A holding company borrows money from its own wholly owned subsidiaries and re-lends those exact funds to its parent corporation at the same interest rate. Must the holding company add back the interest it pays to its subsidiaries as interest 'attributable to subsidiary capital,' even though the borrowed funds never funded an investment in the subsidiaries themselves?

Plain-English summary

The taxpayer is a Delaware-incorporated holding company. It planned to borrow funds from its own wholly owned subsidiaries and then turn around and lend those same funds to its own parent corporation, charging the parent the identical interest rate it was paying the subsidiaries -- essentially acting as a pass-through conduit. The parent would use the funds for its ordinary operating needs.

Tax Law § 208.9(b)(6) requires a corporation to add back to its entire net income "any amount of interest directly or indirectly... attributable... to subsidiary capital or to income, gains or losses from subsidiary capital." The Department first ruled out direct attribution: the taxpayer's borrowing plainly wasn't used to acquire or carry an investment in the subsidiaries themselves, so the real question was whether the interest was "indirectly attributable" to subsidiary capital. That phrase entered the statute via Chapter 715 of the Laws of 1955, aimed originally at a specific abuse: a parent that advances funds to a subsidiary and later borrows to replenish its own working capital, while still trying to deduct the replenishment-loan interest. Since neither the regulations nor any court decision defined "indirectly," the Department turned to a line of State Tax Commission decisions applying what amounts to a purpose test: in B.R. Hewitt, interest was added back in full where money was borrowed specifically to fund the subsidiary; in Sussex Hall, only a proportionate part of refinancing interest was added back, based on how much of the proceeds actually went toward acquiring or retaining subsidiary capital.

Applying that purpose test -- and drawing an analogy to the IRS's own "purpose" test under Rev. Proc. 72-18 for interest on debt used to carry federally tax-exempt securities -- the Department held that the real question is whether the funds were borrowed for the effectuated purpose of supporting the described operation (here, re-lending to the parent). Because the taxpayer borrowed the funds SOLELY to make loans to its parent, and did not "knowingly render itself subject to the necessity of resorting to such borrowing because of the making of investments in subsidiaries," the interest paid on that borrowing is not subject to the § 208.9(b)(6) add-back requirement and remains fully deductible in computing entire net income.

What this means for you

Holding companies that borrow from subsidiaries to fund loans elsewhere in the group

The subsidiary-capital interest add-back turns on the PURPOSE of the borrowing, not merely on the fact that the lender happens to be a subsidiary. If the funds are borrowed to support an unrelated lending or operating purpose (like funding the parent), rather than to acquire or carry an investment in the subsidiary, the interest should remain deductible.

Structuring intercompany financing conduits

Charging the parent the identical rate the taxpayer pays its subsidiaries (a straight pass-through) supports the conclusion that the borrowing's purpose was the onward loan, not the subsidiary investment -- a fact pattern worth documenting if you want to avoid the add-back.

A statute revisited a decade later on nearly identical language

The same section 208.9(b)(6) add-back, and the same purpose-based reasoning, resurfaced a decade later in TSB-A-94(13)C -- also requested by Richard W. Genetelli -- in the different context of acquisition-debt interest on a combined report; that later ruling is worth reading alongside this one for a fuller picture of how the Department applies the add-back across different borrowing purposes.

Common questions

Q: If I borrow money from my own subsidiary, must I automatically add back the interest as attributable to subsidiary capital?
A: No -- the add-back depends on the PURPOSE of the borrowing. If the funds are used for an unrelated purpose (like re-lending to your parent) rather than to acquire or carry an investment in the subsidiary, the interest is not attributable to subsidiary capital.

Q: What test does the Department use to determine "indirect" attribution?
A: A purpose test, borrowed by analogy from the federal tax-exempt-interest rules: whether the borrowing was undertaken for the effectuated purpose of supporting subsidiary investments, or instead for some unrelated purpose.

Q: Does charging the same interest rate on the onward loan matter?
A: It supports characterizing the arrangement as a pass-through conduit rather than a subsidiary investment, which favors the conclusion that no add-back applies.

Q: Can another holding company rely on this specific ruling?
A: No. It binds the Department only as to this taxpayer's own facts and can't be relied upon by other companies, even those with similar intercompany lending structures.

Citations and references

Statutes, legislative history, and rulings:

• Tax Law § 208.9(b)(6)
• Chapter 715 of the Laws of 1955 (McKinney's 1955 Session Laws of New York, 1791)
• Matter of B.R. Hewitt, Inc., TSB-H-80(14)C
• Matter of Sussex Hall, Inc., TSB-H-81(41)C
• Matter of Texaco, State Tax Commission, December 22, 1971
• Matter of Chock Full O'Nuts Corporation, State Tax Commission, August 11, 1971
• Internal Revenue Code § 265(2); Rev. Proc. 72-18

Related rulings:

• TSB-A-94(13)C -- a decade later, the SAME section 208.9(b)(6) add-back was addressed again for the same petitioner's representative (Richard W. Genetelli), this time holding that acquisition-debt interest must be added back on the borrower's separate report but is deductible again on a combined report because the subsidiary capital is eliminated in combination

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1984.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a84_9c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-84 (9) C
Corporation Tax
June 27, 1984

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. C820928B

On September 28, 1982, a Petition for Advisory Opinion was received from Richard W.
Genetelli, C.P.A., of Coopers and Lybrand, 1251 Avenue of the Americas, New York, New York
10020.
At issue is whether interest on loans paid by a taxpayer to its subsidiaries, on funds which
the taxpayer then lends to its own parent, would be deductible by the taxpayer when computing its
entire net income, for purposes of the Franchise Tax on Business Corporations imposed under
Article 9-A of the Tax Law.
The taxpayer in this instance is a holding company incorporated in Delaware. The taxpayer
contemplates borrowing funds from its wholly owned subsidiaries and, in turn, lending these same
funds to its parent corporation. The parent will use these funds for its own operating requirements,
and will pay the taxpayer the same rate of interest which the taxpayer paid to its subsidiaries to
acquire the funds.
Section 208.9(b)(6) of the Tax Law provides for an addition to Federal entire taxable income,
in computing entire net income for purposes of Article 9-A, of:
in the discretion of the tax commission, any amount of interest directly or indirectly and any
other amount directly attributable as a carrying charge or otherwise to subsidiary capital or to
income, gains or losses from subsidiary capital.
Inasmuch as the interest expenses at issue herein is patently not "directly" attributable to
subsidiary capital (or income, gain or losses therefrom, such items hereinafter, where applicable,
subsumed under the rubric of "subsidiary capital"), the dispositive question is whether such interest
expense is "indirectly attributable" to subsidiary capital. The reference to indirect attribution was
added to the Tax Law by Chapter 715 of the Laws of 1955. This legislation addressed itself to the
situation, under the then-existing statute, "where a parent corporation advances funds to its
subsidiary and later borrows additional funds to replenish its working capital," nonetheless retaining
its entitlement to a deduction for the interest expended in connection with the borrowed funds.
McKinney's 1955 Session Laws of New York, 1791. While the Franchise Tax Regulations offer no
elucidation of the term "indirectly", and there appear to be no applicable judicial decisions, a number
of State Tax Commission decisions point toward the conclusion that interest which is neither directly
nor indirectly attributable to subsidiary capital is not subject to the add-back requirement. In B.R.
Hewitt, Inc., TSB-H-80(14)C, for example, the Tax Commission concluded that a portion of the
taxpayer's interest expense was directly attributable to subsidiary capital (where money was

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

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

-2­
TSB-A-84 (9) C
Corporation Tax
June 27, 1984

borrowed in order to provide funds to the subsidiary) and therefore to be added back in full. Certain
other interest income, however, having been shown to be neither directly nor indirectly attributable
to subsidiary capital, was held not to be subject to a "percentage formula." In Sussex Hall, Inc., TSBH-81(41)C, the Tax Commission, having concluded that some of the proceeds acquired through the
refinancing of a mortgage were utilized to acquire or retain subsidiary capital, held "a proportionate
part of the interest paid ... [to be] indirectly attributable to subsidiary capital," such portion to be
determined by formulary allocation.
The question here, then, is whether the interest paid by Petitioner is directly attributable to
its lending operation. That is, the issue is whether the funds were borrowed for the effectuated
purpose of supporting the described operation. Matter of Texaco, State Tax Commission, December
22, 1971; Matter of Chock Full O'Nuts Corporation, State Tax Commission August 11, 1971. It is
noteworthy that an issue similar to that treated herein arises under the Internal Revenue Code.
Section 265(2) of the code denies a deduction with respect to interest incurred to acquire or carry
Federally tax-exempt securities. The Internal Revenue Service, in Rev. Proc. 72-18, applies a
"purpose*' test and holds, with respect to corporations not dealers in tax-exempt obligations, that the
"purpose to purchase or carry tax-exempt obligations will generally not be inferred with respect to
indebtedness incurred or continued to provide funds for carrying on an active trade or business..,
unless it is determined that the borrowing was in excess of business needs...". That ruling, similarly,
holds that "the purpose to carry tax-exempt obligations will be inferred unless rebutted by other
evidence where the taxpayer could reasonably have foreseen at the time of purchasing the tax-exempt
obligations that indebtedness probably would have to be incurred to meet future economic needs of
the corporation of an ordinary, recurrent variety."
Such considerations appear properly to be applicable to the application of Tax Law
§208.9(b)(6). Thus, in the present matter, where Petitioner borrows funds solely in order to make
loans to its parent corporation, and did not knowingly render itself subject to the necessity of
resorting to such borrowing because of the making of investments in subsidiaries, the interest paid
with respect to such borrowing will not be subject to the add-back requirement of Section
208.9(b)(6) of the Tax Law.

DATED: June 12, 1984

s/FRANK J. PUCCIA
Director
Technical Services Bureau

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.