,
$300 of receipts from the sale of widgets and $300 of receipts from widget
repair services. Because related member's receipts from a specified intangible
activity exceed its receipts from any other readily identifiable category of
receipts, related member is "primarily engaged" in that activity for purposes
of Ala. Code §
40-18-35(b)(3) and paragraph (2)(c) of this regulation.
2. EXAMPLE. Related member conducts
manufacturing operations, licenses intangible property and loans money to
Taxpayer. Related member has $1,000 of receipts: $225 of royalty receipts from
Taxpayer, $225 of interest receipts from Taxpayer, $400 of receipts from the
sale of goods to Taxpayer, and $150 of miscellaneous receipts. Due to the fact
that a greater percentage of related member's total receipts (40%) is from the
sale of goods, related member is not "primarily engaged" in either the
specified intangible activities or the financing of related entities.
3. With respect to the indirect expenses
described in (3)(d) below, the primarily engaged definition described in (3)(b)
above should be applied to both the related member that transacts business
directly with the taxpayer and to the related member that transacts business
indirectly with the taxpayer through one or more additional related members. If
either related member is primarily engaged in the specified intangible
activities or the financing of related entities, the taxpayer may not avail
itself of the exception described in (2)(c) above.
(c) "Related Member" includes but is not
limited to any corporation that is included in the taxpayer's federal
consolidated corporate income tax return or any disregarded entity or
subchapter K entity a majority of whose income is included in the taxpayer's
federal income tax return (separate or consolidated).
1. For purposes of determining whether a
related member is primarily engaged in the specified intangible activities or
the financing of related entities, subchapter K entities or entities that are
disregarded for federal income tax purposes shall be separately
considered.
2. EXAMPLE. Corporation
A is the single member owner of Limited Liability Company B ("LLC B"), an
entity disregarded for federal income tax purposes. Corporation A owns
intangible property that it licenses to Corporation C, an Alabama corporate
taxpayer. LLC B owns and operates retail store locations. Corporation A and
Corporation C are wholly owned subsidiaries of Company D. For purposes of
Corporation C, both Corporation A and LLC B are related members. Because LLC B,
is a related member, separate and apart from Corporation A, LLC B's activities
will not be considered for purposes of determining whether Corporation A is
primarily engaged in the specified intangible activities.
(d) Any expense incurred by a taxpayer
corporation, if the expense is related to an intermediate intangible or
interest expense paid from one related member to a second related member, is an
indirect intangible or interest expense that satisfies the definition of
intangible expense and cost provided in Ala. Code §
40-18-1(9) or interest expense and cost provided in Ala. Code §
40-18-1(11).
1. EXAMPLE. Corporations B and C are related
members with respect to Corporation A. Corporation A is an Alabama taxpayer
that sells products it purchases from Corporation B on a cost plus basis.
Corporation B licenses intangible property from Corporation C and makes
intangible expense payments to Corporation C based in part on the sales
Corporation B makes to Corporation A. To the extent the intangible expenses
Corporation B pays to Corporation C are reflected in the costs of the products
Corporation A purchases from Corporation B, the direct intangible expenses of
Corporation B are considered to be indirect intangible expenses of Corporation
A. Furthermore, for purposes of Ala. Code §
40-18-35(b)(3) and subsection (2)(c) of this regulation Corporation A is deemed to directly
pay an intangible expense to Corporation B and indirectly pay an intangible
expense to Corporation C.
(e) "Subject to a tax based on or measured by
the related member's net income" means that the receipt of the payment by the
recipient related member is reported and included in income for purposes of a
tax on net income, and not offset or eliminated in a combined or consolidated
return which includes the payor.
(f) "[R]eported and included in income for
purposes of a tax on net income" means reported and included in post-allocation
and apportionment income for purposes of a tax applied to the net income
apportioned or allocated to the taxing jurisdiction.
(g) The exception described in (2)(d) is
allowed only to the extent the recipient related member includes the
corresponding item of income in post-allocation and apportionment income
reported to the taxing jurisdiction.
1.
EXAMPLE. Corporation A makes a $100 intangible expense payment to Corporation
B, a related member with respect to Corporation A. Corporation B files an
income tax return in State B where it apportions and or allocates 5% of its
income, but files no other income tax returns. Corporation A must add-back $95
of the otherwise deductible $100 intangible expense payment it makes to
Corporation B.
