Tax 3.01 Tax 3.01 Addback and disclosure of related entity expenses.
Tax 3.01(1)(1) Scope. This section provides further interpretation and explanation relating to the addition and subtraction modifications and disclosure provisions in ch. 71, Stats. In general, the addback statutes provide that a taxpayer shall modify federal income to add back interest, rental, and intangible expenses and management fees that are directly or indirectly paid, accrued, or incurred to a related entity or related person. If certain tests are satisfied, the taxpayer may subsequently deduct the expenses. The addback statutes also impose a disclosure requirement for related entity expenses. Notwithstanding a taxpayer satisfying the tests allowing the deductions of related entity expenses, the department has express authority to reallocate a taxpayer's income, deductions, credits, or allowances to prevent tax evasion or to clearly reflect income. The department also has express authority to disregard transactions that lack economic substance.
Tax 3.01(2) (2)Definitions. In this section:
Tax 3.01(2)(a) (a) "Addback" means the addition and subtraction modifications and disclosure requirement required by ss. 71.05 (6) (a) 24. and (b) 45., 71.26 (2) (a) 7. and 8., 71.34 (1k) (j) and (k), 71.45 (2) (a) 16. and 17., and 71.80 (23), Stats. Where applicable, "addback" also refers to subtraction modification to a related entity pursuant to ss. 71.05 (6) (b) 46., 71.26 (2) (a) 9., 71.34 (1k) (L), and 71.45 (2) (a) 18., Stats.
Tax 3.01(2)(b) (b) "Aggregate effective tax rate," for a related entity, is the sum of its effective tax rates for each state, U.S. possession, or foreign country where it is engaged in business. In determining whether a related entity is engaged in business in a state, U.S. possession, or foreign country, the legal standard set forth under s. 71.22 (1r), Stats., shall apply to such other jurisdiction for purposes of applying the addback provisions.
Tax 3.01(2)(c) (c) "Captive insurance company," for purposes of applying the addback provisions, means an insurer that issues any policy of insurance or reinsurance with respect to which the person insured is related under section 267 or 1563 of the Internal Revenue Code.
Tax 3.01(2)(d) (d) "Captive REIT" means a real estate investment trust other than a qualified real estate investment trust under s. 71.22 (9ad), Stats.
Tax 3.01(2)(e) (e) "Combined unitary income" has the meaning given in s. Tax 2.60 (2) (e).
Tax 3.01(2)(f) (f) "Effective tax rate", for a particular jurisdiction for a related entity, means the maximum tax rate imposed by that jurisdiction multiplied by the related entity's apportionment percentage, if any, computed for that particular jurisdiction.
Tax 3.01(2)(g) (g) "Intangible expense" has the meaning given in s. 71.01 (5n), 71.22 (3g), 71.34 (1c), or 71.42 (1sg), Stats., as applicable.
Tax 3.01(2)(h) (h) "Intangible property" has the meaning given in s. 71.01 (5p), 71.22 (3h), 71.34 (1d), or 71.42 (1sh), Stats., as applicable.
Tax 3.01(2)(i) (i) "Interest expense" has the meaning given in s. 71.01 (5s), 71.22 (3m), 71.34 (1e), or 71.42 (1t), Stats., as applicable.
Tax 3.01(2)(j) (j) "Management fees" has the meaning given in s. 71.01 (7v), 71.22 (6d), 71.34 (1h), or 71.42 (3c), Stats., as applicable.
Tax 3.01(2)(k) (k) "Pass-through entities" include tax-option (S) corporations, partnerships, limited liability companies treated as partnerships, estates, and trusts.
Tax 3.01(2)(L) (L) "Rental expenses" or "rent expenses" has the meaning given in s. 71.01 (9an), 71.22 (9an), 71.34 (1r), or 71.42 (4n), Stats., as applicable.
