Massachusetts Appellate Tax Board Holds Parent Company Not Required To Add Back Related-Party Interest

The Massachusetts Appellate Tax Board has held that a parent company qualified for an exception from the corporate excise tax requirement to add back related-party interest because the underlying debt was primarily entered into for a valid business purpose, was supported by economic substance, constituted bona fide debt, and the interest reflected fair value or consideration.1 Specifically, the amounts the parent company advanced to its subsidiary were used for the valid business purposes of funding and expanding the operations of its subsidiaries. In advancing the funds in the form of loans instead of equity, the parent company was motivated by insurance company regulatory concerns rather than a desire to avoid tax. Therefore, the interest paid on the debt was fully deductible for Massachusetts corporate excise tax purposes.

Background

The MassMutual Life Insurance Company (MMLIC) is headquartered in Massachusetts and is one of the largest insurance companies in the United States. In 2003, MMLIC held over $300 billion in assets under management, including debt instruments issued by a variety of third-party borrowers. MMLIC wholly owned MassMutual Holdings LLC (MMH), 2 which acted as a holding company for MMLIC's non-insurance subsidiaries.

In 1993, MMLIC began to issue loans to MMH (referenced as MMH notes). Generally, the original MMH notes were made for seven-year terms, with the principal due at maturity and interest payable monthly. The notes assessed interest at the applicable federal rate plus 2 percent. MMLIC and MMH claimed that the advances were not motivated by tax considerations, but were undertaken due to insurance industry regulatory considerations. The funds primarily were directed to the expansion of a subsidiary's international operations or to fund an ownership interest in another subsidiary. The loans were evidenced by a promissory note with a fixed date of maturity, provisions for the computation and payment of interest, and remedies in the event of default.

From 1993 to 2002, when MMLIC ceased issuing new lines of credit, MMLIC advanced a total of approximately $1.2 billion to MMH. In 1998, MMH refinanced all of its existing debt to MMLIC and issued notes reflecting 10-year terms, with principal due at maturity, and interest payable quarterly at the mid-term federal rate plus 1.5 percent. Pursuant to the terms of the MMH notes, MMH did not make any payments of principal on the notes that were issued in 1993 until they were refinanced in 1998. Following the sale of a successful subsidiary in 2005, MMH made a number of repayments to retire debt related to this subsidiary. The remaining debt of approximately $1 billion was refinanced at maturity in 2008. MMH timely paid all interest due in cash. However, there were several occasions where MMH borrowed additional amounts from MMLIC as advances to fund its interest payments. 3

MMH and other related non-insurance members which comprised the Massachusetts combined group filed a combined Massachusetts corporate excise tax return for each of the periods at issue and did not add back the deductions for interest paid to MMLIC, a related party. 4 According to MMLIC and MMH, the loans constituted bona fide debt that qualified for an exception to the addback requirement. Following an audit, the Massachusetts Commissioner of Revenue issued notices of assessment for the 2003 and 2004 tax years...