SYSCO CORPORATION v. COMMISSIONER OF REVENUE
Docket/Court: C282656; C283182, Massachusetts Appellate Tax Board
Date Issued: 10/20/2011
Tax Type(s): Corporate Income Tax
These are appeals filed under the formal procedure pursuant to G.L. c. 58A, § 7 and G.L. c. 62C, § 39 from the refusal of the appellee, the Commissioner of Revenue (“Commissioner”), to grant an abatement of corporate excise sought by the appellant (“Sysco” or “appellant”) for its fiscal years ended June 29, 1996, June 28, 1997, June 27, 1998, July 3, 1999, July 1, 2000, and June 30, 2001 (“tax years at issue”). 1
Commissioner Scharaffa heard these appeals and was joined by Chairman Hammond and Commissioners Egan, Rose and Mulhern in the decision for the appellee.
These findings of fact and report are made at the requests of the appellant and the appellee pursuant to G.L. c. 58A, § 13 and 831 CMR 1.32.
Philip S. Olsen, Esq., Craig B. Fields, Esq., and Roberta Moseley Nero, Esq. for the appellant.
Christopher M. Glionna, Esq., Andrew P. O'Meara, Esq., Brett M. Goldberg, Esq., and Thomas J. Leonardo, Esq. for the appellee.
FINDINGS OF FACT AND REPORT
These appeals were presented through a Stipulation of Facts and stipulated exhibits, and the testimony and exhibits entered into evidence at the hearing of the appeals. The appellant offered five witnesses, who were called in the following order: George Mitchell Elmer, Senior Vice President, Controller and Chief Accounting Officer; 2 David Lee Brown, Vice President of Finance, Sysco San Diego; Ms. Jill Weise, Managing Director, Ceteris U.S., LLC; Dr. Brian Cody, Principal, KPMG LLP; and Richard D. Pomp, Professor of Law, University of Connecticut, School of Law. The Commissioner offered the testimony of Michael Johnson, Audit Manager, Multi-State Audit Bureau, Massachusetts Department of Revenue (“DOR”), and Robert W. Alltop, Head of Transfer Pricing Practice, Charles River Associates.
On the basis of the foregoing, the Appellate Tax Board (“Board”) made the following findings of fact.
Throughout the tax years at issue, Sysco was a Delaware corporation that maintained its principal place of business in Houston, Texas. Sysco filed Combined Massachusetts Corporate Excise Returns for each of the tax years at issue. 3 Based on the results of an audit initiated by the DOR, the Commissioner issued a Notice of Intention to Assess Corporate Excise (“NIA”) to Sysco dated February 15, 2004, for the tax years 1996 through 1998. The Commissioner subsequently issued an NIA dated August 14, 2005, for the tax years 1999 through 2001.
On March 16, 2004, Sysco filed a Form DR-1, Appeals Form, seeking a pre-assessment conference with DOR's Office of Appeals for the tax years 1996 through 1998. Following a conference which was held on May 12, 2004, the Office of Appeals issued a letter of determination dated March 23, 2005, upholding the proposed assessment in full. Sysco did not seek a pre-assessment conference for the tax years 1999 through 2001.
The Commissioner issued a Notice of Assessment (“NOA”) dated April 27, 2005, relating to the tax years 1996 through 1998 and an NOA dated September 27, 2005, for the tax years 1999 through 2001. Sysco protested the NOAs by filing Applications for Abatement on May 27, 2005, for the tax years 1996 through 1998 and on December 8, 2005, for the tax years 1999 through 2001. The Commissioner denied Sysco's Applications for Abatement by Notices of Abatement Determination dated September 15, 2005, for the tax years 1996 through 1998 and February 22, 2006, for the tax years 1999 through 2001.
Sysco filed a Petition Under Formal Procedure relating to the tax years 1996 through 1998 on November 10, 2005, and a Petition Under Formal Procedure relating to the tax years 1999 through 2001 on April 14, 2006. As originally filed, Sysco's petitions set forth several issues for consideration by the Board. During February of 2009, the parties executed a settlement agreement resolving all of the contested issues with the exception of the Commissioner's adjustments relating to the operation of Sysco's cash-management system. The adjustments included disallowance of interest deductions claimed by Sysco on purported loans resulting from intercompany advances. The Commissioner characterized claimed loan amounts to Sysco as dividends and characterized claimed interest income received by the “loaning” entities from Sysco as capital contributions from Sysco. The amount of taxes remaining at issue for each tax year, exclusive of interest, is as follows:
1996: $ 423,059.37 1999: $1,462,314.50
1997: $ 597,955.00 2000: $ 700,452.48
1998: $3,309,464.63 2001: $ 717,090.76
Based on the foregoing, the Board found and ruled that it had jurisdiction to hear and decide these appeals.