Tax 3.01(2)(m) (m) "Related entity" or "related entities" has the meaning given in s. 71.01 (9am), 71.22 (9am), 71.34 (1p), or 71.42 (4m), Stats., as applicable. The terms include related individuals. In determining relatedness under section 267 of the Internal Revenue Code, section 267 (b) controls, which defines relationships through which taxpayers would be considered related for purposes of disallowing losses or deductions on transactions between related taxpayers. Section 707 (b) of the Internal Revenue Code, incorporated by reference into section 267, applies in determining whether partnerships and limited liability companies treated as partnerships and their respective partners are related. The stock attribution rules of section 318 (a) of the Internal Revenue Code otherwise apply for purposes of establishing indirect stock ownership and thereby determine related entities.
Tax 3.01 Note Examples: The following relationships involving partnerships and limited liability companies (LLC) constitute related entities:
Tax 3.01 Note 1. A partnership and a partner who holds a direct or indirect capital or profits interest in that partnership of more than 50%.
Tax 3.01 Note 2. An LLC and a member who holds a direct or indirect interest in that LLC of more than 50%.
Tax 3.01 Note 3. Two partnerships or LLCs if a single partner or member owns, directly or indirectly, more than 50% of both entities.
Tax 3.01(2)(n) (n) "Related entity expenses" means interest, rent, or intangible expenses, and management fees, either as an individual expense type or a combination of expense types in a transaction or series of transactions whether paid, accrued, or incurred directly or indirectly.
Tax 3.01 Note Examples: 1) Corporation A is the parent company of Corporation B and Corporation C, which are related entities. B owns intangible property that C uses in its manufacturing process. C incurs a royalty expense as a result. A purchases the goods from C that A will hold and sell as inventory. This increased cost due to the royalty is reflected in A's cost of goods sold. The royalty portion of the cost of goods sold represents an indirect related entity expense that must be added back to A's income.
Tax 3.01 Note 2) Corporation A, Corporation B, Corporation C, and Corporation D are related entities. A and D have nexus in Wisconsin, but B and C do not. B is not subject to tax in any state. Previously, D owned intangible property which A used in operating its business. In a series of transactions, D transfers the intangible property to B. B then licenses the intellectual property to C, the inventory purchasing company. A purchases the inventory from C. The royalty portion of A's cost of goods sold represents an indirect related entity expense that must be added back to A's income.
Tax 3.01 Note 3) Corporation O, Corporation H, and Corporation S are related entities. O, the operating company, transfers various items of intangible property to H in conformity with section 351 of the Internal Revenue Code. H enters into an agreement with S that will allow S to license H's intangible property. S and O are related entities. S licenses the intangible property to O whereby O pays fees to S based on a percentage of sales. The intangible expense between O and S is a related entity expenses that must be added back to O's income.
Tax 3.01(3) (3)Addition modification.
Tax 3.01(3)(a)(a) General. A corporation, individual, or pass-through entity shall modify federal income for Wisconsin purposes so that related entity expenses that were paid, accrued, or incurred to a related entity are added back to income.
Tax 3.01(3)(b) (b) Taxpayers required to modify income. The addition modification applies to any individual, corporation, or pass-through entity that has deducted or excluded under the Internal Revenue Code any amounts for related entity expenses that are directly or indirectly paid, accrued, or incurred to, or in connection directly or indirectly with one or more direct or indirect transactions with, one or more related entities.
Tax 3.01(3)(c) (c) Interest expense. Interest expenses include interest expenses otherwise deductible under section 163 of the Internal Revenue Code and otherwise deductible in the computation of Wisconsin adjusted gross income or Wisconsin net income. Expenses deductible as interest expenses under section 163 of the Internal Revenue Code include:
Tax 3.01(3)(c)1. 1. Interest paid or accrued within the taxable year on indebtedness.
Tax 3.01(3)(c)2. 2. Original issue discount.
Tax 3.01(3)(c)3. 3. Non-separately stated interest included in carrying charges for installment purchases.
Tax 3.01(3)(c)4. 4. Redeemable ground rents, excluding amounts paid in redemption.
Tax 3.01(3)(c)5. 5. Premiums paid or accrued for mortgage insurance.
