Spotlight on Tennessee: Factoring Transactions Are Not Subject to Related Party Intangible Expense Add-Back Statute


In 2012, Tennessee amended the excise tax statute to require prior approval before allowing intangible expenses to be deducted from net earnings for intangible expenses paid by one related party to another related party. In Letter Ruling #12-32, dated December 19, 2012, the Tennessee Department of Revenue (Department) has ruled that the discount or loss realized in a related party accounts receivable factoring transaction is not an "intangible expense" for purposes of determining the taxpayer's Tennessee net earnings or loss and, therefore, was not required to be added back to the taxpayer's net earnings.


Factoring of trade accounts receivable is a financing transaction used by companies to manage their accounts receivable and to obtain financing. A "factor" is a specialized financial intermediary that purchases accounts receivable from a taxpayer (or client) at a discount. Pursuant to a factoring agreement, the price paid by the factor for the receivables is discounted from their face amount to take into account the likelihood of collectability or credit risk of the receivables. The payment by the factor for the receivables may be treated as a cash advance, and the factor typically charges interest on the advance plus a commission. In addition, in some cases, the taxpayer and factor may be engaged in a financing arrangement involving securitizing the receivables. Factoring may be on a recourse (taxpayer bears the risk of nonpayment) or nonrecourse basis (factor bears the risk of nonpayment).

Letter Ruling #12-32

In Letter Ruling #12-32, the taxpayer's business generated accounts receivable from the sale of goods or services. The receivables served as collateral for a line of credit at a favorable interest rate for the taxpayer. The taxpayer established a subsidiary corporation to hold that collateral. The subsidiary was located outside Tennessee and was initially capitalized with a contribution of accounts receivable from the taxpayer in exchange for stock of the subsidiary. To maintain the loan collateral, the subsidiary periodically replenished its receivables using factoring transactions with the taxpayer by using the cash received from the collection of receivables to purchase at a discount new receivables from the taxpayer. The amount of the discount was determined to be an amount that was at arm's length. As a result of the discount, the factoring of the receivables generated a deduction for the taxpayer.

As noted above, Tennessee is now one of approximately 21 states that have enacted related party intangible expense "add-back statutes." Like most of these states, Tennessee defines an "intangible expense" as "an expense related to, or in connection with, the acquisition, use, maintenance, management, ownership, sale, exchange, license, or any other disposition of intangible property, …" While the factoring transaction between the taxpayer and the subsidiary in Letter Ruling #12-32 generated a loss or expense item between related parties, the Department ruled that the pre-approval application requirements did not apply because accounts receivable do not fit within the add-back statute's definition of "intangible property."


Letter Ruling #12-32 sets Tennessee apart from a majority of the other states that have enacted similar related party intangible expense add-back statutes. Remember, however, that Tennessee law provides that Letter Rulings (unlike Revenue Rulings) from the Department are applicable only to the individual taxpayer and facts being addressed.

If you would like to discuss Letter Ruling #12-32 or other Tennessee state or local tax issues, please contact one of the following attorneys in the Firm's Tax Department:

Nashville, Tennessee
Scott D. Smith 615.726.7391
Carolyn W. Schott 615.726.7312
Daniel A. Stephenson 615.726.5678
Memphis, Tennessee
William H.D. Fones 901.577.2247
Mary Ann Jackson 901.577.8113
Charles E. Pierce 901.577.2164
East Memphis, Tennessee
James "Josh" Hall  901.579.3126
Christopher J. Coats 901.579.3127
Chattanooga, Tennessee
Carl E. Hartley 423.756.2010
Virginia C. Love 423.209.4118
Sara E. McManus 423.209.4124
Knoxville, Tennessee
L. Eric Ebbert 865.971.5182
Washington, D.C.
James W. McBride 202.508.3467
New Orleans, Louisiana
Robert L. Wollfarth 504.566.8623
Baton Rouge, Louisiana
Alton "Biff" Bayard 225.381.7019

Birmingham, Alabama

Thomas J. Mahoney 205.250.8346
William R.Sylvester 205.250.8372
Adam S. Winger 205.250.8381
Atlanta, Georgia
Nedom A. Haley 404.221.6505
Michael M. Smith 404.589.3419
Michael S. Evans 404.221.6517
Jackson, Mississippi
Stacy E. Thomas 601.351.2484
Jon D. Seawright 601.351.8921
David P. Webb 601.969.4678
C. Tyler Ball 601.351.8959
Orlando, Florida
Donald Christopher 407.367.5402
Richard C. Swank 407.367.5404
Marty Hartley 407.367.5427

Houston, Texas

Brad Chambers 713.286.7193


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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