103 KAR 16:230. Intangible expenses, intangible interest expenses, and management fees.

      RELATES TO: KRS 131.130, 141.205

      STATUTORY AUTHORITY: KRS 131.130(1)

      NECESSITY, FUNCTION AND CONFORMITY: KRS 131.130(1) authorizes the Department of Revenue to promulgate administrative regulations necessary to administer and enforce Kentucky's tax laws. KRS 141.205 disallows intangible expenses, intangible interest expenses and management fees when those expenses and fees are directly or indirectly paid, accrued or incurred to, or in connection directly or indirectly with one or more direct or indirect transactions with one or more related member of an affiliated group or with a foreign corporation, unless certain criteria are met. This administrative regulation establishes the requirements for when these expenses and fees are allowed or disallowed.

      Section 1. Definitions. (1) "Actual comparables" means transactions between the recipient and unrelated parties involving the same intangible property to the subject transaction.

      (2) "Comprehensive income tax treaty" means a convention, or agreement, entered into by the United States and approved by Congress, with a foreign government for the allocation of all categories of income subject to taxation or the withholding of tax on interest, dividends, and royalties, for the prevention of double taxation of the respective nations’ residents, and the sharing of information.

      (3) "Measured by, in whole or in part, net income" means that the receipt of the payment by the recipient is reported and included in income for purposes of a tax on net income or in the franchise for purposes of the franchise tax.

      (4) "Reported and included in income for purposes of a tax on net income or in the franchise," means:

      (a) For a tax on net income, reported and included in the net income apportioned or allocated to the taxing jurisdiction; or

      (b) For a franchise tax, reported and included in the franchise apportioned or allocated to the taxing jurisdiction.

      (5) "Subject transaction" means the transaction giving rise to the intangible expense, intangible interest expense or management fee.

      Section 2. Disclosure; General. As part of the required disclosure, the corporation shall provide a description of the nature of the payment made to the recipient. This description shall contain:

      (1) For intangible expenses or intangible interest expenses:

      (a) A narrative regarding the subject transaction;

      (b) The extent of the rights being transferred (for example, if a patent is being licensed, whether that license is exclusive or nonexclusive, and whether the transferee has any rights to sublicense);

      (c) How the amount of the payment is calculated; and

      (d) If there is a document that sets forth the terms of the subject transaction, a copy of that document; and

      (2) For management fees:

      (a) A narrative of the services being performed for the corporation by the recipient;

      (b) How the amount of the payment is calculated; and

      (c) If there is a document that sets forth the terms of the transaction, a copy of that document.

      Section 3. Disclosure; Arm’s Length Transaction. A corporation may be required to establish that the subject transaction was made at a commercially reasonable rate and at terms comparable to an arm’s length transaction.

      (1) If there are actual comparables, the actual comparables shall be used.

      (2) If there are no actual comparables, the two (2) primary factors to take into account when determining whether the subject transaction was made at a commercially reasonable rate and at terms comparable to an arm’s length transaction shall be:

      (a) The degree of comparability between the subject transaction and the proposed comparable transactions; and

      (b) The quality of the data and assumptions used in the analysis.

      Section 4. Disclosure; Intangible Expense and Intangible Interest Expense. With respect to intangible expense and intangible interest expense, the corporation shall make additional disclosures if it cannot utilize any of the other methods to establish that it is entitled to the deduction. The corporation shall show that the payment made to the recipient reported and included in income for purposes of a tax on net income or franchise was subject to, its state of commercial domicile, a net income tax, or a franchise tax, measured by, in whole or in part, net income. If the recipient is a foreign corporation, the foreign nation shall have in force a comprehensive income tax treaty with the United States. (32 Ky.R. 1823; 2289; 33 Ky.R. 66; eff. 8-7-2006.)