The Massachusetts Appellate Tax Board (Board) has rejected a group of taxpayers’ request for abatement of corporate excise tax liability because it concluded that a series of complex deferred stock subscription arrangements (DSSAs) did not reflect an unconditional obligation to repay the underlying debt and, therefore, did not constitute true indebtedness for Massachusetts tax purposes. The taxpayers were three U.S. subsidiaries of a British multinational electricity and gas utility company. The assessments for the tax years in question were based on audits of a combined corporate excise tax return filed on behalf of the subsidiaries and separate corporate excise tax returns filed by two of the subsidiaries. The dispute involved an interest expense deduction claimed in determining the net income portion of the corporate excise tax liability for the combined group and a liability deduction each of the subsidiaries claimed in separately determining the taxable net worth portion of the excise tax. According to the Board, since the DSSAs did not constitute true debt, intercompany interest payments were not deductible for purposes of determining the net income portion of the excise tax liability for the combined group. Likewise, the Board determined that one of the subsidiaries was not entitled to a deduction for a liability created by the DSSAs in computing its taxable net worth, regardless of having treated the DSSAs as liabilities on its books and records. Finally, the Board found that the taxpayers failed to demonstrate that the other subsidiary was entitled to a deduction for liability in computing taxable net worth for costs purportedly incurred in connection with a merger and acquisition transaction, because neither testimony nor documentary evidence established the propriety of the allocation of those costs to the subsidiary.
The goal of the complex multistep DSSA transactions, the Board said, was to create interest deductions and debt for U.S. tax purposes without corresponding recognition of income in the U.K. The Commissioner of Revenue argued that in seeking to achieve these desired tax results, the taxpayers created documents that clearly did not constitute debt in the U.S. or the U.K. and acted in a duplicitous manner, telling two fundamentally different factual stories to the two jurisdictions. Accordingly, the Commissioner urged application of the form disavowal doctrine, which generally bars a taxpayer from repudiating a freely chosen transactional form. However, the Board disagreed and found that the taxpayers did not intentionally tell two different stories to the U.S. and the U.K. The taxpayers did treat the DSSAs differently in the U.S. and the U.K. for tax and financial reporting purposes, but a change in U.K. law created greater symmetry between the tax treatment of the DSSAs in the U.K. and that claimed by the taxpayers in the U.S. Thus, the change undermined an assertion that U.S. and U.K. tax laws required different treatment of the DSSAs. As a result, the form disavowal doctrine did not apply.
In reaching its conclusion, the Board also conceded that the facts of the case both favored and undermined the assertion that the DSSAs established debt. Those favoring debt included: service of repurchase notice provisions in the DSSAs that gave the right to enforce payment of principal and interest; the incorporation of a fixed rate of interest in the sums due in the call payments; and cash flow generated by the U.S. operating companies was a sufficient source of payment of the interest component of the DSSAs. Facts undermining characterization as debt included: the DSSAs had no fixed maturity date and did not reflect an unconditional obligation to repay the underlying debt; call payments in the DSSAs were discretionary; a lack of evidence that financing could have been obtained from outside sources on terms that were the same as or similar to those provided by the DSSAs; and the names given to the operative documents made reference only to sale and purchase of shares and subscription for share capital.
Lastly, the Board rejected the taxpayers’ assertion that the DSSAs were similar to repurchase agreements because the agreements did not require the seller to buy back the securities at a future date.
National Grid Holdings, Inc. v. Massachusetts Commissioner of Revenue, Massachusetts Appellate Tax Board, Nos. C292287, C292288, C292289, June 4, 2014, ¶401-508