Tax 3.01 Note Example: Taxpayer A and Taxpayer B are related and A paid, accrued, or incurred $3,000 of original issue discount to B. Taxpayer C and Taxpayer D are related and C paid, accrued, or incurred $3,000 of interest that have been capitalized under section 263A of the Internal Revenue Code. Taxpayer E and Taxpayer F are unrelated and E has paid, accrued, or incurred $100,000 of indebtedness interest to F. A is required to add back $3,000 to its income since it paid, accrued, or incurred this amount to a related entity and it is the type of interest expense deductible under section 163 of the Internal Revenue Code. C is not required to add back $3,000 to its income since this type of interest is not the type of interest that is deductible under section 163 of the Internal Revenue Code. E is not required to add back $100,000 since the addback provisions do not apply to unrelated taxpayers.
Tax 3.01(3)(d) (d) Rental expense.
Tax 3.01(3)(d)1.1. Rent expenses include expenses otherwise deductible in computing Wisconsin adjusted gross income or Wisconsin net income which are attributable to, for the use of, or for the right to use, real property, including the following:
Tax 3.01(3)(d)1.a. a. Tangible personal property affixed to real property if the owner of the tangible personal property is the same as or related to the owner of the real property.
Tax 3.01(3)(d)1.b. b. Services rendered in connection with rented real property if the owner of the property is the same as or related to the entity providing the service.
Tax 3.01(3)(d)2. 2. For purposes of the addition modification, the method used to compute the expense and the manner in which it is reported for financial accounting purposes are immaterial.
Tax 3.01 Note Example: Amounts paid under capital leases might not be called "rent expenses" in the financial accounting records of a taxpayer, but these expenses are considered "rent expenses" for purposes of the addition modification.
Tax 3.01(3)(e) (e) Management fees.
Tax 3.01(3)(e)1.1. Other than services provided by the taxpayer's own employees, management fees include expenses and costs otherwise deductible in computing Wisconsin adjusted gross income or Wisconsin net income for the purchase or retention of services, including services that pertain to any of the following:
Tax 3.01(3)(e)1.a. a. Accounts receivable or payable.
Tax 3.01(3)(e)1.b. b. Employee benefit plans.
Tax 3.01(3)(e)1.c. c. Insurance, including self-insurance.
Tax 3.01(3)(e)1.d. d. Legal matters.
Tax 3.01(3)(e)1.e. e. Payroll.
Tax 3.01(3)(e)1.f. f. Data processing.
Tax 3.01(3)(e)1.g. g. Purchasing.
Tax 3.01(3)(e)1.h. h. Taxation.
Tax 3.01(3)(e)1.i. i. Financial matters.
Tax 3.01(3)(e)1.j. j. Securities.
Tax 3.01(3)(e)1.k. k. Accounting.
Tax 3.01(3)(e)1.L. L. Reporting or compliance matters.
Tax 3.01(3)(e)1.m. m. Activities similar to those described in this subd. 1. a. to L.
Tax 3.01(3)(e)2. 2. Subdivision 1. a. to m. are in no way intended to and should not be construed as limiting the scope of the activities subject to this paragraph.
Tax 3.01(3)(f) (f) Intangible expenses.
Tax 3.01(3)(f)1.1. Intangible expenses include any of the following expenses to the extent they would otherwise be deductible in the computation of Wisconsin adjusted gross income or Wisconsin net income:
Tax 3.01(3)(f)1.a. a. Royalty, patent, technical, and copyright fees.
Tax 3.01(3)(f)1.b. b. Licensing fees.
Tax 3.01(3)(f)1.c. c. Losses related to, or incurred in connection directly or indirectly with, factoring transactions or discounting transactions.
Tax 3.01(3)(f)1.d. d. Amortization expenses.
Tax 3.01(3)(f)1.e. e. Other expenses, losses, or costs for, related to, or directly or indirectly in connection with acquiring, using, maintaining, managing, owning, selling, exchanging, or disposing of intangible property.
Tax 3.01(3)(f)2. 2. For a taxpayer purchasing amortizable intangible property from a related entity, the amortization expenses on that property are intangible expenses subject to the addition modification. This also applies to any other amortizable intangible expenses paid, accrued, or incurred between a taxpayer and a related entity.
Tax 3.01(4) (4)Subtraction modification.
