I. Overview

In New York Times Sales, Inc. v. Commissioner of Revenue, 40 Mass. App. Ct. 749 (1996), the Appeals Court upheld the Appellate Tax Board's decision in favor of New York Times Sales (Times Sales). The Appeals Court concluded that, on the record before it, the Board was correct in determining that transfers of cash from Times Sales to its parent, The New York Times Company (Times Company), as part of a cash management system, constituted dividends and not intercompany loans. The Commissioner had argued unsuccessfully that Times Sales' payments to its parent were loans rather than dividends because Times Sales never declared a dividend during the relevant periods and because Times Sales and Times Company carried the cash transactions on their books as accounts receivable and accounts payable, respectively.

The Department of Revenue is issuing this Technical Information Release to explain how cash management and similar systems of affiliated corporations will be treated for corporate excise purposes following the Appeals Court decision . The TIR is organized as follows:

Section I: Overview to the TIR.
Section II A: Summary of New York Times Sales case.
Section II B: Application of the New York Times Sales case. This subsection is divided into seven paragraphs:

1) Presentation of the multi-factor analysis to be used in determining whether a cash transfer between a parent corporation and its subsidiary (or between other closely affiliated corporations) in the context of a cash management system is a loan or dividend.
2) Tax treatment of a net cash transfer determined to be a loan.
3) Tax treatment of a net cash transfer determined to not be a loan, i.e., to be a dividend, return of capital or capital gain.
4) Tax treatment of payments made by a parent corporation on behalf of its subsidiary that exceed the cash transferred by the subsidiary.
5) Application of the multi-factor analysis to brother/sister corporations.
6) Effect of New York Times Sales upon the non-income measure of the corporate excise.
7) Use of safe harbor rules to determine how much of a net cash transfer is reportable as a deemed dividend, deemed return of capital or a deemed capital gain. The safe harbor rules may be elected in lieu of analyzing accumulated and current earnings and profits to determine how much of a net cash transfer is reportable as a dividend, return of capital or capital gain.

The TIR applies to all open tax years. The TIR does not address other transactions among affiliates nor does it address financial institutions taxable under G.L. c. 63, § 2 or utility corporations taxable under G.L. c. 63, § 52A. Cash transfers to and from partnerships and between joint venturers will be categorized following federal tax principles.

II. Discussion

A. Summary of the New York Times Sales case

The facts before the Board were undisputed. For tax years 1977 through 1980, Times Sales, a Delaware corporation doing business in Massachusetts and other states, was one of 47 wholly owned subsidiaries of Times Company. In 1977, Times Company and its subsidiaries established a cash management system that served as a consolidated income and expense payment system for all the U. S. members of the group. Times Sales participated in this system by instructing its customers to make payment directly to one of several lock box bank accounts. On a daily basis, the amounts deposited in the lock box accounts would be transferred to the parent's concentration account in New York.

Times Company paid Times Sales' expenses out of funds in a disbursement account maintained for Times Sales in a North Carolina bank. Invoices were sent or forwarded to Times Company's accounting staff, and Times Company's treasury staff funded the disbursement account from the New York concentration account as needed. In addition, Times Company funded Times Sales' payroll accounts on a payroll period basis. During the years at issue, Times Sales did not formally declare a dividend although it had significant earnings and profits in each year and it transferred amounts of cash to Times Company in excess of the amounts that Times Company used to pay Times Sales' expenses.

The primary purpose of the cash management system was to increase the efficient use of available cash from all members of the Times group leading to, among other benefits, reduced banking fees and interest expenses attributable to loans taken to obtain working capital.

In upholding the decision of the Appellate Tax Board that the amounts transferred to Times Company were dividends from Times Sales, the Appeals Court set forth the law to be applied in determining the character of distributions from a subsidiary to its parent as follows. Whether the parties actually intend a transaction to be a loan or a dividend is a question of fact. "A distribution by a subsidiary to its parent is a loan and not a dividend if, at the time of its payment, the parties intended it to be repaid . . . . To resolve the issue, the courts apply a multi‑factor analysis. No single factor is determinative; rather, all the factors must be considered to determine whether repayment or indefinite retention is intended." New York Times Sales, 40 Mass. App. Ct. 749, at 752 (citations omitted).

