• Management Fees Paid to Affiliated Companies May Trigger Business Tax Liability
  • March 31, 2006 | Authors: Brett R. Carter; J. Leigh Griffith; Michael Stewart; Charles A. Trost; G. Michael Yopp
  • Law Firm: Waller Lansden Dortch & Davis, LLP - Nashville Office
  • Tennessee taxpayers receiving management fees from affiliated companies should be aware that the Tennessee Department of Revenue (the Department) takes the position that markups paid by an affiliated company for management services are subject to the state's business tax. This position was adopted by the Department following a 2004 tax law clarification exempting affiliated company management services from the business tax, provided that "no markup whatsoever" is charged on these services. The exemption applies to taxable services rendered by a management company in Tennessee for an affiliate, if the services are accounted for as allocations of cost between the entities. If an affiliate is charged a management fee that exceeds the cost of such services, the excess becomes taxable to the management company if the management company is doing business in Tennessee.

    The Department's original position on this issue was that the business tax applied to the full amount charged by the affiliated management company, including any markup. However, in response to complaints from various industry representatives on this issue, the Department subsequently modified this position, applying the business tax only to the markup (i.e., the amount charged for the taxable service that exceeds the cost of such service).

    The Department has and continues to encourage taxpayers who have not been paying the business tax on management services provided to an affiliate to enter into voluntary disclosure agreements with the Department to pay business tax for the previous three years. The Department has been working closely with taxpayers over the past year to see that these business tax liabilities are paid.

    Taxpayers should consider reviewing fees received from affiliated companies for management services provided in Tennessee to determine whether any markup is paid and whether any business tax is owed. The Department's position is that a taxpayer entering into a voluntary disclosure agreement will only be liable for the business tax, plus interest, on the markup going back three years. If, however, this issue is brought up on audit by the Department, the Department will look back six years. In these cases the Department will apply the tax to the whole management fee, including the markup, for periods prior to 2003 and only to the markup for subsequent tax periods. Accordingly, there is a significant incentive for taxpayers to enter into voluntary disclosure agreements to avoid a potential tax liability for business tax, which would likely include substantial penalties and interest.