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

Dean Witter Reynolds, Inc. asked the Department to bless a specific interest-deduction theory: where a shareholder owning more than 5% of the 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 (including the shareholder's own subsidiaries, or an individual shareholder's immediate family). The statute lists exactly four exceptions where interest CAN still be fully deducted: amounts up to $1,000; interest on reorganization bonds issued to former bona fide creditors who weren't previously shareholders; situations where the investment allocation percentage applies to entire net income; and interest paid to a federally licensed small business investment company. A pass-through/conduit arrangement is not among them.

The Department held that Petitioner's proposed interpretation "is not consonant with the applicable statutory provision" -- the add-back requirement applies regardless of the underlying economic substance or purpose of the shareholder loan, and "it is not within the power of the administering agencies of the statute to permit other variations" beyond the four enumerated exceptions. In other words, even though the shareholder here functions as a mere financial intermediary rather than actually using the funds for its own purposes, the statute draws no such distinction -- what matters is simply that the interest is paid to a direct more-than-5% shareholder.

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 -- likely a single boilerplate response the Department used to dispose of a wave of nearly-identical petitions. See the Citations section below for the full list of companions.

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 (a direct 5%-plus shareholder), not at what that shareholder does with the money afterward.

Contrast with New York's "grandparent" interest cases

This direct-shareholder result stands in sharp contrast to a separate line of Opinions holding that interest paid to a "grandparent" corporation -- two or more ownership tiers removed, rather than a direct shareholder -- falls OUTSIDE section 208.9(b)(5) entirely, regardless of the loan's purpose. See TSB-A-84(4)C and its companion rulings, and TSB-A-84(9)C, a companion "purpose test" case decided under the RELATED but distinct § 208.9(b)(6) subsidiary-capital-interest add-back. The lesson: the CORPORATE RELATIONSHIP between payor and payee is what controls under (b)(5) -- not the loan's economic purpose, which is what mattered instead under the different (b)(6) provision.

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: Is this the same rule as the "grandparent interest" cases that escape the add-back?
A: No -- those cases involve interest paid to a GRANDPARENT (two or more tiers removed), which falls entirely outside section 208.9(b)(5)'s definition of a covered payee. This ruling involves interest paid to a DIRECT shareholder, which is squarely covered regardless of the loan's purpose.

Q: Can another company with a similar pass-through financing arrangement rely on this Opinion?
A: This Opinion states a general rule of statutory construction rather than resolving a company-specific factual question, but as with all Advisory Opinions, it formally binds the Department only as to the requesting petitioner.

Citations and references

Statutes:

• Tax Law § 208.9(b)(5)

Related rulings:

• TSB-A-82(15.1)C -- THE ORIGIN of this exact holding: same question, same statute, same DATED October 6, 1983 sign-off, decided for The Ore and Chemical Corporation before being applied to this whole seven-ruling family
• TSB-A-83(16)C, TSB-A-83(10)C, TSB-A-83(11)C, TSB-A-83(12)C, TSB-A-83(13)C, TSB-A-83(14)C -- six identical twin rulings, same question, same answer, same DATED October 6, 1983 sign-off, for six different petitioners -- seven total in this identical-boilerplate family
• TSB-A-84(4)C and companion rulings -- the contrasting "grandparent interest" doctrine, where interest paid to a more-remote related entity (rather than a direct shareholder) escapes the add-back entirely
• TSB-A-84(9)C -- a related but distinct "purpose test" ruling under section 208.9(b)(6) (the subsidiary-capital-interest add-back), where a different pass-through loan arrangement WAS found to escape that separate add-back provision

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_15c.pdf

Original ruling text

New York State Department of Taxation and Finance
TSB-A-83(15)C
Corporation Tax
May 10, 1984

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

PETITION NO. C810128A

On January 28, 1981 a Petition for Advisory Opinion was filed by Dean Witter Reynolds,
Inc., 130 Liberty Street, New York, N.Y. 10006.
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 outside lender.
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.
(iii) in full where the investment allocation percentage is applied
to entire net income, and

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

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

-2­
TSB-A-83(15)C
Corporation Tax
May 10, 1984

(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 Petitioner 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