Sysco was formed in 1969 when nine local food distributors operating in markets across the United States combined their businesses in exchange for Sysco common stock. The new company was taken public and commenced operations in 1970. Over time, Sysco expanded its own operations and acquired smaller family-owned businesses. Through its wholly owned subsidiaries and divisions (the “operating companies”), Sysco distributed food and related products to establishments such as restaurants, nursing homes, hospitals, hotels, motels, schools, colleges, cruise ships, sports parks and summer camps.
All of Sysco's revenue was generated from the activities of the operating companies. Each operating company that was a corporation had a board of directors and each company that was a limited liability company had a board of managers. Each operating company had its own officers, and the presidents of the operating companies had responsibility for hiring and dismissing employees. While the management of Sysco made suggestions regarding operating company personnel, the operating companies were not obligated to follow Sysco's suggestions. Sysco's chief operating officer was responsible for hiring and dismissing the operating companies' presidents.
Each operating company paid its own operating expenses, made its own purchasing decisions, placed its own orders for supplies and equipment and was responsible for its own operating results. The operating companies were required to obtain approval from Sysco prior to making capital expenditures exceeding fifty thousand dollars, such as major equipment purchases, expansion of a company's business, or expansion of operating facilities.
B. The Cash-Management System
Soon after its formation in 1969, Sysco implemented a cash-management system in which all of the operating companies were obligated to participate. Mr. Elmer testified extensively about the cash-management system, which he stated was implemented and maintained to function as a “corporate bank” and to achieve various efficiencies including reduction of banking costs and the cost of debt capital.
The cash-management system, which was managed by Sysco's treasury department, had several components. Each operating company maintained bank accounts with commercial third-party banks, including a main depository account and a disbursement account. The companies deposited all revenue generated from operations into their respective depository accounts. At the daily close of business, Sysco initiated a transfer of funds from the depository accounts to what Sysco referred to as its “concentration accounts.” While cash receipts were transferred on a daily basis, the depository accounts were not left with a zero balance because sums reflected in accounts as a result of check deposits were not transferred to the concentration accounts until the checks had cleared.
The disbursement accounts, through which the operating companies paid their expenses, were “zero balance accounts.” Operating company checks presented for payment on a given day were funded by Sysco, which initiated a transfer of funds from the concentration accounts to the disbursement accounts sufficient to cover the checks. Thus, the disbursement accounts were left with a zero balance at the end of each day. An operating company that desired capital expansion requiring approval from Sysco submitted a capital investment proposal (“CIP”), which Sysco in its sole discretion could approve or reject. If approved, an operating company might receive a fixed interest rate and term for the amount approved. Purported payments relating to the capital funding were made through the accounts comprising the cash-management system.
The difference between the sums swept up to Sysco and the amounts transferred from its concentration accounts to the operating companies' disbursement accounts was recorded in Sysco's and each operating company's books and records, which included an “intercompany account.” Weekly and monthly intercompany statements were generated reflecting amounts transferred to and from Sysco to compare Sysco's records to those of the operating companies.
During the tax years at issue, when Sysco had disbursed less to an operating company than it received from the company, the excess received by Sysco was accounted for as a loan from the operating company to Sysco, placing Sysco in a “net borrowing position” relative to the operating company. Conversely, when Sysco had disbursed more than it collected from an operating company, it accounted for the excess received by the operating company as a loan from Sysco to the company, placing Sysco in a “net lending position” relative to the company.
Interest was calculated daily on all intercompany account ending balances. Operating companies that were in a net lending position relative to Sysco were “paid” interest at the prime rate minus one percent by Sysco on outstanding balances. Operating companies in a net borrowing position relative to Sysco “paid” interest at the prime rate to Sysco on the balances. Payments of interest were made by accounting entries on a monthly basis, and sums representing interest payments to the operating companies from Sysco were immediately swept up to the concentration accounts. Consistent with this accounting treatment, Sysco deducted interest paid to the operating companies and reported income received from the companies on its state tax returns. Similarly, the operating companies reported interest income received from Sysco and interest paid to Sysco on their tax returns.
The cash-management system was operated according to procedures set forth in an internal guide called the Financial and Accounting Methods Manual (“FAMM”), which was in force before and during the tax years at issue. 4 The FAMM described in detail the various elements of the cash-management system and, inter alia, set forth methods of accounting for transactions, intercompany and otherwise, as well as generating intercompany reports and accounting for the accrual of interest on intercompany balances. The FAMM consistently and explicitly referred to the various intercompany transactions and balances relating to the cash-management system as reflecting “borrowing” and “lending” between Sysco and the operating companies.