Analyzing the facts in light of the factors previously set out in Alterman Foods, Inc. v. U.S., 505 F.2d 873 (5th Cir. 1974) ( Alterman I) and Alterman Foods, Inc. v. U.S., 611 F.2d 866 (Ct. Cl. 1979) ( Alterman II), the Appellate Tax Board determined the intention of the parties. The Appeals Court agreed with the Board's analysis that several factors demonstrated that the parties intended that the cash transactions be dividends and not loans. The fact that the parties carried the amounts as accounts receivable and accounts payable on their books could not be determinative by itself in light of the multi‑factor test.

B. Application of the New York Times Sales case

1. Presentation of the multi-factor analysis

To determine whether cash transfers from a subsidiary to its parent in the context of a cash management system are loans or dividends, the multi‑factor analysis of New York Times Sales and the Alterman cases applies. Depending on the circumstances of a particular affiliated group, the analysis may or may not have Massachusetts tax consequences. Where corporate advances are made to a corporation's sole stockholder, courts look with care to the surrounding facts and view with some suspicion declarations of intent which have the effect of maximizing tax benefits. See, e.g., Alterman I at 877. Also significant is whether the cash management system serves a substantial business purpose, as was the case with the Times Company system, and whether there may be tax avoidance objectives influencing the particular arrangement.

The Fifth Circuit Court of Appeals in Alterman I set forth different factors courts consider in determining whether an advance from a corporation to a shareholder is a loan or a dividend: 1) the extent to which the shareholder controls the corporation, 2) the earnings and profits history of the corporation, 3) the magnitude of the advances, 4) whether a ceiling existed to limit the amount the corporation advanced, 5) whether or not security was given for the loan, 6) whether there was a set maturity date, 7) whether the corporation ever undertook to force repayment, 8) whether the shareholder was in a position to repay the advances, and 9) whether there was any indication the shareholder attempted to repay the advances. Alterman I at 877 n.7. These factors are not all-inclusive. The Alterman court considered other factors including whether there was a repayment schedule, whether the subsidiaries charged interest, whether there was a particular need on the part of the parent for the advances, and whether notes or certificates of indebtedness were used . Alterman I at 878-879.

2. Tax treatment of a net cash transfer determined to be a loan

If, in the context of a cash management system, a net cash transfer [1] between a parent and its subsidiary, or between other closely affiliated corporations or entities is determined to be a loan rather than a dividend under the multi‑factor analysis, interest income will accrue to the payor and interest expense to the payee under G.L. c. 63, § 33 or § 39A. See, generally, Commissioner v. AMI Woodbroke Inc., 418 Mass. 92 (1994).

3. Tax treatment of a net cash transfer determined to not be a loan, i.e., to be a dividend, return of capital or capital gain

When it is determined that the subsidiary's net cash transfer is not a loan, the net cash transfer is included in the corporation's gross income to the extent of the subsidiary's earnings and profits. [2] In these cases, the dividends received deduction is available for 95% of the dividend amount, if the requirements for the deduction are met (e.g., the parent owns directly at least 15% of the subsidiary's voting stock). See c. 63, § 38(a) and DOR Directives 98-1 and -2. If the subsidiary has no earnings and profits, or if its earnings and profits have been exhausted, the net cash amount transferred to the parent is to be treated by the parent as a return of capital reducing the parent's basis in the subsidiary's stock, and, then, as a capital gain pursuant to § 301(c) of the Internal Revenue Code.

If the net cash transfer is determined to not be a loan, the Department of Revenue will require an analysis of current and accumulated earnings and profits of the subsidiary from its creation or acquisition by the parent in determining how much of the current net cash transfer is reportable as a dividend, return of capital or capital gain. This earnings and profits analysis will include net cash transfers since the inception of the cash management system. Alternatively, safe harbor rules can be elected to determine how much of the net cash transfer is reportable as a deemed dividend, deemed return of capital or deemed capital gain. See Section II. B. 7 of this TIR.

