Tax 3.01 Note
2) Corporation A, Corporation B, Corporation C, and Corporation D are related entities. A and D have nexus in Wisconsin, but B and C do not. B is not subject to tax in any state. Previously, D owned intangible property which A used in operating its business. In a series of transactions, D transfers the intangible property to B. B then licenses the intellectual property to C, the inventory purchasing company. A purchases the inventory from C. The royalty portion of A's cost of goods sold represents an indirect related entity expense that must be added back to A's income.
Tax 3.01 Note
3) Corporation O, Corporation H, and Corporation S are related entities. O, the operating company, transfers various items of intangible property to H in conformity with section
351 of the Internal Revenue Code. H enters into an agreement with S that will allow S to license H's intangible property. S and O are related entities. S licenses the intangible property to O whereby O pays fees to S based on a percentage of sales. The intangible expense between O and S is a related entity expenses that must be added back to O's income.
Tax 3.01(3)(a)
(a)
General. A corporation, individual, or pass-through entity shall modify federal income for Wisconsin purposes so that related entity expenses that were paid, accrued, or incurred to a related entity are added back to income.
Tax 3.01(3)(b)
(b) Taxpayers required to modify income. The addition modification applies to any individual, corporation, or pass-through entity that has deducted or excluded under the Internal Revenue Code any amounts for related entity expenses that are directly or indirectly paid, accrued, or incurred to, or in connection directly or indirectly with one or more direct or indirect transactions with, one or more related entities.
Tax 3.01(3)(c)
(c) Interest expense. Interest expenses include interest expenses otherwise deductible under section
163 of the Internal Revenue Code and otherwise deductible in the computation of Wisconsin adjusted gross income or Wisconsin net income. Expenses deductible as interest expenses under section
163 of the Internal Revenue Code include:
Tax 3.01(3)(c)1.
1. Interest paid or accrued within the taxable year on indebtedness.
Tax 3.01(3)(c)3.
3. Non-separately stated interest included in carrying charges for installment purchases.
Tax 3.01(3)(c)4.
4. Redeemable ground rents, excluding amounts paid in redemption.
Tax 3.01 Note
Example: Taxpayer A and Taxpayer B are related and A paid, accrued, or incurred $3,000 of original issue discount to B. Taxpayer C and Taxpayer D are related and C paid, accrued, or incurred $3,000 of interest that have been capitalized under section
263A of the Internal Revenue Code. Taxpayer E and Taxpayer F are unrelated and E has paid, accrued, or incurred $100,000 of indebtedness interest to F. A is required to add back $3,000 to its income since it paid, accrued, or incurred this amount to a related entity and it is the type of interest expense deductible under section
163 of the Internal Revenue Code. C is not required to add back $3,000 to its income since this type of interest is not the type of interest that is deductible under section
163 of the Internal Revenue Code. E is not required to add back $100,000 since the addback provisions do not apply to unrelated taxpayers.
Tax 3.01(3)(d)1.1. Rent expenses include expenses otherwise deductible in computing Wisconsin adjusted gross income or Wisconsin net income which are attributable to, for the use of, or for the right to use, real property, including the following:
Tax 3.01(3)(d)1.a.
a. Tangible personal property affixed to real property if the owner of the tangible personal property is the same as or related to the owner of the real property.
Tax 3.01(3)(d)1.b.
b. Services rendered in connection with rented real property if the owner of the property is the same as or related to the entity providing the service.
Tax 3.01(3)(d)2.
2. For purposes of the addition modification, the method used to compute the expense and the manner in which it is reported for financial accounting purposes are immaterial.
Tax 3.01 Note
Example: Amounts paid under capital leases might not be called “rent expenses" in the financial accounting records of a taxpayer, but these expenses are considered “rent expenses" for purposes of the addition modification.
Tax 3.01(3)(e)1.1. Other than services provided by the taxpayer's own employees, management fees include expenses and costs otherwise deductible in computing Wisconsin adjusted gross income or Wisconsin net income for the purchase or retention of services, including services that pertain to any of the following:
Tax 3.01(3)(e)2.
