The Indiana Department of Revenue disallowed a taxpayer’s deduction for interest expenses accrued to a subsidiary because the Department considered the loan a sham. Unless eligible for an exemption under Ind. Code § 6-3-2-20(c), a taxpayer that is subject to Indiana’s adjusted gross income tax is required to add back its federal deductions relating to interest expenses paid or accrued to a member of the same affiliated group. The Department determined that the taxpayer did not meet any of the add-back exceptions and that the loan fell within the definition of a “sham transaction” because it lacked “economic substance.” While the form of the transaction was a loan, the Department determined that the substance “could be treated as a capital contribution or some relevant account of money, but the form of the loan is a ‘sham.’” The subsidiary did not have any employees, and its only activity was to hold a master note for a line of credit between the taxpayer and the subsidiary. The Department also noted that although the taxpayer made substantial profits from its operations in Indiana, the income apportioned to Indiana was “severely distorted” by the interest deduction. The Department concluded that the loan was “motivated by nothing other than” the taxpayer’s “desire to secure the attached tax benefit.” The Department also addressed the characterization of the taxpayer’s income from the sale of a specialized industry subsidiary and determined the income was appropriately re-characterized as business income under Indiana’s functional test. Letter of Findings No. 02-20120140, Ind. Dep’t of Revenue (Aug. 28, 2013).