Mr. Elmer maintained that the FAMM provided substantial evidence of a debtor/creditor relationship between Sysco and the operating companies. However, while the FAMM provided detailed guidelines relating to operation of the cash-management system, it did not evidence a legal obligation to repay sums it stated were borrowed from or lent to the operating companies. In particular, the FAMM did not provide for execution of any agreements relating to the purported debt. Nor did the FAMM provide for amortization schedules, default or collateral provisions, or any type of security mechanism to ensure timely repayment. Mr. Elmer acknowledged that no such documents existed.
While Sysco in theory could enforce repayment of balances due from the operating companies by virtue of its 100% ownership of the entities, the operating companies had no such ability and were left without recourse should they have sought to enforce Sysco's claimed obligation to repay outstanding balances. Thus, the Board found that Sysco had no legal obligation to repay transfers of outstanding sums due to the operating companies.
The Board also found that full repayment of purported loans was not intended to and did not in fact occur. In support of its assertion that repayment was intended, Sysco noted that a portion of the funds advanced to Sysco were repaid on a daily basis through disbursements to the operating companies and that a given operating company could go from a net borrowing to a net lending position or the reverse. Mr. Brown testified that Sysco San Diego did just that, having borrowed extensively from Sysco to meet capital needs associated with establishing company operations, thereby placing the company in a net borrowing position. Later, Sysco San Diego achieved profitability, which led it to be in a net lending position. These facts, however, do not indicate that Sysco intended to or did repay the outstanding balances received from the operating companies.
Sysco made payments to the operating companies on the purported loans only on an as-needed basis by funding the companies' disbursement accounts for the purpose of paying daily operating expenses or by funding approved CIPs. Mr. Elmer confirmed this fact when he responded to the question “[d]oes Sysco Corporation intend to repay the operating companies in any other way besides funding of disbursements?” by answering “I would say no.” Transcript Volume I, pp. 64-65. Further, a substantial portion of sums advanced to Sysco, which Sysco claimed to have intended to repay, was used to pay dividends to shareholders. More specifically, during the tax years at issue, not one of the operating companies paid a dividend to Sysco, but Sysco paid dividends to its shareholders as follows:
1996: $ 87,721,000 1999: $126,691,000
1997: $ 99,574,000 2000: $145,418,000
1998: $ 110,928,000 2001: $173,701,000
Moreover, Mr. Elmer testified that “the cash-management system functions as the conduit through which the cash flow from the operating subsidiaries is concentrated into Sysco  so that it can be used for general corporate purposes such as making acquisitions of new companies ...” Transcript Volume II, p. 20.
Given the structure of the cash-management system, any profitable operating company that did not seek funds from Sysco for capital expansion such that it would revert to a net borrowing position would perpetually be in a net lending position relative to Sysco. In fact, Mr. Elmer, who equated a lending operating company with a “profitable business,” testified that “Sysco expects all of its operating subsidiaries to be profitable companies in the long run and so certainly once a company has become profitable and is able to generate a positive cash flow, the expectation is that the positive cash flow will continue forever and ever and ever ...” Transcript, Volume II, pp. 13-14. Under these circumstances, which Mr. Elmer characterized as not only desirable but expected, operating companies could not expect return of advanced funds that exceeded disbursements (“excess cash advances”) which had been swept up to Sysco through operation of the cash-management system. Indeed, sums purportedly due from Sysco to the operating companies were never fully repaid during the tax years at issue. To the contrary, not only was Sysco in a net borrowing position relative to the operating companies during these years, its stated obligations to the companies grew significantly. At the end of tax year 1996, Sysco's net borrowing position was slightly in excess of $700,000,000 and by the end of tax year 2001, it had exceeded $1,800,000,000. Further, not a single operating company requested or received a return of excess cash advances from Sysco.
As previously noted, Sysco's entire income stream was derived from the operating companies, which according to Sysco contributed their receipts to the cash-management system in the form of loans. Sysco thus paid its dividends and made use of funds for general corporate purposes from the purported loans received from the operating companies. These payments depleted the income pool available for repayment of the loans. The sole source of repayment was excess cash advances from the operating companies, which were accounted for as loans to Sysco. These facts substantially undermine Sysco's assertion that it intended to repay its outstanding debts to the operating companies.
Sysco's Expert Testimony
Ms. Jill Weise
Ms. Weise, whom the Board qualified as an expert in transfer pricing, testified that she examined the interest rates utilized in Sysco's cash-management system and found them to be arm's length. To arrive at this conclusion, Ms. Weise applied standards articulated under Internal Revenue Code (“I.R.C.”) § 482 and the associated regulations. In particular, with respect to the interest rate charged on sums outstanding from the operating companies to Sysco, Ms. Weise considered Sysco's AA-bond rating and prevailing market rates and derived upper and lower bounds for Sysco's interest rate. In this manner, she determined that prime minus one percent was an appropriate rate to pay the operating companies. For sums owing to Sysco, Ms. Weise assumed that each operating company was at least “investment grade” and concluded that the prime rate represented an arm's-length interest rate. Ms. Weise did not, however, provide a foundation for her assumption that each of the operating companies was investment grade. Nor did she examine or take into account the creditworthiness of the individual operating companies, which Mr. Elmer had explicitly testified would result in varying credit ratings and associated costs of credit.
