The Tennessee Department of Revenue (“Department”) recently sent notices of assessment to numerous taxpayers disallowing deductions for intercompany intangible expenses. The Department states in the notices that it is adding back the expenses because the deductions lack “business purpose.” Many of these notices were dated December 18, 20091 which is important because taxpayers that received an assessment have only 30 days to request an informal conference. For some taxpayers, the request for an informal conference must be filed by today, January 19.

If a taxpayer timely files a request for an informal conference, the Department must schedule the conference within 20 days of the request, and the Department must hold the conference within 90 days of the request.2 The informal conference is held by a Department conferee. Following the conference, aggrieved taxpayers may appeal the matter to the Tennessee Chancery Court.3 If an informal conference is not timely requested, taxpayers that wish to challenge the assessment can either pay the assessment and file a refund claim or file suit in Chancery Court within 90 days of the mailing date of the assessment.4


For Tennessee excise tax years beginning on or after January 1, 2004, Tennessee taxpayers who deduct intercompany intangible expenses must disclose those expenses to the Department.5 If the expenses are not disclosed, the deductions must be added back to calculate Tennessee net earnings.6 Following the enactment of these disclosure (or addback) requirements, some taxpayers requested guidance from the Department as to the deductibility of their intercompany intangible expenses. In Tennessee Letter Rulings 06-28 and 06-35, the Department was asked whether two taxpayers were permitted to take a deduction for payments made to affiliates for expenses related to the licensing of intangibles.7 The Department relied on the Syms8 and Sherwin-Williams9 cases from Massachusetts to inform its analysis. Based on these cases, the Department outlined eight factors it considers in determining whether a taxpayer may deduct payments it makes for the licensing of intangibles:

  1. The nature of the intangible property and how it is used;
  2. The method by which the taxpayer transferred its patents, trademarks, franchise rights, or other intangibles to its subsidiary;
  3. The existence of formal legal agreements between the parties that govern both the transfer and the use of the intangibles;
  4. The method by which the value of the intangibles transferred was established;
  5. Whether actual cash was exchanged in the relevant transactions;
  6. Whether the company holding the intangibles has property and payroll in its state of domicile;
  7. Whether corporate forms were established with regard to relevant transactions and whether the corporate requirements and formalities are being met; and
  8. Whether there are practical economic effects resulting from the transaction aside from tax planning.10

In both rulings, the Department concluded that the taxpayer was permitted to deduct intercompany royalty expenses because the transactions served a valid business purpose aside from generating tax benefits and there was a reliable method of calculating the value of the payments for the licenses.

SUTHERLAND OBSERVATION: Taxpayers challenging an assessment should be prepared to provide evidence to the Department of how their transactions compare to those discussed in the letter rulings issued by the Department and the facts of the Syms and Sherwin-Williams cases. However, even if these factors cannot be satisfactorily met, there is no Tennessee case law on point regarding the appropriateness of intercompany payments. Thus, taxpayers should consider their facts and the uncertain state of Tennessee law in determining whether to appeal.