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April 27 — The Tax Court of New Jersey ruled against a Kraft Foods subsidiary in a case that could serve as a warning to in-state companies that argue the addback of interest payments is unreasonable.
The court's ruling, the third concerning the “unreasonable” exception to New Jersey's interest addback requirements, further limits a narrow exception to the state's interest addback requirements and could possibly encourage tax authorities to become more strict, David J. Gutowski, a partner in Reed Smith's State Tax Group in Philadelphia, told Bloomberg BNA April 26.
“It’s a good wake-up call for many taxpayers” who weren't paying much attention to New Jersey's addback rules on interest payments, Gutowski said. “It’s fair to say this decision could embolden” the tax division to “tighten the screws a bit on interest addback.”
New Jersey's Business Tax Reform Act of 2002 was intended to eliminate what lawmakers viewed as provisions in the New Jersey corporation business tax regime that allowed companies to avoid taxation in the state, according to the opinion. The 2002 legislation requires a taxpayer to adjust its federal taxable income for New Jersey purposes by adding back related-company interest payments to its New Jersey taxable income, unless the company meets one of five exceptions.
The case involves the fifth exception of New Jersey's addback statute—the Unreasonable Exception. Tax authorities issued a technical advisory memorandum (TAM-2011-13(R)) in February to provide guidance on the Unreasonable Exception and referenced the two earlier cases, Beneficial N.J. v. Div. of Taxation No. 009886-2007 (N.J. Tax Ct. 2010) and Morgan Stanley & Co. v. Dir., Div. of Taxation 28 N.J. Tax 197 (2014).
At issue were the taxable income interest payments on promissory notes that Kraft Foods Global Inc. made in 2005 and 2006 to its parent company, Kraft Foods Inc., a subsidiary of Philip Morris Cos. Inc.
Kraft Foods Global argued that it qualified for the unreasonable exception because the interest payments it made to its parent company were legitimate business expenses, so it would be “unreasonable” to require Kraft to add them back into its taxable income.
The New Jersey Division of Taxation disagreed and after an audit, added back $473 million in interest payments to Kraft Foods' 2005 New Jersey taxable income and another $462 million in 2006, saying that the debt between Kraft Global and Kraft Foods was “not at arm's length.”
The division assessed $7.63 million in tax, penalties and interest for 2005 and $6.96 million for 2006.
The court held that Kraft Foods didn't meet its burden of proof because, among other things, it produced no evidence that it was ultimately responsible for its debt.
The taxpayer “has a higher burden of proof in these circumstances. It must produce clear and convincing evidence that disallowance of the interest deduction is unreasonable,” the opinion said. “Here, the Director acted reasonably when he determined that plaintiff did not meet its evidentiary burden.”
Affiliated companies are “free to organize their business relationships in any way they see fit,” the opinion concludes. They must “accept the tax consequences of those business decisions, whether those consequences were or were not anticipated.”
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The decision is at http://src.bna.com/ery.
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