A New York mining-joint-venture subsidiary is 51%-owned by a New York holding company and 49%-owned by that holding company's own Japanese parent. Both the direct parent and the Japanese grandparent can borrow more cheaply than the subsidiary and plan to re-lend funds to it, sometimes at their own cost and sometimes with a small markup to cover borrowing costs. Can the subsidiary deduct that interest without the section 208.9(b)(5) add-back as a pass-through, and does the parent's own outside borrowing (used only to re-lend) count as part of the parent's subsidiary capital?

Plain-English summary

This ruling was formally revoked two and a half years later -- see TSB-H-81(21.1)C below. MC Minerals Corporation (MCM), a Delaware corporation, was doing business in New York as a general partner (with an unrelated corporation) in a copper-mining joint venture in New Mexico. MCM was 51%-owned by Mitsubishi International Corporation (MIC), a New York corporation, and MIC was itself wholly owned by Mitsubishi Corporation (MC), a Japanese corporation that also directly held the remaining 49% of MCM. Both MIC and MC could borrow more cheaply than MCM, and planned to fund MCM's mining operations by borrowing externally and re-lending to MCM -- sometimes passing along their own exact cost, sometimes with a small markup to cover their own borrowing expenses.

Applying an early four-condition version of the "pass-through" or conduit exception to the Tax Law § 208.9(b)(5) related-party interest add-back, the Department held that if MCM could substantiate (1) that the debt was owed to a qualifying "stockholder," (2) that the stockholder's financial standing let it borrow more cheaply, (3) that the stockholder genuinely borrowed from an unrelated third party solely to re-lend to MCM, and (4) that MCM was adequately capitalized, the interest would escape the add-back except to the extent of any markup charged above the stockholder's own cost. The ruling also separately addressed § 208.9(b)(6): because MIC's re-lent funds to MCM would not constitute part of MIC's own "subsidiary capital" under § 208.4, MIC's own interest expense on its outside borrowings would not be treated as interest attributable to subsidiary capital.

This entire pass-through analysis did not survive. On October 6, 1983 -- the same coordinated date the Department revoked the parallel Kowa Realty (1981) and MCF Footwear/Mitsubishi (1981) pass-through rulings and applied the corrected rule to a wave of pending petitions -- the Department formally revoked this ruling in TSB-H-81(21.1)C, concluding that § 208.9(b)(5) requires the add-back in all cases except its four explicit statutory exceptions, with no room for a substance-based conduit exception. The revocation applied prospectively only under Tax Law § 171, paragraph 24.

What this means for you

Do not rely on this ruling's four-condition pass-through test today

It was formally revoked; see TSB-H-81(21.1)C and the broader October 6, 1983 revocation wave (also affecting Kowa Realty and MCF Footwear/Mitsubishi International).

The same corporate family generated multiple, separately-numbered petitions on the identical legal question

MC Minerals/Mitsubishi International and MCF Footwear/Mitsubishi International (a sibling company under common Mitsubishi ownership) filed SEPARATE petitions raising nearly identical pass-through-interest facts, both resolved -- and both later revoked on the same date -- by the Department. If your corporate family has multiple entities with similar funding structures, expect the Department's evolving position to apply uniformly across all of them, even where they're formally separate rulings.

Common questions

Q: Is the four-condition pass-through test in this ruling still valid?
A: No -- it was formally revoked by TSB-H-81(21.1)C on October 6, 1983.

Q: Does a grandparent shareholder lending alongside a direct parent shareholder change the analysis?
A: Not under this ruling's now-superseded reasoning -- both MIC (direct parent) and MC (indirect, 49% direct co-owner) were treated as potential "stockholders" whose re-lent funds could qualify for pass-through treatment if the four conditions were met.

Citations and references

Statutes and guidance:

• Tax Law § 208.9(b)(5)
• Tax Law § 208.9(b)(6)
• Tax Law § 208.4

Related rulings:

• TSB-H-81(21.1)C -- the October 6, 1983 formal revocation of this ruling
• TSB-H-81(20)C -- a sibling company's (MCF Footwear) nearly identical petition, same Mitsubishi ownership structure, same result and same later revocation
• TSB-A-83(10)C -- a SEPARATE, later petition by this same MC Minerals/Mitsubishi International pairing (Petition No. C810430A), also decided October 6, 1983 as part of the seven-ruling boilerplate family

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1981.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/h81_21c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-H-81(21)C
Corporation Tax
April 14, 1981

