The Arkansas Supreme Court held that a taxpayer’s interest expense is allocable to Arkansas resulting in a refund. This decision is an example of a taxpayer successfully arguing that it can fully deduct – rather than apportion – its interest expense in its state of commercial domicile.
Arkansas adopted the Uniform Division of Income for Tax Purposes Act (UDITPA). Pursuant to UDITPA, income and expenses are apportioned if they are, or are related to, business income. If, however, the income or expense constitutes, or relates to, nonbusiness income, the item is allocated to the taxpayer’s state of domicile.
The taxpayer, domiciled in Arkansas, was spun off from its parent company. As part of the spinoff transaction, the taxpayer incurred debt that was ultimately paid to its former parent company. On its originally filed Arkansas tax return, the interest expense related to this debt was deducted against its apportionable income. The taxpayer amended its Arkansas return to allocate (rather than apportion) the interest expense which resulted in a refund. The Arkansas Department of Finance and Administration (DFA) rejected the refund claim on the basis that the interest expense is properly classified as an apportionable expense.
The Supreme Court agreed with the taxpayer that the expense is properly allocable to Arkansas because the spinoff was an extraordinary, nonrecurring event. The court distinguished the spinoff debt from the taxpayer’s other borrowing. Interestingly, the court also rejected the DFA’s fairness argument – that it would be unfair to allow the taxpayer to allocate the deduction to Arkansas because the taxpayer apportioned the interest deduction on other states’ tax returns. The court concluded that “[i]t is not the role of this court to adjust Arkansas tax returns based on unfairness to Tennessee, Mississippi, or other states.”