2. Subdivision
1. a. to
m. are in no way intended to and should not be construed as limiting the scope of the activities subject to this paragraph.
Tax 3.01(3)(f)1.1. Intangible expenses include any of the following expenses to the extent they would otherwise be deductible in the computation of Wisconsin adjusted gross income or Wisconsin net income:
Tax 3.01(3)(f)1.c.
c. Losses related to, or incurred in connection directly or indirectly with, factoring transactions or discounting transactions.
Tax 3.01(3)(f)1.e.
e. Other expenses, losses, or costs for, related to, or directly or indirectly in connection with acquiring, using, maintaining, managing, owning, selling, exchanging, or disposing of intangible property.
Tax 3.01(3)(f)2.
2. For a taxpayer purchasing amortizable intangible property from a related entity, the amortization expenses on that property are intangible expenses subject to the addition modification. This also applies to any other amortizable intangible expenses paid, accrued, or incurred between a taxpayer and a related entity.
Tax 3.01(4)(a)
(a)
General. Related entity expenses paid, accrued, or incurred to a related entity may be deducted to the extent such expenses meet the requirements of s.
71.80 (23) (a), Stats., and this subsection.
Tax 3.01(4)(b)1.1. Section
71.80 (23) (a), Stats., provides that if a taxpayer added back related entity expenses, the taxpayer may then deduct such expenses if the taxpayer meets the requirements under s.
71.80 (23) (a) 3., Stats. The taxpayer shall establish it meets the requirements under s.
71.80 (23) (a) 3., Stats., by clear and convincing evidence. The taxpayer shall meet all of the following requirements:
Tax 3.01(4)(b)1.a.
a. The primary motivation for the transaction was one or more business purposes other than the avoidance or reduction of state income or franchise taxes.
Tax 3.01(4)(b)1.b.
b. The transaction changed the economic position of the taxpayer in a meaningful way apart from tax effects.
Tax 3.01(4)(b)1.c.
c. The expense was paid, accrued, or incurred using terms that reflect an arm's length relationship.
Tax 3.01(4)(b)2.
2. This paragraph is the primary test for establishing whether related entity expenses may be deducted. The tests in pars.
(d) and
(e) are indicators that the test under this paragraph may have been met.
Tax 3.01(4)(c)
(c) Factors indicating requirements are not met. Factors indicating that the related entity expense does not meet the requirements under par.
(b) include:
Tax 3.01(4)(c)1.
1. There was no actual transfer of funds from the taxpayer to the related entity.
Tax 3.01 Note
Example: A book or journal entry alone is not considered an actual transfer of funds.
Tax 3.01(4)(c)2.
2. There was an actual transfer of funds, then the funds were substantially returned to the taxpayer, either directly or indirectly. Such return need not be immediate in order for this factor to be applicable.
Tax 3.01(4)(c)3.
3. If the transaction was entered into on the advice of a tax advisor, regardless of whether a client relationship exists or existed at the time of the advice, the advisor's fee was determined by reference to the tax savings. “Tax advisor" includes a “material advisor" under s.
71.81 (1) (b), Stats.
Tax 3.01(4)(c)4.
4. The related entity does not regularly engage in similar transactions with unrelated parties on terms substantially similar to those of the subject transaction.
Tax 3.01(4)(c)5.
5. The transaction was not entered into at terms comparable to an arm's length transaction as determined by Treas. Reg. section 1.482-1(b).
Tax 3.01(4)(c)6.
6. There was no reasonable expectation of profit from the transaction apart from the tax benefits.
Tax 3.01(4)(c)7.
7. The transaction resulted in the improper matching of income and expenses.
Tax 3.01(4)(c)8.
8. The expense for the transaction was accrued under Financial Accounting Standards Board Interpretation number 48. For purposes of this section, this factor applies to both income and franchise taxes.