In her expert report, Ms. Weise also likened Sysco's cash-management system to a bank, stating that the activities associated with the cash-management system “are the very definition of a bank.” Weise Expert Report, p. 13. However, Ms. Weise failed to note that a bank, unlike Sysco, is legally bound to return deposits as well as accumulated interest to its customers, and absent anomalous circumstances, does so. Consequently, the Board did not credit this portion of Ms. Weise's opinion.
Finally, Ms. Weise concluded that the intercompany transactions resulted in creation of bona-fide debt. Noting that she “believ[ed] the existence of comparable third party cash management services is ample evidence to support Sysco's treatment of its cash management system as bona fide indebtedness,” Ms. Weise focused her analysis in large measure on factors cited in Roth Steel Tube Company v. Commissioner of Internal Revenue, 800 F.2d, 625 (6 th Cir. 1986) relating to a multi-factor debt/equity analysis. Weise Expert Report, p. 16. 5 These factors had been cited by DOR Audit Manager Michael Johnson in a determination letter to Sysco dated February 14, 2004, relating to the tax years 1996 through 1998, which preceded the issuance of the NIA for those years. The Board found that in her analysis and ultimate opinion, Ms. Weise failed to address sufficiently whether Sysco intended to and in fact did return excess cash advances to the operating companies. Thus, the Board was not persuaded by Ms. Weise's observations that the intercompany transactions at issue resulted in the creation of bona-fide debt.
Dr. Brian J. Cody
The Board qualified Dr. Cody as an expert in the field of economics. Dr. Cody addressed the question of whether, from an economic perspective, advances made by the operating companies to Sysco and from Sysco to the operating companies during the tax years at issue should be characterized as debt or equity. Like Ms. Weise, Dr. Cody's analysis focused largely upon the factors articulated in Roth Steel Tube Company, and based on his analysis, Dr. Cody concluded that the intercompany advances between Sysco and the operating companies within the context of the cash-management system were properly characterized “from an economic point of view” as debt. Also like Ms. Weise, however, Dr. Cody's analysis failed to address sufficiently whether Sysco intended to and in fact did return excess cash advances to the operating companies.
Finally, Dr. Cody made his own comparison between Sysco's cash-management system and a bank, likening excess cash advances to an overdraft on a personal account, which is not secured. Similar to Ms. Weise, Dr. Cody ignored that repayment of outstanding sums relating to bank overdrafts and credit lines is compelled by depository agreements and law. On the basis of the referenced flaws in Dr. Cody's analysis, the Board afforded little weight to his testimony.
Professor Richard Pomp
Professor Pomp, whom the Board qualified as an expert in the field of tax policy, gave his opinion regarding the intercompany transactions at issue “from a tax policy perspective.” Acknowledging that “every tax system .... needs to guard against situations in which a taxpayer may try to disguise a nondeductible expenditure as a business deduction for interest,” such as a corporation's attempt to disguise “an otherwise nondeductible dividend as a deductible payment of interest,” Professor Pomp opined that there was no such attempt evident in the present appeals. Pomp Expert Opinion, p.3. Professor Pomp also stated that “[o]ne overriding rule is that for interest to be deductible there must be 'indebtedness,' that is, an unconditional and legally enforceable obligation for the payment of money.” Id. at p.4.
As did Ms. Weise and Dr. Cody, Professor Pomp spent a considerable portion of his analysis applying the factors employed in Roth Steel Tube Company. At the conclusion of his analysis, Professor Pomp stated that the parties intended to create debt, and that the cash-management system had a business purpose and economic substance and was not implemented for tax-minimization purposes.
Regardless of the presence or absence of business purpose and economic substance and the absence of tax motivation, in his analysis, Professor Pomp failed to demonstrate the existence of “an unconditional and legally enforceable obligation for the payment of money” in the context of Sysco's cash-management system. As previously noted, Professor Pomp characterized this obligation as fundamental to whether interest is deductible. Further, Professor Pomp failed to address relevant facts indicating that excess cash advances were not intended to be returned to the operating companies. For these reasons, the Board did not credit Professor Pomp's opinion as it related to the nature of the intercompany transactions within the cash-management system.