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. C810225B

On February 25, 1981, a Petition for Advisory Opinion was received from MC
Minerals Corporation, 277 Park Avenue, New York, N.Y. 10172, and Mitsubishi
International Corporation, 277 Park Avenue, New York, N.Y. 10172.
At issue is the deductibility, under Article 9-A of the Tax Law, by a
taxpayer of interest paid to a stockholder which owns more than 5% of the
taxpayer's issued capital stock, and whether money borrowed by a parent
corporation for the purpose of lending these same funds to a subsidiary, and
which is so lent, would constitute part of the subsidiary capital of the parent
corporation.
MC Minerals Corporation (MCM) is a Delaware corporation that will be doing
business in New York. MCM will be involved in a copper mining operation and will
be a general partner, together with an unrelated corporation, in a copper mining
joint venture in New Mexico.
Mitsubishi International Corporation (MIC), a New York corporation, owns
51% of the issued capital stock of MCM. Mitsubishi Corporation (MC), a Japanese
corporation not required to file a New York State Franchise Tax Report, owns 49%
of the issued capital stock of MCM. MIC is a wholly owned subsidiary of MC.
According to Petitioners, MCM's operations create financial requirements
that must be met by outside borrowings, consisting of both long-term and short­
term loans. MIC, its parent, and MC, its minority stockholder, can secure funds
at a lower rate of interest than that available to MCM. It is anticipated that
in certain instances MC will lend such funds to MCM at the same rate of interest
which it paid to obtain the funds. In other instances, both MC and MIC will
obtain external borrowings and, in turn, advance the proceeds to MCM at an
interest rate that is slightly higher than their respective annual average
external interest rates, to cover the estimated costs associated with the
external borrowings.
Section 208.9(b)(5) of the Tax Law provides, in pertinent part, that in
arriving at entire net income for franchise tax purposes an addition to federal
taxable income must be made in the amount of interest paid on indebtedness
directly or indirectly owed to any stockholder or shareholder owning more than
five per cent of the taxpayer's issued capital stock, or to a subsidiary of such
a stockholder or shareholder. (Such a stockholder or shareholder, or subsidiary
thereof, shall hereinafter be referred to as "stockholder.")
Section 208.9(b)(6) of the Tax Law provides, in pertinent part, that in
arriving at entire net income the Tax Commission, in its discretion, may require
an addition to Federal taxable income of interest expense directly or indirectly
attributable to subsidiary capital.
Under certain conditions, where a "stockholder" of a corporation borrows
money from an unrelated source, and then lends the borrowed funds to such
corporation, some or all of the interest paid to such "stockholder" by such
corporation is deemed to have actually been paid to the "stockholder" merely as
a conduit, and the provisions of section 208.9(b)(5) are not applicable to such
interest. These conditions are:
JAMES H. TULLY., COMMISSIONER
TP-8 (4/80)

LOUIS M. JACOBSON, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR

2
TSB-H-81(21)C
Corporation Tax
April 14, 1981
1.
2.

3.

4.

The deduction for interest expense must be for indebtedness owed by
the corporation to a "stockholder".
The corporation must demonstrate that at the time the indebtedness
was incurred the "stockholder's" financial standing allowed it to
borrow funds at a lower rate of interest than that obtainable by the
corporation.
The corporation must demonstrate that the funds loaned to it were
borrowed by the "stockholder" from an entity unrelated to either the
"stockholder" or the corporation, for the purpose of re-lending the
funds to the corporation.
The corporation must demonstrate that, at about the time the loan
was made, it was not under-capitalized and that the funds were
needed to meet ordinary business expenses or working capital needs,
and were not a substitute for an investment in the stock of the
corporation.

If all four conditions are met, the "stockholder" is deemed to have acted
as a mere conduit between the unrelated source of funds and the corporation. The
corporation is allowed to deduct as interest expense an amount equivalent to the
amount of interest paid by the "stockholder" to the unrelated source of funds.
Where the "stockholder" and the corporation are related as parent and subsidiary,
the "stockholder" may not deduct the interest paid and deducted by its subsidiary
in the computation of its entire net income because this income, by virtue of the
subsidiary's deduction, would constitute income from business capital rather than
from subsidiary capital. Tax Law §208.4. Where the "stockholder," for example,
borrows funds at 15% and in turn lends these funds to the corporation at 16%, and
where the four conditions set forth above are satisfied, the corporation is
allowed to deduct its interest expense at 15%, and the remaining 1% is required
to be added back to its federal taxable income in determining its entire net
income. Such add-back is required because, under the conduit theory enunciated
herein, the 1% loses its character as interest expense and the federal deduction
therefor is accordingly disallowed for purposes of the franchise tax. Where such
corporation is a subsidiary of the "stockholder," within the meaning of section
208.3 of the Tax Law, the "stockholder" is permitted to subtract the 1%, as
income from subsidiary capital, on its corporation franchise tax report.
A corporation claiming a deduction for interest paid to its "stockholder",
as described herein, must attach a rider to its corporation franchise tax report
providing sufficient information to substantiate such deduction. In addition, the
rider should contain the following information:
1.
2.
3.

Name, address and federal identification number of the "stock­
holder".
The article of the Tax Law, if any, under which the "stockholder" is
subject to tax in New York.
Other borrowings of the corporation during the period in question,
including the rate of interest paid.

In the present instance, where MIC borrows funds for the purpose of lending
these funds to MCM, its subsidiary, as herein described, the amounts owed to MIC
by MCM, the interest on which is deducted by MCM, as provided for herein, will
not constitute part of MIC's subsidiary capital. Accordingly, any interest paid
by MIC to obtain these funds from outside sources will not constitute "interest
directly or indirectly...attributable...to subsidiary capital" for purposes of
section 208.9(b)(6) of the Tax Law.
DATED: March 27, 1981

s/LOUIS ETLINGER
Deputy Director
Technical Services Bureau