United States

Iowa: Parent Holding Company Not Included in Consolidated Group; Disallowance of Deductions for Certain Expenses Upheld

May 08, 2017
From KPMG TaxWatch

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An Iowa appeals court recently addressed two issues affecting the computation of a consolidated group’s Iowa tax liability. The taxpayers at issue were a group of corporations generally engaged in operating adult bookstores under the name Romantix. There were stores in Iowa and elsewhere. The parent holding company owned the subsidiaries and the Romantix trademark. The first issue was whether the parent holding company was doing business in Iowa so that it was included in the Iowa consolidated group. The taxpayer argued that because the holding company owned intangible property (the Romantix trademark) that was used by the Iowa subsidiaries, the holding company had the functional equivalent of a physical presence in Iowa related to its ownership of the subsidiaries and should be included in the consolidated group. The appeals court, however, disagreed citing the Iowa Supreme Court’s recent decision in Myria Holdings. In that case, the Iowa high court held that a parent company was exempt from corporate income tax (and not included in the Iowa consolidated group) because its activities (owning stock and operating a cash management system for its subsidiaries) were limited to “[o]wning and controlling a subsidiary corporation” and it lacked a physical presence in Iowa related to its ownership or control. The appeals court, concluding that based on Myria Holdings that the holding company was not includable in the Iowa consolidated group, did not specifically address whether the use of the Romantix trademark in Iowa equated to a physical presence.

The second issue before the court was whether the Iowa subsidiaries could deduct certain expenses in computing Iowa taxable income. The disputed expenses were related to the acquisition of the business several years earlier and included expenses for amortization of a non-compete agreement and interest on debt related to the acquisition. The subsidiaries had guaranteed both debts. The Department’s position was that the expenses could not be deducted by the subsidiaries because they were (1) not primarily owed and (2) not paid by the subsidiaries. The taxpayers, on the other hand, argued that internal allocation of these expenses by the holding company to the subsidiaries rendered them able to deduct the expenses in computing Iowa taxable income. The taxpayers also argued that the subsidiaries actually paid these expenses. The court rejected both of these arguments, ultimately holding that the Iowa subsidiaries did not pay the expenses although the funds to do so flowed from the subsidiaries to the entity that actually paid the bills. Furthermore, even if internal allocation of the amortization to the subsidiaries constituted “payment” of these expenses, the amortization expenses were not “reasonable and necessary” business expense of the subsidiaries. Please contact Jodie Scott at 612-305-5210 with questions on Romantix Holdings, Inc. v. Iowa Dep’t 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.