Tennessee DOR’s Nettlesome Guidance on Related Party Intangible Expenses

It has been some time since a state tax department has promulgated any guidance on the issue of related party interest and intangible expenses. With fiscal cliffs and other budget problems, states have turned their focus to other means of cracking down on perceived corporate tax abuse. The Tennessee Department of Revenue ("Department") has recently promulgated new guidance addressing the treatment of related party intangible expenses, which will likely throw cold water on taxpayers' interest to pursue such deductions. The new rules apply to tax years ending on or after July 1, 2012, and require pre-approval from the Department for certain types of intangible expenses. Other types are allowable without pre-approval, but still require disclosure by the taxpayer.

In Notice #12-16 ("the Notice"), the Department allows the deduction of intangible expenses paid to affiliates that are:

  1. Located in a country that has a comprehensive income tax treaty with the United States;
  2. Paying, accruing, or incurring such expenses, directly or indirectly, to an unrelated third party during the same tax year; or
  3. Subject to a state's income tax and computing the appropriate portion using the allocation or apportionment rules of that state.

The Notice advises that for each taxable year during which one or more of these safe harbors apply to the particular intangible expense, the taxpayer may deduct such expenses on its tax return, complete Form IE-N, Intangible Expense - Notice of Deduction to disclose the transaction, and file the form with its return.

For tax years ending on or after July 1, 2012, taxpayers may also deduct intangible expenses paid to affiliated entities if the Department determines that the intangible expense did not have as its principal purpose the avoidance of tax. Taxpayers requesting such approval must complete Form IE-A, Intangible Expense - Application for Approval to Deduct. Upon receipt, the Department will evaluate the application and issue a letter to the taxpayer approving or denying the intangible expense deduction. If taxpayers do not receive a letter prior to filling their return, they may deduct the intangible expense and complete the appropriate box on Schedule J of the return. If the deduction is subsequently denied, taxpayers will be assessed additional tax due. If Form IE-A is filed at least 60 days before the original or extended due date of the return and the Department fails to act before the due date, no penalty will be assessed based on the disallowance of the deduction and no interest will accrue on any tax due as a result of the disallowance until 30 days after the date of a denial notice issued by the Department. An approval to deduct intangible expenses will remain in effect for at least five years, so long as the taxpayer completes an annual certification on Schedule J that the facts and circumstances surrounding the transaction remain substantially unchanged.

Taxpayers should be very careful in completing these new forms, as the protections of no penalty and a 30-day interest free period could be very valuable, and the Department will likely review all such forms very stringently. Additionally, these new forms require far more information than was previously required in Tennessee for disclosure of such related party transactions. So taxpayers should be mindful of the increased compliance burden of completing accurately and timely.

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