(h) The
adjustment required in (1) above will be considered unreasonable if:
1. The taxpayer establishes that, based on
the entirety of the taxpayer's particular facts and circumstances, the
adjustments have increased the taxpayer's Alabama income tax liability to an
amount that bears no fair relation to the taxpayer's Alabama presence,
or
2. The taxpayer establishes that
the interest or intangible expense was paid to a related member that "passed
through" the interest or intangible payment via a corresponding interest or
intangible expense payment to an unrelated third party. This subdivision of the
unreasonable exception is subject to the limitations described in paragraphs
(i), (ii), and (iii) below. Taxpayers must first apply the limitation imposed
in paragraph (i) to determine the amount of "pass through" interest or
intangible expense. "Pass through" interest or intangible expense will be
subject to the additional limitations contained in paragraphs (ii) and (iii).
When the taxpayer's related member interest expense exceeds both limitations,
the limitations should be applied together as described in Example 2.
(i) Related member interest or intangible
expense paid to a related member that receives more related member interest or
intangible income (expense to the payor) than it pays interest or intangible
expense to unrelated third parties will be limited because only a portion of
the related member interest or intangible expense/income is considered to have
"passed through" to the unrelated third parties.
(I) EXAMPLE 1. Taxpayer A makes a $100
interest payment to Related Member B. Related Member B receives a total of $400
of related member interest income ($100 from Taxpayer A plus $300 from other
related payors). Related Member B pays $200 of interest expense to unrelated
third parties. Related Member B will be deemed to have passed through to
unrelated third parties only 50% of the interest expense/income it received
from Taxpayer A. Only $50 of Taxpayer A's $100 related member interest expense
payment to Related Member B will be deemed to have been passed through to
unrelated third parties and qualify for the unreasonable exception.
(ii) With respect to both interest
and intangible expenses, if the interest or royalty rate charged the taxpayer
by the related member exceeds the interest or royalty rate charged the related
member by unrelated third party lenders or licensors, then the excess expense
will not qualify for the unreasonable exception and must be added back. If
multiple lending or licensing arrangements exist between the taxpayer and the
related member, or the related member and the unrelated third-party lender or
licensor, then a weighted average rate should be calculated by dividing total
interest expense by total interest bearing debt. The weighted average rate
should then be used to determine the existence of non-qualifying excess
interest or intangible expense. See (I) Example 2.
(iii) With respect to interest expense, if
the taxpayer's debt over asset percentage exceeds the consolidated unrelated
third party debt over asset percentage of its federal affiliated group (as
represented by interest bearing debt reported on the Schedule L balance
sheet(s) included in the consolidated and pro forma federal income tax
returns), then the interest expense associated with the excess debt must be
added back on Schedule A of the Alabama Form 20C and cannot qualify for the
unreasonable exception based on a conduit financing arrangement.
(I) EXAMPLE 2. Taxpayer B makes interest
expense payments of $100 during its taxable year to its parent Company A (a
related member) to service a $1,000 debt between B and A. Company A's related
member interest rate is 10% calculated by dividing its related member interest
expense ($100) by its related member debt ($1000). Company A makes interest
expense payments of $200 to Unrelated Lenders C and D to service the $4,000 of
total debt existing between A and Unrelated Lenders C and D. A's weighted
average unrelated third party interest rate is five percent (5%) calculated by
dividing total unrelated third party interest expense ($200) by total unrelated
third party interest bearing debt ($4,000).
(II) Taxpayer B's separate company federal
income tax return Schedule L balance sheet shows $1,500 of assets and $1,000 of
interest bearing debt which produces a debt over asset percentage of 66.7%. The
Company A and Subsidiaries' federal consolidated income tax return Schedule L
balance sheet shows $6,000 of assets and $3,000 of unrelated third party
interest bearing debt which produces a debt over asset percentage of fifty
percent (50%). Because Taxpayer B's debt over asset percentage, 66.7%, exceeds
the group's unrelated third party debt over asset percentage, 50%, the amount
of Taxpayer B's related member interest expense that may qualify for the
unreasonable exception is limited. The limitation is calculated by multiplying
B's assets ($1,500) by the lower of the taxpayer's debt over asset percentage
or the group's unrelated third party debt over asset percentage (50%) and then
multiplying the product ($750) by the lower of the taxpayer's related member
interest rate or the related member's unrelated third party interest rate (5%),
which yields an ultimate limitation of $37.50.
(i) Requests for alternative
adjustment agreements provided for in
Code of Ala.
1975, §
40-18-35(b)(2) and subdivision (2)(b) of this regulation should be directed to the Alabama
Revenue Commissioner and submitted in writing to the Department of Revenue at
least ten (10) weeks prior to the filing of the taxpayer's corporate income tax
return for which the agreement is requested. The request should describe both
the taxpayer's particular facts and circumstances that warrant an alternative
adjustment and the terms of the proposed alternative adjustment. If the
taxpayer is unable to submit the request ten (10) weeks prior to the filing of
the return, the taxpayer should pay the tax in full and request a refund in the
request for an alternate adjustment agreement.
Author: Joe Garrett