Tax 3.01(4)(a)(a) General. Related entity expenses paid, accrued, or incurred to a related entity may be deducted to the extent such expenses meet the requirements of s. 71.80 (23) (a), Stats., and this subsection.
Tax 3.01(4)(b) (b) Requirements.
Tax 3.01(4)(b)1.1. Section 71.80 (23) (a), Stats., provides that if a taxpayer added back related entity expenses, the taxpayer may then deduct such expenses if the taxpayer meets the requirements under s. 71.80 (23) (a) 3., Stats. The taxpayer shall establish it meets the requirements under s. 71.80 (23) (a) 3., Stats., by clear and convincing evidence. The taxpayer shall meet all of the following requirements:
Tax 3.01(4)(b)1.a. a. The primary motivation for the transaction was one or more business purposes other than the avoidance or reduction of state income or franchise taxes.
Tax 3.01(4)(b)1.b. b. The transaction changed the economic position of the taxpayer in a meaningful way apart from tax effects.
Tax 3.01(4)(b)1.c. c. The expense was paid, accrued, or incurred using terms that reflect an arm's length relationship.
Tax 3.01(4)(b)2. 2. This paragraph is the primary test for establishing whether related entity expenses may be deducted. The tests in pars. (d) and (e) are indicators that the test under this paragraph may have been met.
Tax 3.01(4)(c) (c) Factors indicating requirements are not met. Factors indicating that the related entity expense does not meet the requirements under par. (b) include:
Tax 3.01(4)(c)1. 1. There was no actual transfer of funds from the taxpayer to the related entity.
Tax 3.01 Note Example: A book or journal entry alone is not considered an actual transfer of funds.
Tax 3.01(4)(c)2. 2. There was an actual transfer of funds, then the funds were substantially returned to the taxpayer, either directly or indirectly. Such return need not be immediate in order for this factor to be applicable.
Tax 3.01(4)(c)3. 3. If the transaction was entered into on the advice of a tax advisor, regardless of whether a client relationship exists or existed at the time of the advice, the advisor's fee was determined by reference to the tax savings. "Tax advisor" includes a "material advisor" under s. 71.81 (1) (b), Stats.
Tax 3.01(4)(c)4. 4. The related entity does not regularly engage in similar transactions with unrelated parties on terms substantially similar to those of the subject transaction.
Tax 3.01(4)(c)5. 5. The transaction was not entered into at terms comparable to an arm's length transaction as determined by Treas. Reg. section 1.482-1(b).
Tax 3.01(4)(c)6. 6. There was no reasonable expectation of profit from the transaction apart from the tax benefits.
Tax 3.01(4)(c)7. 7. The transaction resulted in the improper matching of income and expenses.
Tax 3.01(4)(c)8. 8. The expense for the transaction was accrued under Financial Accounting Standards Board Interpretation number 48. For purposes of this section, this factor applies to both income and franchise taxes.
Tax 3.01 Note Note: Financial Accounting Standards Board Interpretation number 48 is available on the Financial Accounting Standards Board's web site at http://www.fasb.org/pdf/fin%2048.pdf.
Tax 3.01(4)(c)9. 9. If the related entity expense is a rental expense, the rent was paid, accrued, or incurred to a captive real estate investment trust.
Tax 3.01(4)(c)10. 10. If the related entity expense is an interest expense, additional factors specific to interest expenses include any of the following:
Tax 3.01(4)(c)10.a. a. The taxpayer is not sufficiently capitalized or has no reasonable expectation to make payment on the debt underlying the interest expense.
Tax 3.01(4)(c)10.b. b. There is no written contract underlying the interest expense.
Tax 3.01(4)(c)10.c. c. There is a contract, but the contract does not reflect an interest obligation resulting from an arm's length transaction.
Tax 3.01(4)(c)10.d. d. The interest is attributable to an unpaid charge that is not an allowable expense, a loan from a captive insurance company, a dividend note, a loan from a related entity with net business loss carryforwards or net operating loss carryforwards, or a loan from a related entity that is an intermediary set up in a jurisdiction that imposes no corporate-level income or franchise tax.
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