Does a company have to add a short-term intercompany trade payable back into its net worth when figuring Tennessee franchise tax?

Plain-English summary

A foreign (non-U.S.) corporation (the "Taxpayer") sells its manufactured products to customers in the Americas through a U.S. branch. When a U.S. customer places an order, the U.S. branch buys the inventory from a related company (an "Affiliate") at an arm's-length price set by a formal Advance Pricing Agreement with the IRS. That purchase creates a short-term intercompany "trade payable" — money the branch owes the Affiliate — which is settled every month and shows up as a current (short-term) liability on the books.

Tennessee's franchise tax is based in part on a company's net worth. To stop companies from artificially shrinking that base, Tennessee has an "add-back" rule: debt a corporation owes to an affiliate must be added back into the franchise-tax base if the company's own capital stock is inadequate for its business needs. The Taxpayer had been playing it safe by adding this trade payable back. It asked the Department whether it actually had to.

The Department ruled no. The purpose of the add-back rule — as a Tennessee court explained in Exxon Mobil Corp. v. Johnson — is to catch thinly capitalized companies that take a capital infusion from an affiliate and dress it up as "debt" instead of equity to dodge franchise tax. An ordinary trade payable that is a current liability — here, settled monthly in the regular course of buying inventory — is not that kind of disguised capital. The Department's position is that current-liability trade payables are simply not affiliated debt, so the add-back in § 67-4-2107(b)(1) does not apply. The Taxpayer was adding it back unnecessarily.

What this means for you

Companies with intercompany payables on their Tennessee franchise-tax return

If your business runs short-term trade payables to affiliates — owed for inventory, goods, or services in the ordinary course and settled within a year — Tennessee's view here is that those current liabilities are not the "affiliated debt" the franchise-tax add-back is aimed at. You generally don't add them back into your net-worth base, which keeps your franchise-tax base (and tax) lower.

What the add-back rule is really for

The add-back targets thin capitalization: a company with too little of its own capital that takes an affiliate's money in as "debt" instead of equity, thereby reducing its net worth and its franchise tax. The hallmark is a capital infusion disguised as debt — not a routine, monthly-settled trade payable.

Current liability vs. affiliated debt

The line the Department drew is current liability (a GAAP obligation reasonably expected to be liquidated within one year — here, settled monthly) versus longer-term affiliated debt. A genuine ordinary-course payable that turns over within a year falls on the non-add-back side.

Accountants and tax professionals

The add-back is § 67-4-2107(b)(1); the amount of affiliated debt to include is governed by Tenn. Comp. R. & Regs. 1320-06-01-.15 ("Rule 15"), which Exxon Mobil Corp. v. Johnson held applies only in limited situations. The ruling assumes the intercompany price was a proper arm's-length price under the Advance Pricing Agreement and addresses only the add-back question, not transfer pricing. The Taxpayer filed on a separate-entity basis (no consolidated-net-worth election).

Common questions

Q: Do I add intercompany trade payables back into net worth for Tennessee franchise tax?
A: Under this ruling, no — not when they are current liabilities settled within a year in the ordinary course (here, monthly). The Department treats those as ordinary trade payables, not the affiliated debt the add-back rule targets.

Q: What kind of affiliate debt does get added back?
A: The rule is aimed at thin-capitalization arrangements — where an under-capitalized company takes a capital infusion from an affiliate and books it as debt rather than equity to lower its franchise-tax base. A routine, short-term, monthly-settled trade payable isn't that.

Q: Does this depend on the intercompany price being correct?
A: The ruling assumes the price was a proper arm's-length price set by the company's Advance Pricing Agreement with the IRS, and it decides only the add-back question — not whether the transfer price itself was right.

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 franchise tax — affiliated-debt add-back:
- Tenn. Code Ann. § 67-4-2107(b)(1) (debt owed to an affiliate is added back to the franchise-tax base if the corporation's capital stock is inadequate for its business needs)
- Tenn. Comp. R. & Regs. 1320-06-01-.15 ("Rule 15") (amount of affiliated debt included in the franchise-tax base)

Case and authority:
- Exxon Mobil Corp. v. Johnson, No. 97-1112-II (Davidson Cnty. Ch. Ct. Sept. 17, 2002) (purpose of the add-back is to prevent thinly capitalized companies from classifying an affiliate's capital infusion as debt; Rule 15 applies only in limited situations)
- ARB 43, Ch. 3 (GAAP: current liabilities are obligations reasonably expected to be liquidated within one year)

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/22-03fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
LETTER RULING # 22-03

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

Applicability of the Tennessee franchise tax add-back requirement for short-term intercompany trade
payables.

