If an out-of-state investment fund's only Tennessee connection is owning mortgages secured by Tennessee property, does it owe Tennessee franchise and excise tax?

Plain-English summary

The taxpayer is an investment fund organized as a limited partnership outside the United States. Its only business is owning mortgages and collecting the payments on them. It doesn't originate or solicit those mortgages itself — an unaffiliated, third-party investment manager finds, negotiates, and signs the loans and then allocates particular mortgages among its many clients (the fund is just one). The fund's only connections to Tennessee are that some of the mortgages it owns are secured by Tennessee property and some borrowers might live in Tennessee. The closing always happens outside Tennessee. The question: does that make the fund subject to Tennessee franchise and excise (F&E) tax?

The Department ruled no — the fund is not "doing business in Tennessee."

F&E tax depends on "doing business in Tennessee." Tennessee imposes a 6.5% excise tax on net earnings and a franchise tax on net worth of persons doing business in the state, and "persons" includes limited partnerships. "Doing business in Tennessee" is defined broadly — "any activity purposefully engaged in within Tennessee… with the object of gain, benefit, or advantage" — but special rules apply to financial institutions.

The fund is a "financial institution." An entity is a "financial institution" if it earns 50% or more of its gross income from the "business of a financial institution," which expressly includes making, acquiring, selling, or servicing loans — including mortgages and deeds of trust on real or personal property. The fund earns 100% of its income from acquiring and holding mortgages, so it's a financial institution for F&E purposes.

Financial institutions have their own nexus rules — and a safe harbor. Normally a financial institution is treated as doing business in Tennessee if its Tennessee-attributed assets plus deposits reach $5 million, or if it does things like maintain an office here, have a representative or independent contractor here, regularly solicit Tennessee customers, own Tennessee property, and so on (§ 67-4-2004(14)(B)). But there's a statutory safe harbor (§ 67-4-2004(14)(C)): a financial institution is not conducting the business of a financial institution in Tennessee if its only activity here is owning an interest in a loan, lease, or note attributed to the state — provided the payment obligations were "solicited and entered into by a person that is independent and not acting on behalf of the owner." The safe harbor also covers activities reasonably required to evaluate, complete, service, or collect on the loan, or to deal with collateral.

The independent investment manager is the key. The fund's Tennessee activity is exactly the kind the safe harbor protects — passively owning loan interests and collecting income. The only question was whether the loans were solicited and entered into by an independent person not acting for the fund. The Department said yes: the investment manager did everything — solicited brokers, negotiated, finalized documents, executed the notes and mortgages for the fund — and only afterward allocated specific mortgages to the fund. And the manager met the statutory definition of an "independent person" (§ 67-4-2004(14)(D)) because:

• the fund had no 15%-or-greater ownership tie to the manager (the entity it acquired the assets from);
• the manager regularly assigns mortgage interests to three or more persons in a 12-month period; and
• no single client (including the fund) received 90% or more of the manager's assigned mortgages.

Because all the fund's Tennessee activities fit within the safe harbor, it is not doing business in Tennessee and owes no F&E tax.

What this means for you

Out-of-state funds and lenders that merely hold Tennessee-secured loans

Passively owning loans, notes, or mortgages tied to Tennessee — and collecting the payments — does not by itself create Tennessee franchise and excise tax exposure for a financial institution, as long as an independent third party (not you, not an affiliate) solicited and originated those loans. The mere fact that collateral sits in Tennessee or a borrower lives there isn't enough.

The safe harbor hinges on "independence" — document it

The protection turns on the originator/manager being genuinely independent: no 15%+ ownership overlap, regularly placing loans with three or more buyers, and not funneling 90%+ of its assets to you. If you use a related or captive manager, originate loans yourself, or solicit Tennessee borrowers directly, you likely fall outside the safe harbor and into "doing business in Tennessee." Keep records showing the manager's independence and its multi-client allocation.

Watch the other nexus triggers

Even a financial institution that holds passive loans can still be doing business in Tennessee through other activities — a Tennessee office, employees or representatives, regular solicitation, $5M+ of Tennessee-attributed assets and deposits, etc. The safe harbor only applies when loan ownership (plus servicing/collection) is your only Tennessee activity.

