A recent Supreme Court of Arkansas decision has upheld a multistate corporation’s allocation to Arkansas of 100% of its interest expenses from borrowings to fund a spin-off. It also rejected as irrelevant the state’s attempt to condition entitlement to such allocation on the taxpayer showing that it did not apportion any of the interest expense in its tax returns filed in other states. Hudson v. Murphy Oil USA, Inc., 2024 Ark. 179 (Ark. Sup. Ct., Dec. 12, 2024).
The Facts: Murphy Oil USA, Inc. (“Murphy Oil”) is an Arkansas-based operator of retail-fueling stations in 24 states. Murphy Oil was spun off from its prior parent company. In order to fund the spin-off, Murphy Oil borrowed $650 million through notes and credit agreements, which amount was then distributed to its new parent company. None of the funds were used to finance Murphy Oil’s retail-fueling operations. Murphy Oil incurred interest expenses on its borrowings, and it was the deductibility of those interest expenses in Arkansas that was the subject of the dispute.
In its originally filed Arkansas corporate tax returns, Murphy Oil apportioned the interest expense among all the states in which it conducted business, so that it was only partly deducted in Arkansas. Murphy Oil later amended its Arkansas returns, allocating 100% of the interest expenses to Arkansas—its commercial domicile—on the grounds that it related to nonbusiness activities (the corporate spin-off), which resulted in Arkansas refund claims.
The Arkansas Department of Finance and Administration (the “Department”) denied the refunds, but a state circuit court judge granted summary judgment in favor of Murphy Oil. This appeal followed.
The Department took the position that the interest was either (i) not deductible at all because Arkansas law prohibited deductions for expenses “allocable to nonbusiness income,” or (ii) related to apportionable business income (as Murphy Oil had originally filed its returns). It also argued that the refund should be denied on “uniform fairness grounds.”
The Decision: The Supreme Court of Arkansas ruled in favor of the taxpayer, holding that under the Uniform Division of Income for Tax Purposes Act (“UDITPA,” which Arkansas has adopted), the separation from one parent company to another in a spinoff was an “extraordinary, non-recurring event” (i.e., not business income under the so-called “transactional test”). The court also rejected the Department’s “functional test” argument for business income treatment, noting that Murphy Oil did not use the borrowed funds to acquire, manage or dispose of its business property.
In addition, the court rejected the Department’s alternative argument that Arkansas law prohibited any deduction for the interest expenses if such expenses are found to relate to nonbusiness income under UDITPA. In interpreting Arkansas law—which the court found to be open to more than one interpretation—the court found that the Arkansas legislature’s purpose for the provision was to limit deductions related to “tax-exempt income,” noting that “it was not materially disputed that these interest expenses were unattributable to [any] income.”
Relevance of Tax Filings in Other States: Finally, the court also addressed an important (and commonplace) issue concerning the relevance of a taxpayer’s returns filed in other states. The Department argued, on “fairness” grounds, that allowing a 100% deduction for Arkansas purposes, without Murphy Oil also having to amend its tax returns in other states where the interest expense was apportioned (and therefore partly deducted), was “unjust” and would allow Murphy Oil a potential tax “windfall” and the refund claims should therefore also be denied on that basis.
The court emphatically and unambiguously rejected the Department’s argument: “It is not the role of this court to adjust Arkansas tax returns based on unfairness to Tennessee, Mississippi, or other states” or to somehow have “a role in requiring taxpayers to file returns in multiple states uniformly under the UDITPA.” Rather, the court viewed its sole role in the case as interpreting and applying Arkansas law.
State tax auditors often request that taxpayers provide information regarding tax returns filed under the laws of other states. The Supreme Court of Arkansas correctly rejected the relevance of such information in interpreting the deductibility and allocation of expenses under Arkansas law.
This update is one in a series of updates written for the January 2025 edition of The BR State + Local Tax Spotlight.
© 2025 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.
