Push-down accounting and alternatives: risks and opportunities in corporate consolidations

Tax Executive, The, Sept-Oct, 1998 by Arthur R. Rosen, Alysse Grossman

[A]lthough the note submitted by [the taxpayer]

appears on its face to be certain as to the amount

and time of payment, there is no evidence that the

obligation constituted a legally enforceable obligation

of [the taxpayer] for the report periods in

issue.

More specifically, the ALJ stated that the taxpayer had not offered any evidence of why the note was pushed down after being carried on the parent's book for four years, no payment had been made and no interest had been paid or accrued on the debt through the audit period, and no evidence had been adduced demonstrating what the taxpayer had received to trigger its issuance of the note. Comptroller's Decision No. 33,517, 1995 Tex. Tax LEXIS 468 (July 10, 1995). This decision seemingly flowed from the failure to prove the validity of the note and the underlying debt, thus leaving open the possibility that a valid debt instrument might be able to reduce Target's surplus for purposes of the Texas Franchise Tax.

The relevant taxing authority might contend that the interest expense on "mirror debt" is nonbusiness expense that cannot be used to offset Target's business income. To avoid this, the taxpayer should argue that the new debt of Target to Holding is merely a recapitalization of Target. For example, if when a corporation started doing business in a state it had a debt-equity ratio of 50 percent, and had always had such a ratio, the interest paid to service that debt would surely be considered a business expense. The result should be no different if a corporation changes its debt-equity ratio, for example, from 50 percent to 60 percent.

2. Combined Reporting. In jurisdictions where combined reporting of corporations entails applying a single combined apportionment formula to a single combined income figure (sometimes called state "consolidated" returns), the use of push-down accounting might not be necessary inasmuch as the problem that push-down accounting is intended to mitigate -- me offsetting of Target's income with Holding's interest expense -- can be addressed by the filing of a combined return; a taxpayer should not encounter any problems in using the interest payments to offset Target's income in those states that permit taxpayers, in either a de jure or a de facto manner, to elect combination. See Colorado (Colo. Rev. Stat. [sections] 39-22-305(1) (1996), but see Reg. [sections] 39-22-305.3); Arizona (Ariz. Rev. Stat. [sections] 43-947 (1996)).

In those states that allow combination only for those companies involved in the conduct of a unitary business, the answer is not so clear, especially if Holding is purely a holding company because whether a pure holding company can be engaged in a unitary business (i.e., whether it conducts any business at all) is not always clear. In The First National Bank of Manhattan v. Kansas, 779 P. 2d 457 (Kan. Ct. App. 1989), the Kansas Court of Appeals determined that a holding company formed for the purpose of holding the stock of a bank, which had no employees or officers and owned virtually no property, was not involved in a unitary business with its subsidiary bank. The facts in this case are particularly relevant since the holding company's only activity was the paying off of debt that it had incurred in acquiring the stock of its subsidiary bank; the holding company received the money with which to pay off its debt from dividends distributed by the bank.