Example 1. Corporation A and its wholly‑owned subsidiaries S1, S2 and S3 have a cash management system. On a daily basis, the gross receipts of the subsidiaries are sent to A and A pays their expenses. During the taxable year, the gross receipts of each subsidiary exceed its expenses. The subsidiaries have available earnings and profits and there is no intention that A repay any excess amounts it receives under the tests applied in New York Times Sales. To the extent of its earnings and profits each subsidiary pays a dividend to A, includible in A's Massachusetts gross income. Because A owns more than 15% of the voting stock of the subsidiaries, it may deduct 95% of the dividends in computing taxable net income for the taxable year.

Example 2. Corporation B and its tiered subsidiaries HC and OC have a cash management system. On a daily basis, OC sends its gross receipts to B and B pays its expenses. During the taxable year, the gross receipts of OC exceed its expenses. OC has available earnings and profits and there is no intention that B repay any excess amounts it receives under the tests applied in New York Times Sales. To the extent of its earnings and profits, OC pays a constructive dividend to its parent HC, includible in HC's Massachusetts gross income. Because HC owns more than 15% of the voting stock of OC, it may deduct 95% of the dividend in computing taxable net income for the taxable year. In turn, in the taxable year, to the extent of its earnings and profits, HC pays a constructive dividend to B, includible in B's Massachusetts gross income. Because B owns more than 15% of the voting stock of HC, it may deduct 95% of the dividend in computing taxable net income for the taxable year.

4. Tax treatment of payments made by a parent corporation on behalf of its subsidiary that exceed the cash transferred by the subsidiary

If the payments by the parent on the subsidiary's behalf exceed the cash transfers by the subsidiary during the taxable year, the excess paid by the parent will either be a loan or a capital contribution by the parent to the subsidiary, depending on the facts and circumstances of the particular transactions.

Example 3. Corporation C and its subsidiary S have a cash management system. On a daily basis, S sends its gross receipts to C, which pays S's expenses. During the taxable year, the expenses of S exceed its gross receipts and there is no intent that S repay any excess amounts paid on its behalf. The excess payment by C is a capital contribution to S.

If the subsidiary is the cash manager and the payments it makes on the parent's behalf exceed the parent's cash transfers during the taxable year, the excess paid by the subsidiary will either be a loan or a dividend, depending on the facts and circumstances.

5. Application of the multi-factor analysis to brother/sister corporations

With respect to cash transfers between brother and sister corporations as part of a cash management system, the multi‑factor analysis also applies. If it is determined that the parties intend the cash transfers to be dividends rather than loans, to the extent they are made out of the earnings and profits of the payor, there will be a constructive dividend to the common parent, deductible under § 38(a) if all the conditions of that section are met, followed by a loan or a capital contribution by the parent to the payee.

Example 4. Corporation D and its subsidiaries S1, S2 and S3 have a cash management system. On a daily basis, S1, S2 and D send their gross receipts to S3, which pays their expenses. During the taxable year, the gross receipts of S1, S2 and D exceed their expenses. S1 and S2 have available earnings and profits and there is no intention that S3 repay any excess amounts it receives. To the extent of their earnings and profits, S1 and S2 pay a constructive dividend to D, includible in D's Massachusetts gross income, and D makes a corresponding loan or capital contribution to S3 depending on the facts and circumstances. Because D owns more than 15% of the stock of S1 and S2, it may deduct 95% of the dividends in computing taxable net income for the taxable year. The excess of D's gross receipts over its expenses is a capital contribution to S3.

6. Effect of New York Times Sales upon the non-income measure of the corporate excise

The characterization of an inter‑company payment under the net income measure of the corporate excise may affect the determination of net worth under the non‑income measure of the excise at both the parent and the subsidiary level. In general, net worth must be determined in a manner that is consistent with the classification. In addition, generally accepted accounting principles (GAAP) must be applied to determine the net worth of affiliated corporations on a separate entity basis.

For example, under G.L. c. 63, §§ 30.8 and 30.9, net worth includes the book value of a corporation's investment in its subsidiaries determined under generally accepted accounting principles. A deduction is allowed under §§ 30.8 and 30.9 for investment in and advances to a subsidiary to the extent the parent owns directly 80% or more of the subsidiary's voting stock. In the context of a cash management system, if cash transfers from the subsidiary to the parent exceed the payments the parent makes on the subsidiary's behalf during the taxable year, as they did in New York Times Sales, there may be a net reduction in the investment in or advances to the subsidiary under GAAP. If the payments the parent makes on behalf of the subsidiary exceed the cash transfers from the subsidiary to the parent during the taxable year, there may be a net increase in the investment in or advances to the subsidiary under GAAP.

