Massachusetts Appellate Tax Board Holds No Bona Fide Debt In Related-Party Transaction

The Massachusetts Appellate Tax Board has held that related-party transactions which occurred as part of a cash management system did not give rise to bona fide debt.1 Therefore, the amounts a taxpayer advanced to its subsidiaries pursuant to these transactions did not qualify as debt for purposes of the net income portion or the net worth portion of the Massachusetts corporate excise tax.

Background

Staples, Inc. (Staples) is headquartered in Massachusetts and, through its wholly-owned subsidiaries, is a wholesale and retail distributor of office supplies. Staples managed the cash generated by its domestic subsidiaries on a centralized basis through a cash management system (CMS) generally described as a "cash sweep." Staples' subsidiaries maintained zero-balance accounts, as cash generated by each subsidiary's operations was "swept" on a nightly basis into a common bank account maintained by Staples. Affiliated entity expenses, such as invoices from vendors, payroll, third-party professional service providers, utilities, and rent, were paid from this common account. If expenses paid on behalf of a particular subsidiary exceeded that subsidiary's cash contribution from its operations, the subsidiary was in a net payable position. Conversely, if a subsidiary had contributed more than its share of expenses, it was in a net receivable position.2

Staples entered into written agreements with CMS participants, including Staples Contract & Commercial, Inc. (SCC), which stated that each subsidiary would execute a note in favor of Staples for $75 million, and Staples would execute a promissory note in favor of each subsidiary for the same amount.3 In fact, several promissory notes including interest and repayment terms were executed by Staples in favor of its subsidiaries, including a note with Staples West for $75 million, SCC for $100 million and Staples East for $200 million. No corresponding demand notes were executed and no invoices requesting payment of principal and/or interest were produced. Aside from bookkeeping entries recording amounts generally characterized as due to or due from Staples, no evidence of payments on the notes was offered. The actual balances due from Staples to its subsidiaries, including SCC, significantly exceeded the stated limits in the notes.4

For the tax years ended January 31, 2002 through January 31, 2005, Staples filed a Form 355C, Combined Massachusetts Corporate Excise Tax Return, as the principal reporting corporation for a combined group of affiliated entities including SCC. On the returns, Staples deducted amounts characterized as interest paid with respect to the amounts owed to its subsidiaries in computing the income tax portion of the excise tax. Staples' subsidiaries, including SCC, deducted the CMS balances in computing their non-income measure of the tax. In 2010, the Commissioner issued Notices of Assessment to Staples and SCC assessing corporate excise, interest and penalties based on the notion that the transactions giving rise to the balances did not constitute bona fide debt for Massachusetts corporate excise tax purposes, and therefore the amounts were not deductible under both the income and non-income measures of the tax. The Commissioner was deemed to deny the taxpayers' applications for abatement, and the taxpayers timely filed appeals with the Board in March 2011.

Intercompany Transactions Were Not Bona Fide Debt

Income...