When a company sells its trade accounts receivable to an affiliated company at a discount to maintain loan collateral, is that discount an 'intangible expense' that has to be added back when calculating Tennessee franchise and excise tax — and pre-approved to be deducted again?

Plain-English summary

The Taxpayer is a company that wanted access to a line of credit at favorable interest rates, using its trade accounts receivable as collateral. It set up a subsidiary to hold that collateral, capitalizing the subsidiary with an initial contribution of receivables. To keep the collateral pool fresh, the subsidiary periodically buys more receivables from the Taxpayer in a factoring transaction — using cash collected from receivables it already owns to purchase new ones — at a discount equal to what an unrelated party would charge in a similar transaction. Both the Taxpayer and the subsidiary file Tennessee franchise and excise (F&E) tax returns.

The question: is that discount an "intangible expense" under Tennessee's F&E add-back rule? Tennessee generally requires a taxpayer to add back any intangible expense paid, accrued, or incurred in a transaction with an affiliate when computing net earnings (§ 67-4-2006(b)(1)(K)) — and the taxpayer must separately apply to the Commissioner for approval before deducting that add-back again (§ 67-4-2006(b)(2)(N)). This rule exists to prevent companies from shifting income to affiliates through intangible-asset transactions (like licensing a trademark to a related party at an inflated royalty) purely to reduce Tennessee tax.

The Department ruled the discount is NOT an intangible expense. "Intangible expense" is defined to mean an expense related to the acquisition, use, maintenance, management, ownership, sale, exchange, license, or other disposition of "intangible property" — a defined term covering patents, trade names, trademarks, service marks, franchise rights, copyrights, licenses, research, formulas, designs, patterns, processes, formats, and similar intangible assets (§ 67-4-2004(25)). Trade accounts receivable that arise in the ordinary course of business from selling a company's products simply aren't any of those things — they're a routine business asset, not an intangible asset of the patent/trademark/copyright variety. Because the underlying property (the receivables) isn't "intangible property" under the statute, the discount charged on it can't be an "intangible expense" either — so the add-back rule, and the related application-for-deduction requirement, don't apply at all.

What this means for you

Companies using accounts-receivable factoring or securitization with related entities

Selling ordinary trade receivables to an affiliated special-purpose entity at an arm's-length factoring discount doesn't trigger Tennessee's intangible-expense affiliate add-back, because trade receivables aren't "intangible property" under the F&E statute's specific list (patents, trademarks, copyrights, licenses, and similar IP-type assets). This is true even though the factoring discount is, functionally, a related-party charge.

Businesses navigating the intangible-expense add-back generally

This ruling sharpens the boundary of what counts as "intangible property" for the add-back: the statute's list is IP-and-licensing-focused, not a catch-all for any related-party financial arrangement. If your related-party transaction doesn't involve patents, trademarks, copyrights, formulas, or similar assets, it's worth checking whether the add-back even applies before going through the Commissioner's application process.

Accountants and tax professionals

Note the ruling doesn't address whether the factoring discount might be scrutinized under some other related-party or arm's-length pricing doctrine — it answers only the narrow "intangible expense" classification question under § 67-4-2004(23) and § 67-4-2004(25). A footnote in the ruling also flags Franchise and Excise Tax Notice #12-16 for more on the intangible-expense add-back/deduction regime generally.

Common questions

Q: Does selling receivables to a related company always avoid the intangible-expense add-back?
A: Under these facts — ordinary trade receivables from product sales, factored at an arm's-length discount — yes, because receivables aren't "intangible property" as Tennessee defines it. A different kind of related-party intangible transaction (e.g., a trademark license) would likely be treated differently.

Q: What counts as "intangible property" for this add-back rule?
A: Patents, patent applications, trade names, trademarks, service marks, franchise rights, copyrights, licenses, research, formulas, designs, patterns, processes, formats, and similar intangible assets (§ 67-4-2004(25)) — not ordinary receivables.

Q: Does a company still need to apply to the Commissioner if its related-party expense isn't an "intangible expense"?
A: No — the application-and-approval requirement under § 67-4-2006(b)(2)(N)(i) only applies once an expense is determined to be an "intangible expense" in the first place.

Q: Can another company with a similar factoring arrangement rely on this letter ruling?
A: No. A Tennessee letter ruling binds the Department only as to the specific taxpayer and facts it was issued to. This summary is informational only, not legal or tax advice.