7. Use of the safe harbor rules to determine how much of a net cash transfer is reportable as a deemed dividend, deemed return of capital or deemed capital gain

If the net cash transfer is determined not to be a loan, the Department of Revenue will require an analysis of current and accumulated earnings and profits of the subsidiary from its creation or acquisition by the parent in determining how much of the current net cash transfer is reportable as a dividend, return of capital or capital gain. This earnings and profits analysis will include net cash transfers since the inception of the cash management system.

In the alternative, the following safe harbor rules may be elected to determine how much of the net cash transfer is reportable as a deemed dividend, deemed return of capital or deemed capital gain. Safe harbor treatment is elected by applying the safe harbor rules in characterizing the subsidiary's net cash transfer on its corporate excise return. An election to apply the safe harbor rules is binding upon subsequent tax years and cannot be revoked, except if the election was made for an open tax year, by amending the excise return for that year and any subsequent tax years in which the safe harbor rules were applied.

A. Deemed Dividend: A net cash transfer through the cash management system during the year will be treated as a deemed dividend to the extent that the net cash transfer does not exceed an amount equal to the sum of i) the subsidiary's book income for the year (after reduction for formal dividends distributed during the year) and ii) the subsidiary's ending year unappropriated retained earnings from U.S. Form 1120, Schedule M-2 (after adjustment for prior years' deemed dividends from the cash management system). In determining whether a net cash transfer will be treated as a deemed dividend, the net cash transfer will be applied first against the subsidiary's adjusted book income and second against the subsidiary's adjusted ending year unappropriated retained earnings.

B. Deemed Return of Capital: A net cash transfer not treated as a deemed dividend will be treated as a deemed return of capital to the extent that it does not exceed the parent's capital contributions (after adjustment for prior years' deemed return of capital).

C. Deemed Capital Gain: A net cash transfer not treated as a deemed dividend or a deemed return of capital will be treated as a deemed capital gain.

D. Initial Adjustment to Unappropriated Retained Earnings: In the first year the safe harbor rules are applied, the subsidiary's beginning year unappropriated retained earnings balance must be restated to account for any net cash transfers arising out of the cash management system that would have been deemed as dividends had the safe harbor rules been applied. The look-back period for making the adjustment to the beginning year unappropriated retained earnings balance is the later of the earliest tax year open under G.L. c. 62C, § 37 or the year the cash management system was implemented.

In the event the cash manager is another subsidiary of a common parent, the above rules will also apply to determine the character of distributions reportable by the parent on account of the net cash transfer received by the cash manager from each brother/sister corporation.

The aggregate amount of all such dividends received from all subsidiaries that participate in the cash management system should be reported by the parent on its Massachusetts corporate excise return on Schedule E, line 8 for tax year 1999 (or the equivalent line item for other years) as "Deemed Dividends - Cash Management System." If the conditions of § 38(a) are met, 95% of the amount will be deductible. Schedule E-1 will be modified on future Forms 355C-A and 355C-B to reflect the treatment of the cash management system deemed dividends. In addition, the cumulative amount of the dividends distributed by each subsidiary that participates in the cash management system should be reported by the subsidiary on its 1999 Massachusetts corporate excise return on Schedule A, line 15 (intercompany receivables) and line 30 (retained earnings). These line items on Schedule A will also be modified on future Forms 355C-A and 355C-B to reflect the requirements of the safe harbor rules.

If a taxpayer uses the safe harbor, the Commissioner will not require an analysis of earnings and profits or further adjustments with respect to dividends deemed through the cash management account. The cumulative Massachusetts amount for deemed dividends, deemed return of capital and deemed capital gains from a cash management system represent the Massachusetts adjustment to the parent corporation's investment in its subsidiary.

Examples 5 and 6 below demonstrate how the character of a distribution is determined under the safe harbor rules. Where an example involves a return of capital, it is assumed the parent has contributed the necessary amounts. Net cash transfers, unappropriated retained earnings, book income, formal dividends and prior deemed dividends are assumed to be as stated below for each corporation.