The Commissioner's Expert Testimony
Robert W. Alltop
The Board qualified Mr. Alltop as an expert in transfer pricing. Mr. Alltop's testimony centered upon Ms. Weise's opinion and report. In particular, Mr. Alltop stated that he disagreed with Ms. Weise's decision not to examine the creditworthiness of the operating companies when deciding on an appropriate interest rate to be paid by the companies because in an arm's-length transaction, creditworthiness of the borrowing entity would be reflected in the interest rate. Mr. Alltop also indicated that for Ms. Weise's analysis regarding the nature of the intercompany transactions to be complete, he would have expected a focus on facts which demonstrated a reasonable expectation of repayment on the part of the operating companies, a focus which was not present either in Ms. Weise's testimony or her report. Finally, having noted that legal decisions shape what is done by economists, Mr. Alltop questioned why Ms. Weise failed to draw a distinction between the facts in the present case and those considered in New York Times Sales, Inc. v. Commissioner of Revenue, 40 Mass. App. Ct. 749, 753 (1996) , in which the Massachusetts Appeals Court found that intercompany transfers effected within the context of a cash-management system did not constitute indebtedness. Summary
On the basis of the evidence presented and reasonable inferences drawn therefrom, the Board found that intercompany transfers associated with Sysco's cash-management system during the tax years at issue did not give rise to bona-fide debt. The Board's finding was based on an examination of the specific facts and circumstances of these appeals, with particular focus on various facts which inexorably led to the inference that the structure and operation of Sysco's cash-management system indicated Sysco did not intend, nor did the operating companies expect, repayment of the excess cash advances, which therefore were permanent in nature. These facts included, but were not limited to: the absence of a legal obligation to repay advanced funds; Sysco's expectation that the operating companies would be profitable and therefore, yield a perpetual stream of excess cash advances; the substantial increase in Sysco's stated liability to the operating companies during the tax years at issue; Sysco's failure to repay excess cash advances in full; Sysco's payment of dividends to shareholders from advances made by the operating companies and its use of the advances for its general corporate purposes; the lack of instruments evidencing debt; the absence of limits on the amounts upstreamed to Sysco from the operating companies; the absence of repayment schedules or fixed dates of maturity; the lack of security, default or collateral provisions associated with the purported debt; and the operating companies' failure to request repayment of excess cash advances made to Sysco.
Accordingly, and for the reasons discussed in the following Opinion, the Board decided these appeals for the appellee.
Pursuant to G.L. c. 63, § 30(4) , a corporation's net income generally consists of gross income less the deductions, but not credits, allowed under the I.R.C. Pursuant to I.R.C. § 163(a) , a corporation may deduct “all interest paid or accrued within the taxable year on indebtedness.” Sysco argued that for each of the tax years at issue, intercompany transactions associated with its cash-management system gave rise to bona-fide debt and consequent interest expenses for Sysco and interest income for its subsidiaries. The Commissioner responded that the facts and circumstances of the appeals, taken as a whole, indicated that the transactions did not constitute true indebtedness. The Board agreed with the Commissioner.
For a transaction to give rise to a valid interest deduction, the transaction must constitute true indebtedness. Knetsch v. United States, 364 U.S. 361, 364-65 (1960) . True indebtedness requires, at the time funds are transferred, both “'an unconditional obligation on the part of the transferee to repay the money, and an unconditional intention on the part of the transferor to secure repayment.'” Schering-Plough Corporation v. United States, 651 F.Supp. 2d 219, 244 (D.N.J. 2009) (quoting Geftman v. Commissioner of Internal Revenue, 154 F.3d 61, 68 (3 rd Cir. 1998) ).
“Related but separate corporations can freely enter into contracts including debt transactions, like any corporations or individuals.” Overnite Transportation Company v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 1999-353, 370, aff'd, 54 Mass. App. Ct. 180 (2002) (citing Bordo Products Co. v. United States, 476 F.2d 1312, 1323 (Ct. Cl. 1973) ). However, courts examine these transactions with greater scrutiny because the transactions “do not result from arm's length bargaining.” Overnite Transportation Company, Mass. ATB Findings of Fact and Reports at 1999-370 (citing Kraft Foods Co. v. Commissioner, 232 F.2d 118, 123-24 (2 nd Cir. 1956) ); see also, Overnite Transportation Company, 54 Mass. App. Ct. at 186 (“When 'the same persons occupy both sides of the bargaining table, form does not necessarily correspond to the intrinsic economic nature of the transaction, for the parties may mold it at their will with no countervailing pull'”) (quoting Fin Hay Realty Co v. United States, 398 F.2d 694, 697 (3d Cir. 1968) ). Furthermore, “the method by which two related businesses account for cash transfers on their internal financial records is not deemed to be a controlling factor in determining the nature of the transaction” as such records are a product of the parties and therefore “do not necessarily constitute a reliable reflection of the true nature of the transaction.” New York Times Sales, Inc. v. Commissioner of Revenue, 40 Mass. App. Ct. at 753 (citing Alterman Foods, Inc. v. United States, 505 F.2d 873, 878 (5 th Cir. 1974) (“Alterman I”) ; J.A. Tobin Const. Co. v. Commissioner of Internal Revenue, 85 T.C. 1005, 1022 (1985) ).
