For years, companies have been using a Delaware Holding Company (DHC) structure to mitigate state income taxes. After years of wrestling with possible solutions, Pennsylvania introduced the Pennsylvania Tax Reform Code Bill (House Bill 465) as part of the recent state budget to include a corporate tax expense addback provision to close the so-called “Delaware Loophole.” Given this change, what are the options companies with a DHC should consider?
New Reform Rules and Exceptions
The new legislation includes a corporate tax expense addback provision requiring addbacks of intangible expenses (patents, royalties, trademarks, etc.) between related parties unless the purpose of the transaction is not tax avoidance and the transactions were made at arm’s-length. The bill includes a provision requiring the addback of interest expense between related parties if the expense is related to the licensing of intangibles. These changes become effective as of 1/1/2014.
There are some exceptions to the addback. For example, the addback is not required if the transaction is “made at arm’s length,” and it has a valid business purpose other than tax avoidance. The addbacks are also excepted if:
- The expense is ultimately paid to a non-affiliated entity;
- The DHC or the royalty income is subject to tax in another jurisdiction; or
- If the DHC is domiciled in a jurisdiction that has a comprehensive tax treaty with the U.S. (subject to certain provisions).
Is the DHC still viable in PA?
While most taxpayers will have done a cost/benefit analysis of this long-standing state tax planning strategy and many have ultimately “unwound” the structure, there is still some merit to considering how to use the structure to mitigate state tax liabilities:
- Would your current structure establish a valid business purpose other than tax ‘mitigation’? Review all formation documents, agreements and contracts, and performance of duties by DHC personnel.
- Do you have a current royalty study and/or performed a Section 482 type analysis of the transactions?
Next Steps and Planning Ideas for Companies with a DHC
- “Activate” the DHC in other jurisdictions (requiring a review of all activities and jurisdictions and a cost/benefit analysis). Take advantage of apportionment formulas and lower tax rates in many jurisdictions.
- Consider geographic expansion of DHC operations to establish a multiform business unit.
- Re-purpose the DHC into a management and intangible asset protection company.
- Split the intangible licensing and finance activities of the DHC. Segregate the operations, people, and assets into multiple entities so that each can fulfill its own purpose/function and be respected for tax purposes.
- Consider forming a Delaware Headquarters Management Corporation (HMC’s) as an alternative to the DHC. An HMC is exempt from taxation under Chapter 19 of Title 30 of the Delaware Code but will be subject to an alternative tax calculation under the new Chapter 64.
To “enjoy” a robust discussion of the changes in Pennsylvania or of the above ideas, contact your RKL tax services provider. For timely updates and insights on the tax code, accounting and business issues, sign up for RKL Alerts or follow us on Twitter, LinkedIn and Facebook.
Contributed by Frank J. Tobias, CGFM, (firstname.lastname@example.org) a principal in RKL’s Tax Services Group. He specializes in the area of multi-state planning and compliance with extensive experience in all areas of Pennsylvania taxation. Frank brings a well-rounded perspective on state and local tax issues with his experience in both public accounting and his previous professional experience overseeing the administration of PA Corporation taxes for the PA Department of Revenue.