With oral argument and briefing complete, the Massachusetts Department of Revenue’s authority to increase the net worth component of a taxpayer’s corporate excise using its “true debt” analysis is under review by the Appeals Court in National Grid Holdings, Inc. et. al. v. Commissioner. The appeal should be of particular interest to taxpayers because, in addition to reviewing whether the taxpayers are entitled to interest deductions from the income tax base, it would be the first Appellate Court decision that involves a true debt attack on a taxpayer’s net worth tax base since Overnite Trans. Co. v. Commissioner, 54 Mass.App.Ct. 180 (2002).
By way of background, the Department has been issuing assessments that increase a taxpayer’s net worth subject to the corporate excise by denying a deduction for intercompany debt. The Department asserts that the intercompany obligation is not “true debt”, and therefore, cannot be deducted as a liability from the taxpayer’s net worth leading to an assessment. This can lead to substantial assessments for taxpayers. In some cases, the Department makes the adjustment even though the obligation is treated as debt for purposes of the taxpayer’s financial reporting and debt treatment has been respected at the federal level and all other state jurisdictions.
Whether the Department has the authority to make these “true debt” adjustments for purposes of computing the net worth tax base is now before the Appeals Court. The taxpayer is arguing that under Massachusetts statutes and case law interpreting the net worth statute, a taxpayer’s accounting treatment of the obligation on its books and records is controlling. If the obligation is treated as a liability in the taxpayer’s books and records, it is deductible, regardless of whether it is “true debt” for income tax purposes. At oral argument, the taxpayer particularly emphasized the importance of the obligation’s characterization for financial reporting purposes, highlighting that its obligations were treated as liabilities in financial reports made to the Securities and Exchange Commission on several occasions. In its brief, the taxpayer argued that its analysis is consistent with Appellate Tax Board rulings in other net worth tax cases that indicate that following a taxpayer’s accounting treatment in its books and records ensures that taxpayers are not unnecessarily forced to keep “two separate sets of books, one for financial accounting purposes and one for tax accounting purposes”.
The fact pattern is a particularly complex international debt arrangement that required hundreds of pages of briefing and weeks of testimony at the Appellate Tax Board, it may take the Appeals Court some time to issue a decision (a longer discussion of National Grid’s fact pattern is discussed in greater detail here). But given the number of pending appeals on the issue, the decision will be eagerly anticipated by many. It is our hope that the Appeals Court takes the opportunity to reverse the Appellate Tax Board and stops what we consider to be an example of Departmental overreach. If it does not, taxpayer’s may still want to preserve their appeals. True debt appeals are fact intensive and there have been some rumblings from the Legislature of adopting retroactive legislation to cure this issue. You can read more about that legislation here.