New Jersey Superior Court Denies Interest Addback Exception in Kraft Foods Global Inc.

DALLAS, May 23, 2018 /PRNewswire/ -- The Superior Court of New Jersey held that the Division of Taxation Director ("Director") was correct in denying the application of the unreasonable exception and requiring Kraft Foods Global Inc. ("Global") to add back intercompany interest in Kraft Foods Global Inc. v. Division of Taxation, 2018 N.J. Super. Unpub. DOCKET NO. A-1157-16T1, May 17, 2018.

Kraft Foods Inc. ("Kraft") was an out-of-state corporation with activity in New Jersey, filing corporate business tax returns for the years at issue. The returns did not include an addback of the intercompany interest paid by Global to the parent, Kraft, based on the unreasonable exception to the addback provision provided in N.J. Stat. § 54: 10A-4(k)(2)(l). The parent had issued public debt in the form of bonds periodically, followed by a transfer to Global of the proceeds of the issuance to allow Global to pay off its debts. Global then issued a series of notes to Kraft for the amounts lent. These notes provided only for interest payments equivalent to the interest Kraft was to pay bondholders. The notes did not contain a guarantee to Kraft's bondholders, nor did they provide for a repayment of the principal borrowed. 

During an audit of the applicable returns (2005–2006), the Division of Taxation ("Division") denied the deduction of the interest payments related to the intercompany loans because 1) the debt between Global and Kraft was not at arm's length, as Kraft charged the same rate as it was paying to bond holders; and 2) Global was not the legal guarantor of the debt. The Tax Court agreed with the Director's assertions in its decision in 2016.

The Superior Court only addressed the issue of whether the taxpayer qualified for the unreasonable exception to New Jersey's interest expense addback provision. Although there are five exceptions to the addback, the taxpayer claimed only the unreasonable exception, which requires the taxpayer to establish "by clear and convincing evidence, as determined by the director, that the disallowance of a deduction is unreasonable." 

The Court held that the Director was correct in denying the application of the exception to the addback by relying on the lack of guaranty of the loans and the lack of tax paid by the affiliate receiving the income. While earlier decisions established that the Director could not rely solely on the absence of tax paid on the income to deny the unreasonable exception, in this case, there were other factors—the lack of guaranty and lack of arm's-length terms, notwithstanding that the latter fact was not established.

To prevail on this issue, the taxpayer bears a high burden of proof to produce clear and convincing evidence that the Director's disallowance is unreasonable. The Superior Court's decision illustrates how fact and circumstance dependent exception appeals are, and the challenge, taxpayers face.

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