Citations and references

Tennessee statutes (Tenn. Code Ann.):

• § 67-4-2006(b)(1)(K) (Supp. 2012) (intangible-expense affiliate add-back)
• § 67-4-2006(b)(2)(N) (Supp. 2012) (application requirement to deduct the add-back)
• § 67-4-2004(23)(A)-(B) (Supp. 2012) (definition of "intangible expense")
• § 67-4-2004(25) (definition of "intangible property")
• § 67-4-2006(a)(1) (Supp. 2012) (definition of "net earnings"/"net loss")
• § 67-4-2007(a) (2011) (6.5% excise tax); §§ 67-4-2105(a), -2106(a) (2011) (franchise tax); § 67-4-2004(37) (definition of "persons" subject to F&E tax)

Other authority:

• 2012 Public Chapter 842 (effective Apr. 27, 2012, applicable to tax years ending on or after July 1, 2012) (intangible-expense application/approval process)
• Franchise and Excise Tax Notice #12-16 (referenced for further guidance on the intangible-expense add-back/deduction regime)

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/fae/12-32fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
LETTER RULING # 12-32
WARNING
Letter rulings are binding on the Department only with respect to the individual taxpayer
being addressed in the ruling. This ruling is based on the particular facts and
circumstances presented, and is an interpretation of the law at a specific point in time. The
law may have changed since this ruling was issued, possibly rendering it obsolete. The
presentation of this ruling in a redacted form is provided solely for informational purposes,
and is not intended as a statement of Departmental policy. Taxpayers should consult with a
tax professional before relying on any aspect of this ruling.
SUBJECT
Whether the discount charged on trade accounts receivable arising in the ordinary course of
business from the sale of a company’s products constitutes an “intangible expense” for purposes
of determining net earnings or loss under TENN. CODE ANN. § 67-4-2006(b)(1)(K), -(b)(2)(N)
(Supp. 2012).
SCOPE
This letter ruling is an interpretation and application of the tax law as it relates to a specific set of
existing facts furnished to the Department by the taxpayer. The rulings herein are binding upon
the Department, and are applicable only to the individual taxpayer being addressed.
This letter ruling may be revoked or modified by the Commissioner at any time. Such revocation
or modification shall be effective retroactively unless the following conditions are met, in which
case the revocation shall be prospective only:
(A) The taxpayer must not have misstated or omitted material facts involved in
the transaction;
(B) Facts that develop later must not be materially different from the facts upon
which the ruling was based;
(C) The applicable law must not have been changed or amended;
(D) The ruling must have been issued originally with respect to a prospective or
proposed transaction; and
(E) The taxpayer directly involved must have acted in good faith in relying upon
the ruling; and a retroactive revocation of the ruling must inure to the taxpayer’s
detriment.
FACTS
[TAXPAYER] is a [REDACTED] company that produces [PRODUCTS]. [REDACTED].