“Although the issue of whether transfers between a subsidiary and its parent constitute debt has been extensively litigated, courts have not established a bright-line rule for making such a determination but have instead employed a case-by-case analysis based on the specific facts and circumstances of a particular case.” The TJX Companies, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2007-790, 881, aff'd in part, remanded in part on other grounds, Mass. App. Ct., No. 07-P-1570, Memorandum and Order under Rule 1:28 (April 3, 2009), aff'd, Mass. App. Ct., No. 09-P-1841, Memorandum and Order under Rule 1:28 (July 23, 2010) . Consequently, “[t]he Board must review the facts and circumstances surrounding a purported inter-company loan to determine whether a true debt obligation exists.” Id. at 882.
Within the context of this review, “[i]t is well settled that a distribution by a subsidiary corporation to its parent is a loan and not a dividend if, at the time of its payment, the parties intended it to be repaid. Whether the parties actually intended the transaction to be a loan or dividend is an issue of fact. 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.”
Kimberly-Clark Corporation & Kimberly-Clark Global Sales, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2011-1, 43 (quoting New York Times Sales, 40 Mass. App. Ct. at 752 ). (internal citations omitted).
In New York Times Sales, the Massachusetts Appeals Court upheld the Board's decision that sums transferred from a subsidiary to its parent in the context of a cash-management system were not loans but dividends. The Board had determined that the parties did not intend the transactions to be loans in light of several factors which had previously been set forth in Alterman I, and Alterman Foods, Inc. v. U.S., 611 F.2d 866 (Ct. Cl. 1979) (“Alterman II”) . See The New York Times Sales, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 1995-137, aff'd., 40 Mass. App. Ct. 749 (1996) . On appeal, the Appeals Court endorsed the Board's reasoning relating to:
several factors [which] demonstrated that the parties intended that the cash transactions be dividends and not loans. They included (1) the amounts transferred were not limited in any manner; (2) there was no repayment schedule and no fixed dates of maturity; (3) the amounts 'upstreamed' to Times Company were intended to remain with the Times Company for use in fulfilling its various corporate purposes; (4) no interest was charged; (5) no notes or other evidences of indebtedness existed; (6) the transferred cash was not secured in any manner; (7) at no time did Times Sales request repayment; (8) there was no evidence that Times Sales had any expectations of repayment; and (9) at no time did Times Company make any effort to repay the amounts transferred to it by Times Sales.
New York Times Sales, 40 Mass. App. Ct. at 752 .
In the present appeals, the facts of the case and the factors cited by the Appeals Court in New York Times Sales weigh heavily against Sysco. In New York Times Sales, the Times Company and its subsidiaries, like Sysco, maintained a cash-management system designed to foster certain efficiencies within a corporate group. Like the operating companies in these appeals, the relevant subsidiary in New York Times Sales participated in the cash-management system and its receipts were upstreamed on a daily basis to Times Company's concentration account. As did Sysco, Times Company paid its subsidiaries' expenses from funds that had been advanced to Times Company by the subsidiaries and which were subsequently deposited in the subsidiaries' disbursement accounts. Finally, Sysco, like Times Company, retained excess cash advances and used the advances for general corporate purposes. Against this backdrop, the Appeals Court considered the factors cited above, each of which the Board addressed as follows.
(1) The operating companies deposited all their revenue into their depository account, from which the deposits were swept up to Sysco's concentration accounts on a daily basis. Thus the Board found that “the amounts transferred were not limited in any manner.” New York Times Sales, 40 Mass. App. Ct. at 752 . Curiously, Sysco argues that the transfers were “limited” by the amount of the operating companies' revenue. Not only is this argument counter-intuitive, but in New York Times Sales, as in the present appeals, the Appeals Court reviewed a cash-management system like Sysco's in which the only limit on the amounts advanced to the parent corporation was dictated by the ability of the subsidiaries to generate revenue. If such a “limit” were dispositive, the Appeals Court would have overturned the Board's prior determination that cash transfers limited only by the financial success of a subsidiary are, in fact, unlimited. See The New York Times Sales, Inc., Mass. ATB Findings of Fact and Reports at 1995-148 .
(2) In the present appeals, there were no repayment schedules or fixed dates of maturity in the day-to-day operation of the cash-management system.
