If a more-than-5% shareholder borrows money solely to re-lend it to the corporation, and the corporation pays interest to the shareholder that just passes through to the shareholder's outside lender, is that pass-through interest exempt from New York's 90% related-party interest add-back as a mere 'conduit' payment?

Plain-English summary

General Discount Corporation and CBT Leasing Corporation, joint petitioners, asked the Department to bless a specific interest-deduction theory: where a shareholder owning more than 5% of a corporation's stock borrows funds from an outside lender SOLELY to re-lend those same funds to the corporation, and the corporation's interest payments to the shareholder simply "pass through" the shareholder -- like a conduit -- to that outside lender, shouldn't the interest be fully deductible rather than subject to the related-party add-back?

Tax Law § 208.9(b)(5) requires a corporation to add back 90% of its federal deduction for interest paid on debt owed to a shareholder owning more than 5% of the corporation's stock. The statute lists exactly four exceptions where interest CAN still be fully deducted, and a pass-through/conduit arrangement is not among them. The Department held that Petitioners' proposed interpretation "is not consonant with the applicable statutory provision" and that "it is not within the power of the administering agencies of the statute to permit other variations" beyond the four enumerated exceptions.

This is one of seven identical rulings, all DATED October 6, 1983 and issued to seven different, unrelated petitioners raising the exact same pass-through/conduit theory. See TSB-A-83(15)C for the fullest writeup and the complete list of companion rulings (TSB-A-83(10)C, TSB-A-83(11)C, TSB-A-83(12)C, TSB-A-83(14)C, TSB-A-83(16)C).

What this means for you

Businesses financing through a majority/significant shareholder as an intermediary

Don't assume that structuring shareholder debt as a "pass-through" of outside financing will avoid New York's 90% related-party interest add-back -- the statute looks only at WHO the interest is paid to, not at what that shareholder does with the money afterward. The Department rejected this exact theory for at least seven different taxpayers the same day.

Common questions

Q: If my shareholder is just passing borrowed funds through to me, is the interest I pay exempt from the add-back?
A: No -- section 208.9(b)(5)'s add-back applies to interest paid to any more-than-5% shareholder regardless of the loan's economic substance or purpose; only the four specifically enumerated statutory exceptions escape it.

Q: Can another company with a similar pass-through financing arrangement rely on this Opinion?
A: It binds the Department only as to these petitioners' own facts, though the Department applied identical reasoning to at least six other petitioners the same day.

Citations and references

Statutes:

• Tax Law § 208.9(b)(5)

Related rulings:

• TSB-A-83(15)C -- fullest writeup; full list of the seven identical same-day companion rulings

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1983.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a83_13c.pdf

Original ruling text

New York State Department of Taxation and Finance
TSB-A-83(13)C
Corporation Tax
May 10, 1984

Taxpayer Services Division
Technical Services Bureau
STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. C810819A

On August 19, 1981 a Petition for Advisory Opinion was received from General Discount
Corporation and CBT Leasing Corporation, both located at 60 State Street, Boston, Massachusetts
02109.
Petitioner requests an Advisory Opinion to the effect that interest paid by a corporation to
a shareholder owning more than 5% of the issued capital stock of such corporation would be fully
deductible where such shareholder borrows funds solely on behalf of such corporation, to which the
funds are re-lent in turn, the interest paid by such corporation to the shareholder being merely
"passed-through" the shareholder, as through a conduit, to the lender from which such shareholder
derived the funds.
Article 9-A of the Tax Law imposes the State Franchise Tax on Business Corporations,
which tax is computed on the one of four alternative bases which yields the highest tax. One of these
bases is "entire net income", which is Federal taxable income with certain modifications. The
modification set forth in section 208.9(b)(5) of the Tax Law, with certain statutory exceptions,
disallows ninety per cent of a corporate taxpayer's Federal deduction for interest paid on
indebtedness to a shareholder owning more than 5% of the stock of the taxpayer. Such provision
reads as follows:
(b) Entire net income shall be determined without the exclusion, deduction or credit of:
. . .
(5) ninety per centum of interest on indebtedness directly or
indirectly owed to any stockholder or shareholder (including
subsidiaries of a corporate stockholder or shareholder), or members
of the immediate family of an individual stockholder or shareholder,
owning in the aggregate in excess of five per centum of the issued
capital stock of the taxpayer, except that such interest may, in any
event, be deducted.
(i) up to an amount not exceeding one thousand dollars,
(ii) in full to the extent that it relates to bonds or other evidences of
indebtedness issued, with stock, pursuant to a bona fide plan of
reorganization, to persons who, prior to such reorganization, were
bona fide creditors of the corporation or its predecessors, but were not
stockholders or shareholders thereof,

RODERICK G. W. CHU, COMMISSIONER
TP-8 (3/83)

GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR

-2­
TSB-A-83(13)C
Corporation Tax
May 10, 1984

(iii) in full where the investment allocation percentage is applied to
entire net income, and
(iv) in full to the extent that it is paid to a federally licensed small
business investment company.
It is hereby determined that the interpretation requested by Petitioners is not consonant with
the applicable statutory provision. Section 208.9(b)(5) of the Tax Law requires the add-back of
ninety per cent of the taxpayer's Federal deduction for interest paid to the shareholder. The only
exceptions to this requirement arise in those situations which come within the purview of section
208.9(b)(5)(i) through (iv) of the Tax Law. It is not within the power of the administering agencies
of the statute to permit other variations.

DATED: October 6, 1983

s/FRANK J. PUCCIA
Director
Technical Services Bureau