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By Zachary Atkins and Jack Trachtenberg
The Commonwealth notched another win before the Massachusetts Appeals Court in a case of first impression affirming corporate excise tax assessments based on a disallowance of the taxpayers’ interest and royalty expenses for pre-addback (pre-2002) and addback tax years (post-2001). Under a clear and convincing evidence standard, the court held that the taxpayers’ intercompany notes and related book entries did not create bona fide debt because the “debt” was unsecured, the notes did not contain any default or collateral provisions, and the notes were never repaid. Thus, disallowance of the intercompany interest expense was affirmed by the court. With respect to the royalty and rebate expenses, the court further held that disallowance of such expenses was not unreasonable because the taxpayers failed to demonstrate that tax avoidance was not a principal purpose of the restructuring and resulting royalty payment system. In affirming the royalty expense disallowance, the court specifically noted the circular flow of funds between the taxpayers, a parent and a wholly-owned subsidiary that owned and managed the intellectual property in question; the lack of evidence of any licensing agreements with third parties; and the taxpayers’ documented recognition that restructuring their intellectual property ownership and management system would result in significant tax savings. The Massachusetts Supreme Judicial Court denied the taxpayers’ application for review. Kimberly-Clark Corp. v. Comm’r of Revenue, Case No. 11-P-632 (Mass. App. Ct. Jan. 11, 2013).