United States

Massachusetts: Cash Management System Balances not Bona Fide Debt

Sep 14, 2015
From KPMG TaxWatch

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The Massachusetts Appellate Tax Board recently addressed whether balances owed by a parent corporation to certain of its subsidiaries constituted bona fide debt. The balances arose as a result of the group’s cash management system whereby any cash generated by a subsidiary’s operations was “swept” on a nightly basis into a common bank account maintained by the parent. Any expenses of the members of the group were paid from the sweep account. Any excess deposits over expenses accumulated in a “net accounts payable balance,” and interest was credited to the subsidiaries on the balance. The subsidiaries deducted the intercompany balances in computing the non-income measure of the corporate excise, and the parent deducted its interest expenses in computing Massachusetts taxable income. The Massachusetts Commissioner of Revenue asserted that the transactions giving rise to the balances did not constitute bona fide debt for Massachusetts purposes and therefore neither amount was deductible. The matter eventually came before the Appellate Tax Board.

The Board noted that “true indebtedness requires, at the time funds are transferred, both an unconditional obligation on the part of the transferee to repay the money, and an unconditional intention on the part of the transferor to secure repayment.” In analyzing whether the balances at issue constituted bona fide debt, the Board reviewed a number of factors gleaned from earlier federal and Massachusetts cases addressing whether debt was true debt. After reviewing all the facts and circumstances, the Board ruled that the totality factors weighed in favor of the Commissioner. First, the amounts transferred to the parent under the cash management system were not limited in any manner. Second, there were no repayment schedules, no history of repayments, and no other evidence indicating that there was any actual repayment or intent to repay the excess cash retained the parent. The excess cash transfers appeared to be permanent in nature and were not intended to be returned. In addition, while payments of interest and principal were referenced in promissory notes between the parties, no amounts were ever actually paid to the subsidiaries under the system. Thus, although the parties papered the CMS with promissory notes, the formal indicia of the arrangement was diminished by the lack of payments. Finally, the Board noted that the debt was not secured in any way. In light of all these facts, the Board ruled that the debt was not deductible in computing the net worth component of the corporate excise tax. Finally, the Board rejected the taxpayers’ assertion that because the related party addback statute contained an exception to the addback requirement for transactions giving rise to an intercompany expense that have a valid business purpose, the interest should be deductible.  The Board determined that a purported business purpose for using the cash management system to manage the consolidated group’s funds did not alter the finding that the payments at issue were not true debt. As the balances were not true debt, the addback statute did not come into play. Please contact Yanina Reid at 617-988-5913 with questions on Staples, Inc. v. Commissioner of Revenue.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.