Accountants and tax professionals

"Doing business in Tennessee" is defined at § 67-4-2004(14)(A); the financial-institution thresholds/factors at § 67-4-2004(14)(B); the safe harbor at § 67-4-2004(14)(C) (with the independent-loan-ownership prong at (C)(iii)); and "independent person not acting on behalf of the owner" at § 67-4-2004(14)(D) (15% ownership / three-or-more transferees / 90% tests). Financial-institution definition: § 67-4-2004(17) (50% gross-income test), § 67-4-2004(5)(B); the "business of a financial institution" includes acquiring mortgages under § 67-4-2004(5)(A)(iii)(c). Excise tax § 67-4-2007(a); franchise tax §§ 67-4-2105(a), 67-4-2106(a); "persons" include limited partnerships § 67-4-2004(38); the privilege tax is imposed under §§ 67-4-2005, 67-4-2104, and substantial nexus is required (§§ 67-4-2007, 67-4-2105). The definition is meant to reach the limits of the U.S. and Tennessee Constitutions.

Common questions

Q: My out-of-state fund owns mortgages secured by Tennessee real estate. Do we owe Tennessee franchise and excise tax?
A: Not necessarily. If owning the loans (and collecting/servicing them) is your only Tennessee activity, and an independent third party originated and solicited those loans, you fall within the financial-institution safe harbor and are not "doing business in Tennessee."

Q: What makes the originator/manager "independent"?
A: Under § 67-4-2004(14)(D): you don't own 15% or more of it, it regularly assigns loan interests to three or more persons in a 12-month period, and it doesn't transfer 90% or more of its assets to you in that period.

Q: What if we originate or solicit the loans ourselves, or use an affiliated manager?
A: Then the safe harbor likely doesn't apply, because the payment obligations wouldn't have been solicited and entered into by an independent person not acting on your behalf. You could be doing business in Tennessee and subject to F&E tax.

Q: Does having Tennessee borrowers or Tennessee collateral, by itself, create nexus?
A: No. The Department made clear that the fund's only Tennessee links — collateral located here and possible Tennessee borrowers — did not take it outside the safe harbor.

Q: Can I rely on this ruling?
A: Not directly. A Tennessee letter ruling binds the Department only as to the taxpayer and exact facts it addressed and cannot be relied on by anyone else. Confirm your own facts with a tax professional.

Citations and references

Tennessee statutes (Tenn. Code Ann.):
- § 67-4-2004(14)(A) (definition of "doing business in Tennessee"); § 67-4-2004(14)(B) ($5,000,000 asset/deposit threshold and deemed-doing-business factors)
- § 67-4-2004(14)(C) (financial-institution safe harbor); § 67-4-2004(14)(C)(iii) (independent-loan-ownership prong); § 67-4-2004(14)(D) (definition of "independent person not acting on behalf of the owner")
- § 67-4-2004(17), § 67-4-2004(5)(B) (definition of "financial institution" — 50% gross-income test); § 67-4-2004(5)(A)(iii)(c) (business of a financial institution includes acquiring mortgages)
- § 67-4-2007(a) (6.5% excise tax on net earnings); §§ 67-4-2105(a), 67-4-2106(a) (franchise tax on net worth); § 67-4-2004(38) ("persons" include limited partnerships); §§ 67-4-2005, 67-4-2104 (privilege tax); §§ 67-4-2007, 67-4-2105 (substantial nexus)

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/20-07fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
LETTER RULING # 20-07
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 a financial institution, whose activities in Tennessee are limited to those identified in TENN.
CODE ANN. § 67-4-2004(14)(C), is doing business in this state and is subject to Tennessee franchise and
excise taxes.
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] (the “Fund”) is organized as a limited partnership formed and domiciled [OUTSIDE THE
UNITED STATES]. The capital investment for the Fund was provided by its limited partner, which is a
bank formed in and operating under the laws of a country other than the United States. The general
partner of the Fund is domiciled [OUTSIDE THE UNITED STATES] and does not maintain an office, have

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any presence directly or through an agent, or provide any services in Tennessee or anywhere else in
the United States.
The Fund's only business activity is owning mortgages and receiving payments on those mortgages.
The Fund does not conduct any business activity in Tennessee. Its only connections to Tennessee are
that, from time to time, some of the real or personal properties securing some of the mortgages the
Fund owns are located in Tennessee and some of the borrowers could possibly also be located in
Tennessee.
To acquire the mortgages it owns, the Fund relies on the actions of an independent investment
manager (the "Investment Manager"). The Investment Manager is a third-party service provider and
registered Investment Advisor and is not affiliated with the Fund by ownership or in any other way.
The Investment Manager provides similar services for many other clients in addition to the Fund. The
Fund receives the mortgages it owns - including those secured by property in Tennessee - through the
following process involving the Investment Manager and independent mortgage brokers
(''Independent Brokers"):
Step 1:

Independent Brokers that are regularly engaged in the business of brokering
mortgage loans work with sponsors of mortgages to prepare an offering
memorandum that is sent to several prospective lenders or their
representatives, including the Investment Manager. Like the Investment
Manager, the Independent Brokers are not affiliated by ownership or in any
other way with the Fund. The Independent Brokers also have no affiliation with
the Investment Manager.

Step 2:

The Investment Manager reviews, evaluates, and submits an indication of
interest for the mortgage on behalf of its clients. Those clients include the Fund
and the Investment Manager’s other clients, all of which are prospective
lenders. The indication of interest submitted by the Investment Manager does
not identify the Fund but is, instead, submitted collectively on behalf of the
Investment Manager’s numerous clients.

Step 3:

After an Independent Broker receives indications of interest from the
Investment Manager and from other prospective lenders, the list of potential
lenders is narrowed through negotiations and other communications between
the Independent Broker and the prospective lenders or their representatives,
including the Investment Manager acting on behalf of the multiple clients it
represents.

Step 4:

If the Investment Manager’s indication of interest for a mortgage is ultimately
selected by an Independent Broker, the Investment Manager then finalizes a
formal application and the essential financial and other terms of the loan
documents, which were preliminarily set forth in the indication of interest and
commitment documents exchanged in the solicitation process.

Step 5:

Simultaneous with the finalization of documentation but after principal
material economic terms have been agreed upon, the Investment Manager

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decides which of its clients should receive the mortgage. This decision is
typically based on a standardized allocation system applicable to all of the
lenders the Investment Manager represents.
Step 6:

If the Investment Manager chooses the Fund as the client that will receive a
particular mortgage, the Investment Manager executes the notes, mortgages,
and other loan documents on behalf of the Fund. In some instances, but not
always, the Investment Manager will use a single purpose entity as the lender
identified in those documents. When a single purpose entity is not used, the
Investment Manager identifies the Fund as the lender in the loan documents.
The Investment Manager is never, itself, identified as a lender to a mortgage it
acquires on behalf of its clients and never, at any time, owns the mortgages it
enters on behalf of those clients. Instead, and assuming the Fund is the client
that receives a particular mortgage, the Fund or a single purpose entity is
identified as the lender in the notes, mortgages, and other loan documents
the Investment Manager acquires on behalf of the Fund.

Step 7:

The closing on the loan documents takes place outside Tennessee, and the
borrower pays the Independent Broker’s fees. The Fund never owns and is
never deemed to own any equity interest in a borrower.

After receiving ownership of a mortgage through the activities of the Investment Manager described
above, the Fund, through a mortgage servicer or collection agent, collects payments on the mortgage
when the payments become due. The Fund’s only connections to Tennessee are that some of the
mortgages from which it receives those payments are secured, in part, by property located in
Tennessee, and some of the borrowers could possibly reside in Tennessee.
RULING
Is the Fund “doing business in Tennessee” as that term is used in TENN. CODE ANN. § 67-4-2004(14)
(Supp. 2019) to determine whether an entity has Tennessee franchise and excise tax filing and
payment responsibilities?
Ruling: No. The Fund is not “doing business in Tennessee” and is, therefore, not subject to
Tennessee’s franchise and excise taxes because its activities are limited to those identified in
TENN. CODE ANN. § 67-4-2004(14)(C).
ANALYSIS
LEGAL BACKGROUND
Tennessee imposes an excise tax at the rate of 6.5% on the net earnings of all persons doing business
within Tennessee. 1 Tennessee also imposes a franchise tax at the rate of $0.25 per $100, or major

1

TENN. CODE ANN. § 67-4-2007(a) (Supp. 2019).