(3) The Board's conclusion that the structure and operation of Sysco's cash-management system indicated that excess cash advances were not intended to be returned to the operating companies and thus were permanent in nature equates to a finding that “the amounts upstreamed to [Sysco] were intended to remain with [Sysco] for use in fulfilling its various corporate purposes.” New York Times Sales, 40 Mass. App. Ct. at 752 .
Regardless, Sysco asserted that repayment was intended, and in fact occurred through daily disbursements and acceptance of requests for capital CIPs. As a threshold matter, the Board, embracing the holdings in Alterman I and Alterman II, has rejected the notion that “a parent's payment of its subsidiary's expenses constituted a repayment of the cash transferred to it.” The New York Times Sales, Inc., Mass. ATB Findings of Fact and Reports at 1995-149 .
Further, according to Sysco, full repayment of outstanding sums was evident in those instances in which an operating company went from being a net lender to net borrower of funds from Sysco. Notwithstanding Sysco's assertions, the Board found that repayment of purported loans was not intended and did not occur.
All revenue received by the operating companies was swept up to Sysco on a daily basis. Having issued disbursements to the companies only to satisfy their operating and intermittent capital needs, excess balances remained with Sysco indefinitely. Within the structure of the cash-management system, a profitable operating company that did not receive funds for capital expansion such that it would revert to a net borrowing position remained indefinitely in a net lending position. Mr. Elmer, who equated a lending operating company with a “profitable business,” explicitly confirmed Sysco's expectation that all of the operating companies would be profitable, and that a profitable entity would generate positive cash flow into the indefinite future. Further, Sysco was in a growing net borrowing position relative to the operating companies during the tax years at issue and used excess cash advances received from the operating companies to pay shareholder dividends and for general corporate purposes. These facts, taken together, amply support the Board's finding that Sysco did not intend to return excess cash advances to the operating companies.
(4) Unlike the taxpayer in New York Times Sales, Sysco made daily calculations of interest and accounting entries for interest accrued on intercompany accounts. However, as noted, supra, Sysco's transfer-pricing expert, Ms. Weise, failed to establish that the interest rate charged by Sysco to operating companies that were in a net borrowing position was arm's length. More importantly though, interest accounting entries were just that, and amounts credited to operating companies as interest were immediately swept up to Sysco forming part of a rapidly growing net liability from Sysco to the companies during the tax years at issue. As previously noted, the Board found that the operating companies could not expect or require repayment of this liability, therefore, in practice, interest was not “paid” as it would be in a third-party lending transaction.
(5) There were no promissory notes or formal agreements of any type evidencing the purported debt in these appeals. Sysco contended that the FAMM provided substantial evidence that a debtor/creditor relationship had been established, but the Board found this argument unpersuasive. The FAMM was an internal manual, which provided guidelines relating to operation of the cash-management system. It did not, however, evidence a legal obligation to repay sums it stated were borrowed from or lent to the operating companies. In particular, the FAMM did not provide for execution of agreements relating to the purported debt. Nor did the FAMM provide for amortization schedules, default or collateral provisions, or any type of security mechanism to ensure timely repayment. Finally, although the FAMM referred to the various intercompany transactions and balances relating to the cash-management system as reflecting “borrowing” and “lending” between Sysco and the operating companies, the FAMM's instructions and the resultant internal accounting entries are not controlling in the context of intercompany transactions. New York Times Sales, 40 Mass. App. Ct. at 753 .
(6) During the hearing of these appeals, Sysco's executives acknowledged that the purported loans were not secured in any manner. Sysco, however, asserted that this factor is immaterial. For example, Dr. Cody compared the flow of excess cash advances to Sysco with an over-drafted bank account, noting that when an account holder withdraws funds in excess of the value of his personal bank account, the bank has made an unsecured loan to its customer. Dr. Cody (as did Ms. Weise) ignored, however, that repayment of outstanding sums relating to bank deposits or overdrafts is compelled by depository agreements and law. Moreover, repayment of third-party unsecured debt taken on by Sysco would be similarly compelled. There is no such compulsion attendant to the advances made by the operating companies to Sysco. Thus, security in the present matters takes on importance it does not have in the context of certain third-party lending transactions.
(7-9) Two of the last three New York Times Sales factors relate to the operating companies' requests for and expectation of repayment and the final factor is whether Sysco, as the parent corporation, made any effort toward repayment. The record reflects that at no time did the operating companies request repayment of excess cash advances from Sysco. With regard to the operating companies' expectation of repayment, the facts that indicate that Sysco did not intend to repay excess advances to the operating companies, which are discussed in detail above, compel the conclusion that the companies had no expectation of repayment. These facts indicate as well that Sysco made no systematic effort toward repayment of the excess cash advances.
In sum, consideration of the various factors articulated in New York Times Sales, with particular focus on those indicating that repayment of excess cash advances to Sysco was neither intended nor expected, was central to the Board's finding that the advances did not constitute bona-fide debt.