Example 5. Corporation E and its subsidiaries S1, S2, S3 and S4 have a cash management system. During the taxable year, S1, S2, S3 and S4 send their gross receipts to E on a daily basis. E in turn pays the expenses of each subsidiary. In E's intercompany cash management account, the transfer of gross receipts to E is treated as an advance and reported on E's books as an intercompany payable and on the books of S1, S2, S3, and S4 as an intercompany receivable. As E pays each subsidiary's expenses, the intercompany receivable and payable are reduced accordingly. The difference between the gross receipts transferred to E and the expenses paid on behalf of each subsidiary is called a net cash transfer.

BY = Beginning Year, EY = Ending Year, MA = Massachusetts, and RE = Unappropriated Retained Earnings.



Sub 1 Sub 2 Sub 3 Sub 4
Advance$200$200$200$200
- Expense <150> <150> <150> <250>
Net Cash Transfer$ 50 $ 50 $ 50 $ 50
BY RE$100$100$100$100
+ Book Income50503050
- Formal Dividends 0 <50> <50> 0
EY RE$150 $100 $ 80 $150
EY RE$150$ 100$ 80$ 150
- Prior Deemed Dividends 0 0 <40> 0
MA EY RE Before Current Adjustment15010040150
- Net Cash Transfer <50> <50> <50> ---
MA EY RE$100 $ 50 <10> $150

Sub 1 - The net cash transfer of $50 is a dividend because it does not exceed the difference between book income and formal dividends.

Sub 2 - The net cash transfer of $50 is a dividend. Although the net cash transfer exceeds the difference between book income and formal dividends, the net cash transfer does not exceed the amount of Massachusetts ending year unappropriated retained earnings before adjustment for the net cash transfer.

Sub 3 - The net cash transfer of $50 is a dividend to the extent of $40 and a return of capital to the extent of $10.

Sub 4 - The net cash transfer of $<50> is a contribution to capital.

Example 6. Corporation F and its subsidiaries S1, S2 and S3 have a cash management system. During the taxable year, S1 and S2 send their gross receipts to S3, the cash manager, on a daily basis. S3 in turn pays the expenses of S1 and S2. In the group's intercompany cash management account, as S1 and S2 send gross receipts to S3, they are carried as an intercompany receivable to S1 or S2 and as an intercompany payable by S3. As S3 pays the expenses of S1 and S2, the intercompany receivable and payable are reduced accordingly.

S1S2
Advance$175$175
- Expense <150> <200>
Net Cash Transfer$ 25 $ <25>
BY RE$200$200
+ Book Income5050
- Formal Dividends <10> 0
EY RE$240 $250
EY RE$240$250
- Prior Deemed Dividends 0 0
MA EY RE Before Current Adjustment240250
- Net Cash Transfer <25> 0
MA EY RE$215 $250

Sub 1 - The net cash transfer of $25 to S3 is a constructive dividend to F because it does not exceed the difference between book income and formal dividends.

Sub 2 - The net cash transfer of $<25> from S2 to S3 is a dividend from S3 to F and a contribution to capital from F to S2.

/s/Frederick A. Laskey
Frederick A. Laskey
Commissioner of Revenue

FAL:DMS:bm

December 17, 1999

TIR 99-22




[1] In the context of a cash management system, a net cash transfer is the difference between the gross receipts transferred to the cash manager and the expenses paid by the cash manager on the subsidiary's behalf during the taxable year.

[2] In 1995, minor changes were made to the federal treatment of dividends under the consolidated return regulations promulgated pursuant to the Code. See Treas. Reg. §§ 1.1502‑13, 1.1502‑32 (stating intercompany dividends are to be "excluded" from federal gross income under certain circumstances instead of "eliminated" as was true under prior law). The federal change that "excluded" intercompany dividends from gross income rather than simply eliminating their effect as intercompany transfers among affiliated group members was not intended to have any federal substantive effect. Notice of proposed rule making, 59 FR 18011, 18016 (4/15/94).

The change has no significance for Massachusetts purposes because under the corporate excise, whether or not a combined return is filed, corporations determine taxable net income separately. Modifications to the taxable incomes of federal consolidated group members are not used in determining Massachusetts net income, and the net income of each corporation must be adjusted to compensate for any federal modifications. G.L. c. 63, § 32B and 830 CMR 63.32B(7).