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fraction thereof, on the net worth of a person doing business in Tennessee. 2 Persons subject to
Tennessee franchise and excise taxes include, but are not limited to, limited partnerships. 3
“Doing business in Tennessee” is defined as “any activity purposefully engaged in within Tennessee,
by a person with the object of gain, benefit, or advantage, consistent with the intent of the general
assembly to subject such persons to the Tennessee franchise/excise tax to the extent permitted by
the United States Constitution and the Constitution of Tennessee.” 4
The definition of a “financial institution” includes any entity that generates fifty percent (50%) or more
of its gross income from carrying on the “business of a financial institution.” 5 Furthermore, the
“business of a financial institution” includes “making, acquiring, selling or servicing loans or extensions
of credit, including . . . [m]ortgages or deeds of trust or other secured loans on real or tangible
personal property.” 6
A financial institution is doing business in Tennessee “if the sum of its assets and the absolute value
of its deposits attributable to sources within this state is five million dollars ($5,000,000) or more.” 7 In
addition, a financial institution is deemed to be doing business in Tennessee if the institution:
(i)
(ii)
(iii)
(iv)
(v)
(vi)

(vii)
(viii)

Maintains an office in this state;
Has an employee, representative or independent contractor conducting business in
this state;
Regularly sells products or services of any kind or nature to customers in this state
that receive the product or services in this state;
Regularly solicits business from potential customers in this state;
Regularly performs services outside this state that are consumed in this state;
Regularly engages in transactions with customers in this state that involve intangible
property, including loans, and result in receipts flowing to the taxpayer from within
this state;
Owns or leases property located in this state; or
Regularly solicits and receives deposits from customers in this state. 8

However, a financial institution is not considered to be conducting the business of a financial
institution in Tennessee if its only activity in this state is the ownership of “an interest in a loan, lease,
note or other assets attributed to this state and in which the payment obligations were solicited and

2

TENN. CODE ANN. §§ 67-4-2105(a) and -2106(a) (2013 & Supp. 2019).

3

TENN. CODE ANN. § 67-4-2004(38) (Supp. 2019).

4

TENN. CODE ANN. § 67-4-2004(14)(A).

5

TENN. CODE ANN. § 67-4-2004(17), see also TENN. CODE ANN. § 67-4-2004(5)(B).

6

TENN. CODE ANN. § 67-4-2004(5)(A)(iii)(c).

7

TENN. CODE ANN. § 67-4-2004(14)(B).

8

Id.

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entered into by a person that is independent and not acting on behalf of the owner.” 9 In addition, a
financial institution is not considered to be conducting the business of a financial institution in
Tennessee when it conducts “activities within this state that are reasonably required to evaluate and
complete the acquisition or disposition of the [aforementioned] property, the servicing of the property
or the income from it, the collection of income from the property, or the acquisition or liquidation of
collateral relating to the property.” 10
Within the context of TENN. CODE ANN. § 67-4-2004(14)(C), an “independent person who is not acting
on behalf of the owner” means:
(i)

At the time of the acquisition of the assets, the owner of the asset does not directly or
indirectly own fifteen percent (15%) or more of the outstanding stock or, in the case
of a partnership or limited liability company, fifteen percent (15%) or more of the
capital or profits interest, of the entity from which the owner originally acquired the
asset. . . . ;

(ii)

The entity from which the owner acquired the asset regularly sells, assigns or transfers
interest in such assets to three (3) or more persons during the full twelve-month
period immediately preceding the month of acquisition; and

(iii)

The entity from which the owner acquired the asset does not sell, assign or transfer
ninety percent (90%) or more of its exempt assets to the owner during the full twelvemonth period immediately preceding the month of acquisition. 11
APPLICATION

Tennessee imposes franchise and excise taxes on persons for the privilege of doing business in this
state. 12 Persons subject to franchise and excise taxes include limited partnerships. 13 A limited
partnership will be subject to franchise and excise taxes if it is doing business in this state and if it has
a substantial nexus in this state. 14 This ruling addresses whether the Fund is doing business in this
state so as to be subject to Tennessee franchise and excise taxes.
The statutory definition of “doing business in Tennessee” is broad and encompasses “any activity
purposefully engaged in within Tennessee, by a person with the object of gain, benefit, or
advantage.” 15 However, within the context of “doing business in Tennessee,” there are certain
9

TENN. CODE ANN. § 67-4-2004(14)(C)(iii).

10

TENN. CODE ANN. § 67-4-2004(14)(C).

11

TENN. CODE ANN. § 67-4-2004(14)(D).

12

TENN. CODE ANN. §§ 67-4-2005 and -2104.

13

TENN. CODE ANN. § 67-4-2004(38).

