Alabama Loses Interest Addback Attack, Yet Again

The BR State + Local Tax Spotlight

By Mitchell A. Newmark

Alabama’s Department of Revenue (“DOR”) struck out again when it attacked related party interest transactions. In Huhtamaki, Inc. v. Alabama DOR, Docket Nos. BIT 19-890-JP, BIT 19-1091-JP (Ala. Tax Tribunal 2024), the Alabama Tax Tribunal analyzed the Alabama interest addback statute and reasoned that the exception for payments to related parties in treaty countries contemplated payments that were directly or indirectly paid. Against the DOR’s arguments to the contrary, the Tribunal held that the Taxpayer was entitled to the addback exception when the Taxpayer paid interest to its ultimate parent, and its parent paid interest to a related party that was in a treaty country.

The addback statute, AL Code § 40-18-35(b)(1), clearly provides that:

a corporation shall add back otherwise deductible interest expenses and costs and intangible expenses and costs 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 members, except to the extent the corporation shows …that the corresponding item of income was in the same taxable year: … b. subject to a tax based on or measured by the related member's net income by a foreign nation which has in force an income tax treaty with the United States, if the recipient was a ‘resident’ (as defined in the income tax treaty) of the foreign nation. For purposes of this section, subject to a tax based on or measured by the related member's net income means that the receipt of the payment by the recipient related member is reported and included in income for purposes of a tax on net income, and not offset or eliminated in a combined or consolidated return which includes the payor.… That portion of an item of income which is attributed to a taxing jurisdiction having a tax on net income shall be considered subject to a tax even if no actual taxes are paid on such item of income in the taxing jurisdiction by reason of deductions or otherwise.

(Emphasis added.)

The case was not the first case to deal with the interest addback. In Pfizer, Inc. v. Alabama DOR, Docket No. BIT 18-236-JP (Ala. Tax Tribunal 2022), the Tribunal previously held that a direct payment to a related party in a treaty country ended the inquiry regarding eligibility for the exception to the addback. The Pfizer Tribunal concluded that the DOR was not entitled to look through that treaty country return to determine whether interest was paid out by the treaty-country-located interest recipient to another entity. It so concluded because: (1) the statute asks only whether the Taxpayer made a qualifying payment; and (2) the statute states that the exception applies even if no tax is ultimately paid in the treaty country.

The DOR asked the Huhtamaki Tribunal to reconsider its decision in Pfizer. The same Judge hearing the Huhtamaki case ruled in Pfizer. It was no surprise to us that the Huhtamaki Tribunal declined to reconsider Pfizer.

The Huhtamaki Tribunal cited the clear language used several times in the interest addback statute that expressly allowed for direct or indirect payments to the recipient in the treaty country. In its discussion, the Tribunal noted that the record demonstrated, and the DOR did not dispute, that the interest payments were indirectly made to related recipients in treaty countries (a Luxembourg affiliate and a Hungary affiliate). Therefore, the Tribunal allowed the interest addback exception.

Courts will apply the plain meaning of statutes. Words matter!

This update is one in a series of updates written for the March 2024 edition of The BR State + Local Tax Spotlight.

© 2024 Blank Rome LLP. All rights reserved. Please contact Blank Rome for permission to reprint. Notice: The purpose of this update is to identify select developments that may be of interest to readers. The information contained herein is abridged and summarized from various sources, the accuracy and completeness of which cannot be assured. This update should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.