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Transfer pricing in state taxation is gaining momentum. Interest payments should be a business expense and should be an exception on their tax return.

Kraft Foods Global Inc. v. Director, Division of Taxation

This case highlights the significance of intercompany transactions in state taxation and the importance of distinguishing between federal and state tax legislation.

The New Jersey Tax Court’s recent decision on Kraft Foods Global Inc. v. Director, Division of Taxation to disallow interest payment deductions by a Kraft Foods Inc. subsidiary is another signal that transfer pricing in state taxation is gaining momentum.

The case concerned interest payments that Delaware-based Kraft Foods Global Inc. made on loans from its parent, Kraft Foods Inc. New Jersey passed a 2002 law that eliminated the ability of companies to take interest deductions in a related-party setting, even though they could under federal law. The law requires a company to add back these interest payments to taxable income for New Jersey corporation income tax purposes. In 2005 and 2006, Kraft Foods Global Inc. (the subsidiary) did not add back the interest payments made on the intercompany loan between it and Kraft Foods Inc. on the NJ corporation income tax return, claiming that these interest payments qualified for a legal exception.

The NJ Division of Taxation determined that Kraft Foods Global did not establish that the exception applies and that it was eligible for the interest payment deduction. The court ruled that Kraft Foods Inc. did not establish clear and conclusive evidence that it was entitled to an exception. As such, Kraft Foods Global Inc. could not deduct from its taxable income $934 million in interest payments made to the parent company.

However, the company argued that the parent company’s debt should be viewed as belonging to Kraft Foods Global Inc., and the interest payments made to Kraft Foods Inc. should be classified as a business expense. The Division of Taxation contended that there is no evidence that Kraft Foods Inc. served as a conduit for the interest payments. Kraft Foods Inc. and its bondholder had no contractual recourse if Kraft Foods Global Inc. could not make its interest payments, thereby invalidating the company’s argument.

The Division of Taxation can determine if a company qualifies for the exception to the interest payment add-back provision. The tax court ruling determined that Kraft Foods Global Inc. did not produce sufficient documentation that it is responsible for Kraft Foods Inc.’s bondholder debt.

Henric Adey is the Transfer Pricing Practice Leader at EisnerAmper. As practice leader, he is responsible for advising clients over a wide span of industries concerning both international and multi-state transfer pricing matters.

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