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In [YEAR], [TAXPAYER] [REDACTED - DESCRIPTION OF TRANSACTION] in order to
obtain access to a line of credit at favorable interest rates. [TAXPAYER’S] trade accounts
receivable (the “Accounts Receivable”) constituted the collateral for the line of credit.
[REDACTED]. [TAXPAYER] established [SUBSIDIARY] to [HOLD THE COLLATERAL].
[SUBSIDIARY] was initially capitalized with a contribution of Accounts Receivable from
[TAXPAYER]. The Accounts Receivable originated in the normal course of [TAXPAYER’S]
business operations from the sale of [TAXPAYER’S] products.
[SUBSIDIARY] regularly replenishes its stock of Accounts Receivable so as to maintain the
loan collateral [REDACTED]. Accordingly, [SUBSIDIARY] periodically acquires Accounts
Receivable from [TAXPAYER] in a factoring transaction by using the cash [SUBSIDIARY]
receives from the payment of existing receivables. These Accounts Receivable are purchased by
[SUBSIDIARY] at a discount (the “Discount”) equal to the discount that would be charged in a
similar transaction between unrelated parties.
Both [TAXPAYER] and [SUBSIDIARY] file Tennessee franchise and excise tax returns.
[REDACTED].
RULING
Is the Discount charged on the Accounts Receivable an “intangible expense” as that term is
defined in TENN. CODE ANN. § 67-4-2004(23) (Supp. 2012), for purposes of determining net
earnings or loss under TENN. CODE ANN. § 67-4-2006(b)(1)(K), -(b)(2)(N) (Supp. 2012)?
Ruling: No. The Discount charged on the Accounts Receivable is not considered an
“intangible expense” as defined in TENN. CODE ANN. § 67-4-2004(23) (Supp. 2012).
Accordingly, the application requirements set forth under TENN. CODE ANN. § 67-42006(b)(2)(N)(i) (Supp. 2012) do not apply with respect to the deduction of the Discount
by [TAXPAYER] for Tennessee excise tax purposes.
ANALYSIS
Tennessee imposes an excise tax at the rate of 6.5% on the net earnings of all persons, as defined
under TENN. CODE ANN. § 67-4-2004(37) (Supp. 2012), doing business within Tennessee. TENN.
CODE ANN. § 67-4-2007(a) (2011). Tennessee also imposes a franchise tax at the rate of $0.25
per $100, or major fraction thereof, on the net worth of a person doing business in Tennessee,
pursuant to TENN. CODE ANN. §§ 67-4-2105(a), -2106(a) (2011). Persons subject to the
Tennessee franchise and excise taxes include, but are not limited to, corporations such as
[TAXPAYER] and [SUBSIDIARY]. See TENN. CODE ANN. § 67-4-2004(37).
TENN. CODE ANN. § 67-4-2006(a)(1) (Supp. 2012) provides in pertinent part that, for a
corporation, the term “‘net earnings’ or ‘net loss’ is defined as federal taxable income or loss
before the operating loss deduction and special deductions provided for in 26 U.S.C. §§ 241, 242
[repealed], 243-247” and as adjusted by TENN. CODE ANN. § 67-4-2006(b) and (c). In particular,
TENN. CODE ANN. § 67-4-2006(b)(1)(K) requires the taxpayer to add to its net earnings or loss
“[a]ny intangible expense, or portion thereof, that is paid, accrued or incurred in connection with
a transaction with one (1) or more affiliates.” The intangible expense can be deducted on the
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same return if the Commissioner determines, upon application by the taxpayer, that the
intangible expense did not have as its principal purpose the avoidance of the excise tax.1
For purposes of determining net earnings or loss under TENN. CODE ANN. § 67-4-2006(b)(1)(K),
-(b)(2)(N), TENN. CODE ANN. § 67-4-2004(23)(A) defines the term “intangible expense” as “an
expense related to, or in connection with, the acquisition, use, maintenance, management,
ownership, sale, exchange, license, or any other disposition of intangible property, to the extent
such amounts are allowed or allowable as deductions or costs in determining federal taxable
income on a separate entity basis.”2 TENN. CODE ANN. § 67-4-2004(23)(B) further defines
“intangible expense” to mean “interest expenses directly or indirectly allowed as deductions or
costs in determining federal taxable income on a separate entity basis to the extent such interest
expenses are directly or indirectly for, related to, or in connection with the direct or indirect
acquisition, use, maintenance, management, ownership, sale, exchange, license, or any other
disposition of intangible property.”3
Thus, for the Discount charged on the Accounts Receivable to be considered an “intangible
expense” for these purposes, it must be an expense related to the acquisition, use, maintenance,
management, ownership, sale, exchange, license, or any other disposition of intangible property.
“Intangible property” is defined as “patents, patent applications, trade names, trademarks, service
marks, franchise rights, copyrights, licenses, research, formulas, designs, patterns, processes,
formats, and similar types of intangible assets.” TENN. CODE ANN. § 67-4-2004(25).
Here, the Accounts Receivable are the property sold by [TAXPAYER] to [SUBSIDIARY]. To
constitute “intangible property” as defined under TENN. CODE ANN. § 67-4-2004(25), the
Accounts Receivable must be properly considered patents, patent applications, trade names,
trademarks, service marks, franchise rights, copyrights, licenses, research, formulas, designs,
patterns, processes, formats, or similar types of intangible assets.
The facts indicate that the Accounts Receivable are trade accounts receivable that originate in the
normal course of [TAXPAYER’S] business operations from the sale of [TAXPAYER’S]
products. Because trade accounts receivable arising in the ordinary course of business from the
sale of a taxpayer’s products are clearly none of the types of property described under TENN.
CODE ANN. § 67-4-2004(25), the Accounts Receivable cannot be considered “intangible
property” for purposes of determining net earnings or loss under TENN. CODE ANN. § 67-42006(b)(1)(K), -(b)(2)(N).

1

See 2012 Public Chapter 842, effective April 27, 2012, and applicable to tax years ending on or after July 1, 2012.
If the Commissioner approves the taxpayer’s application to deduct the intangible expense, such determination shall
remain in effect so long as the taxpayer submits an annual certification that the transaction remains substantially
unchanged. The Commissioner is authorized to require that the taxpayer reapply for the deduction beginning no
sooner than five years following the most recent application. For more information about the intangible expense
add-back and deduction, including exceptions to the application requirement, see Franchise and Excise Tax
Notice #12-16, available on the Department’s website at http://tn.gov/revenue/notices/fae/12-16fe.pdf.
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(Emphasis added).

3

(Emphasis added).

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Because the Accounts Receivable are not intangible property, it follows that the Discount
charged on the Accounts Receivable is not considered an “intangible expense” for purposes of
determining net earnings or loss under TENN. CODE ANN. § 67-4-2006(b)(1)(K), -(b)(2)(N).
Since the Discount is not considered an intangible expense, the application requirements set forth
under TENN. CODE ANN. § 67-4-2006(b)(2)(N)(i) do not apply with respect to the deduction of
the Discount by [TAXPAYER] for Tennessee excise tax purposes.

Kristin Husat
General Counsel

APPROVED:

Richard H. Roberts
Commissioner of Revenue

DATE:

December 19, 2012

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