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Massachusetts Appellate Tax Board Applies Wicked Mad Scrutiny to Taxpayer's Intercompany Interest Expense

The Massachusetts Appellate Tax Board recently upheld the Commissioner of Revenue’s denial of deductions for interest expense on intercompany loans. Sysco Corp. v. Comm’r of Revenue

November 14, 2011

The Massachusetts Appellate Tax Board recently upheld the Commissioner of Revenue’s denial of deductions for interest expense on intercompany loans. Sysco Corp. v. Comm’r of Revenue, Docket Nos. C282656 & C283182 (Mass. App. Tax Bd., Oct. 20, 2011).

In Sysco, the taxpayer employed a common cash management arrangement in which cash was swept on a nightly basis from its subsidiary entities to a common “cash manager” for investment purposes. If Sysco received more money from an operating company than it disbursed to it, the subsidiary earned interest (prime rate less 1%) on the balance, and if Sysco disbursed more money than it received, Sysco earned interest (prime rate) from the subsidiary.

The Board determined that the loans were not true indebtedness. The Board found that the purported loans were not memorialized in writing (whether in the form of promissory notes or formal agreements) and there were no repayment schedules or fixed maturity dates. Also, the Board determined that the upstream payments were intended to remain with Sysco for use in its corporate activities, including paying dividends. The Board found that Sysco had no intention of repaying the funds transferred by the operating companies and that the operating companies never once requested repayment from Sysco. The Board placed great reliance on the fact that the aggregate amount Sysco owed to its operating companies increased dramatically from approximately $700 million in 1996, to more than $1.8 billion in 2001. Further, the Board gave no weight to Sysco’s experts because they “failed to demonstrate the existence of ‘an unconditional and legally enforceable obligation for the payment of money’ in the context of Sysco’s cash-management system.”

The Board’s decision is troubling because it interferes with a common intercompany arrangement for large multi-entity businesses that is meant to reflect the compensation for the use of each legal entity’s capital in an efficient manner. Some states have even imputed a charge on intercompany transactions when a taxpayer has not charged a related company for such an arrangement. See, e.g., United Parcel Serv. Gen. Servs. Co. v. Director, Div. of Taxation, 25 N.J. Tax 1 (2009). Finally, it is worth noting that the sting of the Board’s decision is lessened by Massachusetts’ shift to combined reporting.

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