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 “Taxpayer”) is a [REDACTED] corporation that does business as [REDACTED]. The
Taxpayer manufactures, assembles and sells [PRODUCTS]. Nearly all the Taxpayer's products are
manufactured and assembled at affiliated plants in [REDACTED].

The Taxpayer conducts operations within the United States through its [REDACTED] US Branch (the
“U.S. Branch”), which is domiciled in [REDACTED]. For federal income tax purposes, the Taxpayer
reports the activity of its U.S. Branch on IRS Form 1120-F (United States income tax return of a foreign
corporation). The U.S. Branch serves primarily to ensure that the products of the various business
groups flow smoothly from the Taxpayer to customers in North and South America; specifically, it
provides administrative control and coordination with Taxpayer’s major customers in the United
States.

When a customer in the United States places an order for a product, the U.S. Branch purchases the
inventory from an affiliate of the Taxpayer (the “Affiliate”). This process creates a short-term
intercompany trade payable (the “Trade Payable”) based on an executed Advance Pricing Agreement
with the Internal Revenue Service (the “IRS").’ The Advance Pricing Agreement establishes an
appropriate “arm’s length,” or “third-party” price for the inventory purchased by the U.S. Branch from
the Affiliate. The Trade Payable is settled on a monthly basis.

The Trade Payable owed by the U.S. Branch to the Affiliate is reported as a short-term or current
liability on the Taxpayer's balance sheet and is reflected likewise on Schedule L of the federal Form
1120-F. The Taxpayer files its Tennessee franchise and excise tax return on a separate entity basis and
reports the activity of the U.S. Branch. Currently, the Taxpayer adds back the Trade Payable in arriving
at its net worth when calculating its franchise tax liability. ?

RULING

Is the Taxpayer required, in accordance with TENN. CODE ANN. 8 67-4-2107(b)(1) (2013), to add back a
short-term intercompany Trade Payable owed by the U.S. Branch to the Affiliate for purposes of
calculating the Taxpayer's Tennessee franchise tax liability?

Ruling: No. The Taxpayer is not required to add back a short-term intercompany Trade Payable
owed by the U.S. Branch to the Affiliate.

'A Trade Payable is generally defined as an amount billed to a company by its suppliers for goods delivered to or services
consumed by the company in the ordinary course of business. See eg., Trade Payables, The Law Dictionary,
https://thelawdictionary.org/trade-payables/ (last visited March 14, 2022); Trade payable definition, AccountingTools,
https://www.accountingtools.com/articles/2017/5/15/trade-payable (last visited March 14, 2022); What are Trade Payables,
Simple-accounting, https://simple-accounting.org/what-are-trade-payables-definition-and-explanation/ (last visited March 14,
2022).

? The facts herein assume that an appropriate “arm's length,” or “third-party” price is established by the Advanced Pricing
Agreement. The ruling solely addresses whether the Trade Payable is subject to the add-back requirement.

3 The Taxpayer has not made an election to compute net worth on a consolidated basis.

ANALYSIS

Under TENN. CODE ANN. 8 67-4-2107(b)(1), debt that a corporation owes to an affiliate corporation must
be added back to its franchise tax base calculation if its capital stock is inadequate for its business
needs. Relatedly, TENN. COMP. R. & REG. 1320-06-01-.15 (“Rule 15”) governs the amount of affiliated debt
that must be included in a corporation's franchise tax base.

In Exxon Mobil Corp. v. Johnson, the court found that the purpose of the statute is to prevent thinly
capitalized or poorly capitalized companies that obtain an infusion of capital from an affiliated
corporation from classifying such infusion as debt rather than equity, thereby avoiding the franchise
tax.* Additionally, the court in Exxon found that Rule 15 is only applicable in certain limited situations.
In light of the purpose of the statute, the Tennessee Department of Revenue (the “Department”) takes
the position that account or trade payables that are current liabilities are not considered affiliated
debt.

Here, the Trade Payable owed by the U.S. Branch to the Affiliate is settled on a monthly basis. GAAP
defines current liabilities as “obligations that are reasonably expected to be liquidated within one
year.”° Because the Trade Payable is settled monthly, it appears that the Taxpayer appropriately
classifies it as a current liability for financial reporting purposes. Under the Department's position that
trade payables that are current liabilities should not be treated as affiliated debt, the add-back
provision of TENN. CODE ANN. 8 67-4-2107(b)(1) does not apply to the Trade Payables in question.

APPROVED: David Gerregano
Commissioner of Revenue

DATE: May 4, 2022

4 No. 97-1112-II, 20 (Davidson Cnty. Ch. Ct. Sept. 17, 2002).

5 ARB 43: Restatement and Revision of Accounting Research Bulletins, Chapter 3, Section A(7) lune 1953).