New Jersey Nixes Interest Deductions

New Jersey nixes interest deductions

June 06, 2016 | By Keith Martin in Washington, DC

New Jersey denied deductions for interest a corporation doing business in the state paid on a loan from its parent company.

The case is a reminder to companies with intercompany debt between affiliates that interest on such loans may not be deductible.

Most US states require companies to calculate state income taxes by starting with the income they reported on their federal tax returns, determine the share that was earned in the state and then make adjustments to account for any differences in state versus federal tax rules for calculating taxable income. The differences could lead to “add backs.”

Kraft Foods Global, Inc. makes and markets macaroni and cheese, processed meat products, coffee and other groceries across the United States, including in New Jersey.

It has an immediate parent, called Kraft Foods, Inc. and an ultimate parent, Philip Morris.

It owed money under three notes to its ultimate parent. Philip Morris assigned the notes to a subsidiary.

The immediate parent, Kraft Foods, Inc., borrowed $9.6 billion from third parties and lent the money to Kraft Foods Global. Global then used the money to repay the outstanding notes that had originally been held by Philip Morris and were by then held by another Philip Morris subsidiary.

Global paid interest on the $9.6 billion loan from its immediate parent. The interest matched what the parent owed the third parties from whom it borrowed the money. However, there was no provision for repayment of principal to the immediate parent, and the third-party lenders had no rights to enforce repayment of the debt from Global directly.

Global deducted the interest for purposes of determining its federal taxable income that was the starting point for calculating New Jersey income for the state corporate income tax.

The state tax department made Kraft add back the interest.

By law in New Jersey, interest paid to a related company must be added back, unless one of five exceptions applies. The only one that could possibly have applied is where “the taxpayer establishes by clear and convincing evidence, as determined by the [state tax department], that the disallowance of a deduction is unreasonable . . . .”

The state tax court said it agreed the interest had to be added back. It said it could see the logic of allowing the interest deduction where the parent is a mere conduit for borrowing from third parties, but that is not this case since the subsidiary, Global, is not liable on the debt to the third parties.             

The case is Kraft Foods Global, Inc. v. Director, Division of Taxation. The New Jersey tax court issued its decision on April 25.