Alabama tax tribunal rules taxpayer entitled to interest deduction

TAX ALERT | August 01, 2022

Authored by RSM US LLP

Since 2001, Alabama has required an addback for intercompany interest expenses and intangible expenses to the extent the expenses were paid to a related member. Under current law, the state allows for an exception to the required add-back in certain circumstances, one of which is when the taxpayer can support that the related member receiving the payment is “subject-to-tax” on the income in another jurisdiction (see Ala. section 40-18-35(b)). In a July 28, 2022, decision, the Alabama tax tribunal issued a taxpayer-favorable verdict and provided clarity on how the intercompany add-back and subject-to-tax exception provisions should apply.


During the tax year at issue in the case, the taxpayer paid $658 million in interest expense to a foreign-affiliated entity operating in Ireland. This amount of intercompany interest expense was included in interest income by the Ireland affiliate but was fully offset by a corresponding deduction of the same amount related to interest expense paid by the Ireland affiliate to one of its affiliates operating in Luxembourg. Ireland’s tax code for the year at issue provides that corporations should be subjected to tax on all profits, regardless of where they were earned. 

The taxpayer filed Alabama returns claiming a deduction for the $658 million of intercompany interest expense under the premise that the inclusion of the interest income in the affiliate’s Ireland return satisfied the requirements of Alabama’s subject-to-tax exception, and, therefore, no intercompany addback was required. Upon review of the taxpayer’s separate Alabama corporate income tax return, the Alabama Department of Revenue adjusted the amount of Alabama net operating losses generated to add back the interested expense paid by the taxpayer to the Ireland affiliate. The taxpayer appealed the department’s decision to the Alabama tax tribunal, requesting a ruling on the proper interpretation of the state’s subject-to-tax exception to the intercompany add-back rules. 

Alabama law and the tribunal’s interpretation

Alabama’s subject-to-tax exception to the intercompany interest add-back specifically provides that the exception will apply when the recipient affiliate is subject to tax in a foreign jurisdiction which has an income tax treaty with the United States, and the affiliate is considered a “resident” of the foreign jurisdiction under treaty definitions, and the payment is included in income by the affiliate and not eliminated in a combined filing. Further, Ala. section 40-18-35(b)(1) provides that “the portion of an item of income which is attributed to a taxing jurisdiction having a tax on net income shall be considered subject to a tax even if no actual taxes are paid on such item of income in the taxing jurisdiction by reason of deductions or otherwise.” 

The question at issue, in this case, was whether the interest income at the Ireland affiliate was truly "subject to a tax" in Ireland. The department’s position urged that consideration must be given to the overall economic impact of the back-to-back intercompany transaction, which effectively included no income as subject to tax if the transactions between the taxpayer and the Ireland affiliate and between the Ireland affiliate and its Luxembourg affiliate were considered on a net basis. The tax tribunal determined that the taxpayer’s intercompany transaction with the Ireland affiliate clearly met the requirements of the subject-to-tax exception. The tribunal found that because the Ireland affiliate included the interest payment in the computation of income subject to tax in Ireland, the tax treaty and residency requirements were therefore satisfied, and thus the entire amount was properly attributable to Ireland under the country’s sourcing methodology. In the tribunal’s analysis, the fact that Ireland allowed the affiliate a deduction for interest expense paid to its Luxembourg affiliate should have no bearing on whether the income was considered subject to a tax in Ireland, in keeping with the provisions of Alabama’s statutory language related to the definition of “subject to tax.” 


In a climate where states are increasingly departing from applying the letter of the law in favor of approaches that consider broad economic impacts, the tribunal’s decision is a somewhat surprising and potentially significant win for taxpayers. Although the taxpayer’s Ireland affiliate was seemingly only serving as a conduit or pass-through for intercompany interest expense in the back-to-back transactions described by the facts, the tax tribunal held that the transaction between the taxpayer and the Ireland affiliate as well as the affiliate’s treatment of the transaction for tax purposes satisfied the specific requirements of the subject-to-tax exception to the state’s intercompany add-back rules. Alabama has routinely examined intercompany transactions under audit, requires extensive disclosures with returns claiming an addback exception, and often adopts narrow interpretations of their statutory exceptions to the intercompany add-back rules. 

Taxpayers who are currently adding back intercompany interest or other intangible expenses should carefully consider whether the recent decision’s interpretation of the requirements of the subject-to-tax exception may provide an opportunity to reduce Alabama corporate income tax liability. Note that, in the context of domestic intercompany transactions, the portion of income that is subject to a tax for the purposes of the exception is considered on a post-apportionment basis. Since the case at hand involved an international affiliate, this issue was not immediately relevant to the tax tribunal’s decision, but it could impact the analysis of how the decision may benefit taxpayers with domestic intercompany transactions subject to addback. Please consult your state and local tax adviser with questions related to Alabama’s intercompany add-back requirements or the tribunal’s decision. 

Let's Talk!

Call us or fill out the form below and we'll contact you to discuss your specific situation.

  • Topic Name:
  • Should be Empty:

This article was written by Anna Cronic, David Brunori, Mark Siegel and originally appeared on 2022-08-01.
2022 RSM US LLP. All rights reserved.

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Jackson Thornton is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise and technical resources.

For more information on how Jackson Thornton can assist you, please contact us.