14

TENN. CODE ANN. §§ 67-4-2007 and -2105.

15

TENN. CODE ANN. § 67-4-2004(14)(A).

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statutory provisions that apply specifically to financial institutions. Therefore, it must be ascertained
whether the Fund is a financial institution for Tennessee franchise and excise tax purposes.
The Fund's only business activity is owning mortgages and receiving payments on those mortgages.
The Fund acquires the mortgages it owns through the actions of the independent Investment
Manager. Accordingly, the Fund’s business activity consists of “acquiring . . . [m]ortgages or deeds of
trust or other secured loans on real or tangible personal property,” which constitutes the “business of
a financial institution.” 16 Because the Fund generates 100% of its gross income from carrying on the
“business of a financial institution,” the Fund is a “financial institution” for Tennessee franchise and
excise tax purposes. 17
Notwithstanding the statutory directive, at TENN. CODE ANN. § 67-4-2004(14)(B), which provides specific
criteria as to when a “financial institution” is presumed to be “doing business in Tennessee,” TENN.
CODE ANN. § 67-4-2004(14)(C) provides a statutory safe harbor whereby a “financial institution” is not
considered to be “doing business in Tennessee.” This statute provides,
[A] financial institution is not considered to be conducting the business of a financial
institution in this state, if the only activity of the financial institution in this state is the
ownership of . . . [a]n interest in a loan, lease, note or other assets attributed to this state and
in which the payment obligations were solicited and entered into by a person that is
independent and not acting on behalf of the owner. 18
As previously established, the Fund's only business activity is owning mortgages and receiving
payments on those mortgages, some of which are secured by property located in Tennessee (the
“Tennessee mortgages”); in addition, some of the borrowers could possibly reside in Tennessee.
Consequently, the Fund’s business activity in Tennessee is limited to owning “an interest in a loan,
lease, note or other assets attributed to this state” and collecting income from such property, which
is an activity that is also protected under the statutory safe harbor. 19 However, in order for the Fund’s
ownership interest in the Tennessee mortgages to satisfy the requirements of the statutory safe
harbor, such payment obligations must have been “solicited and entered into by a person that is
independent and not acting on behalf of the owner.” 20
The Tennessee mortgages were “solicited and entered into” by the Investment Manager. The
Investment Manager does everything necessary to solicit, negotiate, and enter into the mortgages the
Fund owns. The Investment Manager negotiates with potential brokers on behalf of all of its clients,
including the Fund. It is only after the negotiation and initial documentation process has been
completed that the Investment Manager might assign a particular mortgage to the Fund. Even then,
the Investment Manager executes the notes, mortgages, and other loan documents for the Fund. The
Fund’s only involvement in this process is the closing, which takes place outside Tennessee.
16

TENN. CODE ANN. § 67-4-2004(5)(A)(iii)(c).

17

TENN. CODE ANN. § 67-4-2004(17), see also TENN. CODE ANN. § 67-4-2004(5)(B).

18

TENN. CODE ANN. § 67-4-2004(14)(C)(iii).

19

See TENN. CODE ANN. § 67-4-2004(14)(C).

20

Id.

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The Fund is not affiliated by ownership or in any other way with the Investment Manager, the entity
from which the Fund originally acquired the Tennessee mortgages. In addition to the Fund, the
Investment Manager has numerous other clients, all of which are prospective lenders, to whom the
Investment Manager regularly assigns an interest in mortgages; typically, the Investment Manager
decides which of its clients should receive the mortgage based on a standardized allocation system
applicable to all of the lenders the Investment Manager represents. During any given twelve-month
period, the Investment Manager regularly assigns an interest in mortgages to three or more persons
and no single person, including the Fund, is assigned 90% or more of such mortgages. Thus, pursuant
to TENN. CODE ANN. § 67-4-2004(14)(D), the Investment Manager is an “independent person who is not
acting on behalf of” the Fund, and the statutory safe harbor requirements, under TENN. CODE ANN. § 674-2004(14)(C), are met by the Fund.
Because the Fund’s business activities in Tennessee are limited to those identified in TENN. CODE ANN.
§ 67-4-2004(14)(C), the Fund is not “doing business in Tennessee” and is, therefore, not subject to
Tennessee franchise and excise taxes.

APPROVED:

David Gerregano
Commissioner of Revenue

DATE:

10/8/2020

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