Although not a factor considered in New York Times Sales or any other case cited by Sysco, Sysco placed great emphasis on the business purpose underlying formation and operation of its cash-management system, as well as the absence of a tax motive, arguing that these factors are “crucial” to a determination of whether the intercompany transactions at issue in these appeals qualify as bona-fide debt. The Board does not agree that business purpose and absence of tax avoidance substantially support an assertion that intercompany transfers constitute debt. In fact, in New York Times Sales, the court explicitly described the business purpose underlying the operation of the taxpayer's cash-management system, stating that its “primary purpose .... was to increase the efficient use of available cash from all of the members of the Times Company group. One significant benefit of the system was that it reduced Times Company's banking fees by consolidating banking arrangements and eliminating individual bank loans for working capital, thereby reducing interest expenses.” New York Times Sales, 40 Mass. App. Ct. at 752 . Moreover, there was no assertion of tax avoidance as a motive for implementation of Times Company's cash-management system. Consequently, the Board found Sysco's arguments relating to the import of business purpose and absence of a tax avoidance motive unpersuasive.
Finally, in its post-hearing brief, Sysco argued that if the Board were to determine that the intercompany advances at issue did not qualify as loans, the Commissioner's proposed adjustments would be in violation of the Commerce Clause and the Due Process Clause of the United States Constitution. Sysco correctly noted that a state cannot tax extraterritorial values. See, e.g. Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768 (1992) . However, “[i]t remains the case that 'in order to exclude certain income from the apportionment formula, the company must prove that “'the income was earned in the course of activities unrelated to [those carried out in the taxing] State.'”'” Allied-Signal, Inc., 504 U.S. at 787 (quoting Exxon Corp. v. Department of Revenue of Wis., 447 U.S. 207, 223 (1980) (quoting Mobil Oil Corp. v. Commissioner of Taxes of Vt., 445 U.S. 425, 439 (1980) ); see also Gillette Co. v. Commissioner of Revenue, 425 Mass. 670, 680 (1997) (quoting Container Corporation of America v. Franchise Tax Board., 463 U.S. 159, 164 (1983) ) (holding that “the taxpayer has the 'distinct burden of showing by “clear and cogent evidence” that [the State tax] results in extraterritorial values being taxed.'”).
In the current appeals, Sysco offered only its unsubstantiated argument that the Commissioner's adjustments would result in constitutionally impermissible taxation. During the hearing of these appeals, Sysco did not support this argument with substantive evidence or analysis establishing that the adjustments resulted in taxation of extraterritorial values. Thus, the Board found that Sysco's contentions regarding the constitutionality of the Commissioner's adjustments were unavailing.
Having considered the specific facts and circumstances of Sysco's cash-management system, and mindful that related entities can enter into debt transactions, the Board found and ruled that the intercompany transfers at issue in these appeals did not give rise to bona-fide debt. The Board reached its determination with particular focus on facts indicating that the excess cash advances made within Sysco's cash-management system were not intended or expected to be repaid. Accordingly, the Board decided these appeals for the appellee.
THE APPELLATE TAX BOARD
Thomas W. Hammond, Jr., Chairman
A true copy,
Clerk of the Board
Pursuant to G.L. c. 63 § 30 , Sysco's fiscal years were deemed ended on June 30 th of each of the tax years at issue.
Mr. Elmer stated that he was employed by Sysco Services, LP, a limited partnership that “leased professional services” to Sysco. Although not employed directly by Sysco, Mr. Elmer was responsible for all of Sysco's financial reporting, corporate credit management and tax compliance functions.
Included in the returns were The Sygma Network, Inc. and The Sygma Network of Ohio, Inc., the only two of Sysco's wholly owned subsidiaries that had taxable nexus with the Commonwealth.
Although Sysco did not establish that the portion of the FAMM introduced into evidence was identical to the FAMM employed during the tax years at issue, there was no indication that it had been altered in a manner that would affect the outcome of these appeals.
The Court in Roth Steel Tube Company identified and applied the following factors “to be used in making the capital contribution versus loan determination: (1) the names given to the instruments, if any, evidencing the indebtedness; (2) the presence or absence of a fixed maturity date and schedule of payments; (3) the presence or absence of a fixed rate of interest and interest payments; (4) the source of repayments; (5) the adequacy or inadequacy of capitalization; (6) the identity of interest between the creditor and the stockholder; (7) the security, if any, for the advances; (8) the corporation's ability to obtain financing from outside lending institutions; (9) the extent to which the advances were subordinated to the claims of outside creditors; (10) the extent to which the advances were used to acquire capital assets; and (11) the presence or absence of a sinking fund to provide repayments.” Roth Steel Tube Company, 800 F.2d, at 630 .