Tax 3.01 Note
Note: Financial Accounting Standards Board Interpretation number 48 is available on the Financial Accounting Standards Board's web site at
www.fasb.org.
Tax 3.01(4)(c)9.
9. If the related entity expense is a rental expense, the rent was paid, accrued, or incurred to a captive real estate investment trust.
Tax 3.01(4)(c)10.
10. If the related entity expense is an interest expense, additional factors specific to interest expenses include any of the following:
Tax 3.01(4)(c)10.a.
a. The taxpayer is not sufficiently capitalized or has no reasonable expectation to make payment on the debt underlying the interest expense.
Tax 3.01(4)(c)10.c.
c. There is a contract, but the contract does not reflect an interest obligation resulting from an arm's length transaction.
Tax 3.01(4)(c)10.d.
d. The interest is attributable to an unpaid charge that is not an allowable expense, a loan from a captive insurance company, a dividend note, a loan from a related entity with net business loss carryforwards or net operating loss carryforwards, or a loan from a related entity that is an intermediary set up in a jurisdiction that imposes no corporate-level income or franchise tax.
Tax 3.01(4)(d)1.1. `Requirements.' Section
71.80 (23) (a), Stats., provides that if a taxpayer added back related entity expenses, the taxpayer may then deduct such expenses if the taxpayer meets the requirements under s.
71.80 (23) (a) 1., Stats. The taxpayer shall establish it meets the requirements under s.
71.80 (23) (a) 1., Stats., by clear and convincing evidence. The taxpayer shall meet all of the following requirements:
Tax 3.01(4)(d)1.a.
a. The related entity to which the taxpayer paid, accrued, or incurred related entity expenses during the taxable year directly or indirectly paid, accrued, or incurred such amounts in the same taxable year to a person who is not a related entity. In this subdivision, “taxable year" means the taxable year of the taxpayer claiming the deduction for related entity expenses paid, accrued, or incurred to the related entity. The department will consider such expenses the related entity pays, accrues, or incurs to an unrelated entity by the unextended due date of the taxpayer's income or franchise tax return to be paid, accrued, or incurred within the taxpayer's “taxable year." However, such expenses that occur after the end of the taxpayer's taxable year may not then be counted again as occurring in the subsequent taxable year.
Tax 3.01(4)(d)1.b.
b. Except as provided in subd.
2., the related entity to which the taxpayer paid, accrued, or incurred such expenses is a holding company or a direct or indirect subsidiary of a holding company, as defined in
12 USC 1841(a) or (l) or
12 USC 1467a(a)(1)(D).
Tax 3.01(4)(d)2.
2. `Investments of a bank, subsidiary, or affiliate.' Related entity expenses may not satisfy the test in subd.
1. b. when such expenses are paid, accrued, or incurred directly or indirectly to an entity that is organized under the laws of another jurisdiction and that primarily holds and manages investments of a bank, subsidiary, or affiliate, unless the related entity expenses satisfy the provisions in subd.
1. a. Tax 3.01(4)(d)3.
3. `Interest on acquisition of stock.' As specifically provided under s.
71.80 (23) (a) 1., Stats., interest expense paid, accrued, or incurred in connection with any debt incurred to acquire taxpayer's assets or stock under section
368 of the Internal Revenue Code may not satisfy the test under this paragraph.
Tax 3.01 Note
Example: Corporation A borrows money from Corporation B. No portion of the debt was used to acquire A's own stock or assets under section
368 of the Internal Revenue Code. In order to obtain the funds to loan to A, B borrows money from Bank C. A is a calendar year taxpayer, while B is on a fiscal year beginning July 1 and ending June 30. During the calendar year 2008, A accrued $100,000 of interest expense attributable to the loan from B. In turn, B accrued $90,000 of interest expense attributable to the loan from C during that same time period of January 1, 2008, through December 31, 2008. During the period of January 1, 2009, through March 15, 2009, B accrued $10,000 of interest expense to C.
