In 2002, the Massachusetts legislature enacted G.L. c. 63, § 31I, which generally requires, in the context of a transaction between affiliates ("affiliate transaction") involving intangible property, the add back of an otherwise deductible expense that relates to the property. See TIR 03-19; 830 CMR 63.31.1. This provision is broadly worded to prevent the reduction in state taxes that would otherwise result from these affiliate transactions; however, there are specific statutory exceptions to this broad disallowance of deductions. See id. This Directive addresses the application of the add back rules set forth in G.L. c. 63, § 31I to a corporation that seeks, based on section 197 of the Internal Revenue Code (IRC), to claim a Massachusetts deduction for the amortization of certain intangible property that it has acquired from a "related member." 
Must a taxpayer corporation add back an amount that it seeks to deduct for the amortization of intangible property described in G.L. c. 63, § 31I, using a calculation based on IRC section 197, in determining the taxpayer's Massachusetts net income when the deduction derives from the acquisition of intangible property from a related member?
Yes, the Massachusetts add back statute, G.L. c. 63, § 31I, applies to such an asserted deduction. Consequently, in calculating its net income under G.L. c. 63, § 30.4, a corporation must add back an amount that it seeks to deduct for the amortization of intangible property described in G.L. c. 63, § 31I that it has acquired from a related member, using a calculation based on IRC section 197, unless the claimed deduction is eligible for one of the statutory exceptions. This Directive does not state a change in law or policy; rather, it describes a particular application of the existing law under G.L. c. 63, § 31I. Accordingly, this Directive is applicable to all taxable years to which the add back rules apply. 
Discussion of Law
A corporation's Massachusetts net income is gross income less the deductions, but not credits, allowable under the provisions of the Code. G.L. c. 63, § 30.4. Massachusetts limits this general allowance of federal deductions in certain ways, among them the requirement that in calculating its net income, a taxpayer must add back the amount of certain otherwise permitted deductions, including an otherwise deductible inter-affiliate intangible cost or expense. See G.L. c. 63, § 31I. Among the items that are subject to the intangible add back statute are deductions that derive from a transaction with a related member pertaining to a broad classification of intangible property, such as patents, trademarks, and other intangible assets. See G.L. c. 63, § 31I(b). Further, the add back statute broadly applies to various expenses and costs that relate to intangible property, including:
(1) expenses, losses and costs for, related to, or in connection directly or indirectly with the direct or indirect acquisition, use, licensing, maintenance, or management, ownership, sale, exchange, or any other disposition, of intangible property to the extent such amounts are allowed as deductions or costs in determining taxable income before operating loss deductions and special deductions for the taxable year under the Code; (2) losses related to, or incurred in connection directly or indirectly with, factoring transactions or discounting transactions; (3) royalty, patent, technical and copyright fees, (4) licensing fees; and (5) other similar expenses and costs.
G.L. c. 63, § 31I(a).
Because the amortization amount that may be permitted as a deduction pursuant to Code § 197 would represent a recovery of "costs for, related to, or in connection directly or indirectly with the direct or indirect acquisition or ownership of intangible property," it meets the definition of an intangible expense subject to the add back statute. G.L. c. 63, § 31I. See also 830 CMR 63.31.1(2); 830 CMR 63.31.1(3)(a). Therefore, in any case in which the asserted amortization deduction derives from the acquisition from a related party of intangible property that is referenced within the wide scope of G.L. c. 63, § 31I, the amount is subject to the statutory add back.
As with all items subject to the add back statute, there are certain exceptions that may allow a taxpayer to show by clear and convincing evidence that a particular add back would be unreasonable. See G.L. c. 63, §§ 31I(c). See also 830 CMR 63.31.1(4), (5). For example, a taxpayer may show by clear and convincing evidence that the transaction that gives rise to the purported cost or expense was primarily entered into for a valid business purpose and is supported by economic substance. See 830 CMR 63.31.1(4)(a)1.b.  However, in such cases a taxpayer will not carry its burden of proof unless it establishes by clear and convincing evidence that reduction of tax was a not a principal purpose for the transaction. Id.
Commissioner of Revenue
October 10, 2007
A "related member" within the meaning of the add back statute is a person who is: 1) a related entity, 2) a component member as defined subsection (b) of section 1563 of the Code, 3) a person to or from whom there is attribution of stock ownership in accordance with subsection (e) of section 1563 of the Code, or 4) a person that, notwithstanding its form of organization, bears the same relationship to the taxpayer as a person described in (1) to (3), inclusive. See G.L. c. 63, § 31I.
The deductions described in this directive may also be subject to scrutiny for tax years beginning prior to January 1, 2002, the date of application of G.L. c. 63, § 31I, to evaluate, among other things, the adequacy of the underlying transaction's economic substance and business purpose.
A taxpayer can claim this exception by using Exception 3 on Form ABIE, by completing the relevant lines and providing greater detail about the transaction in the blank space provided.
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