For purposes of determining if the test under subd. 1. a. applies to A's interest expense, B may be considered to have accrued $100,000 of interest expense ($90,000 + $10,000) to C in A's 2008 taxable year. However, in A's 2009 taxable year, A cannot consider the $10,000 of interest expense accrued by B to C during the period of January 1, 2009, through March 15, 2009, to be accrued during A's 2009 taxable year.
Tax 3.01(4)(d)4.
4. `Allocation of expense paid to unrelated entity.' If less than 100 percent of the total related entity expenses paid, accrued, or incurred to the related entity from the taxpayer and all other related entities is paid, accrued, or incurred to an unrelated entity, a pro rata share of the taxpayer's related entity expenses is considered to satisfy the test under subd.
1. a. Tax 3.01 Note
Example: Taxpayer A made a $200,000 interest payment to Taxpayer B. No portion of the underlying debt was used to acquire the taxpayer's own stock or assets under section
368 of the Internal Revenue Code. B received a total of $800,000 of related entity interest income during A's taxable year. Of this amount, $200,000 was from A and $600,000 from other related entities. In A's taxable year, B paid $400,000 of interest expense to unrelated entities. In this case, $100,000 (($200,000/$800,000) x $400,000) of the interest A paid to B would be considered paid, accrued, or incurred to unrelated entities in A's taxable year.
Tax 3.01(4)(e)1.1. `Requirements.' Section
71.80 (23) (a), Stats., provides that if a taxpayer added back related entity expenses, the taxpayer may then deduct such expenses if the taxpayer meets the requirements under s.
71.80 (23) (a) 2., Stats. The taxpayer shall establish it meets the requirements under s.
71.80 (23) (a) 2., Stats., by clear and convincing evidence. The taxpayer shall meet all of the following requirements:
Tax 3.01(4)(e)1.a.
a. The related entity was subject to tax on, or measured by, its net income or receipts in this state or any state, U.S. possession, or foreign country.
Tax 3.01(4)(e)1.b.
b. The related entity's tax base in such state, U.S. possession, or foreign country included the income received from the taxpayer corresponding to the related entity expenses.
Tax 3.01(4)(e)1.c.
c. The related entity's aggregate effective tax rate applied to such income or receipts was at least 80 percent of the taxpayer's aggregate effective tax rate.
Tax 3.01(4)(e)1.d.
d. The related entity is not a real estate investment trust under section
856 of the Internal Revenue Code, other than a qualified real estate investment trust.
Tax 3.01(4)(e)2.
2. `Differing taxable years.' For both the taxpayer and the related entity, compute the aggregate effective tax rate for the taxable year that included the transaction date. If the related entity is on a taxable year that ends after the taxpayer's taxable year, the aggregate effective tax rate shall be determined as follows:
Tax 3.01(4)(e)2.a.
a. If in the related entity's most recently ended taxable year the related entity was subject to a tax on or measured by net income or receipts in a state, U.S. possession, or foreign country, the related entity's aggregate effective tax rate shall be computed based on the related entity's most recently ended taxable year.
Tax 3.01(4)(e)2.b.
b. If the related entity was not subject to such tax for its most recently ended taxable year, the related entity shall modify the computation of the aggregate effective tax rate as provided in subd.
2. c. Tax 3.01(4)(e)2.c.
c. The related entity uses 100 percent as the related entity's apportionment percentage and the related entity uses the statutory tax rate of the state where the related entity is incorporated, organized, formed, or, if the related entity is an individual, where the individual resides.
Tax 3.01(4)(e)3.
3. `Items not includable in aggregate effective tax rate.' The following are not included in the computation of the aggregate effective tax rate:
Tax 3.01(4)(e)3.a.
a. If the related entity expense was paid, accrued, or incurred to a pass-through entity, any tax rate that is imposed at the shareholder, partner, member, or beneficiary level rather than at the pass-through entity level for that state, U.S. possession, or foreign country.
