Iowa Administrative Code › Agency 701 - Revenue Department › Title I - Administration › Chapter 54 - Allocation and Apportionment › Rule 701-54.3 - Application of Related Expense to Allocable Interest, Dividends, Rents and Royalties-tax Periods Beginning on or After January 1, 1978

Current through Register Vol. 47, No. 3, July 24, 2024
Rule 54.2(422) deals with the separation of "net" income;
				  therefore, determination and application of related expenses must be made, as
				  hereinafter directed, before allocation and apportionment within and without
				  Iowa. Related expenses shall mean those expenses directly related, including
				  related federal income taxes.
Allphin v. Joseph E. Seagram &
				  Sons,
204 S.W. 2d 515 (Ky. 1956). For tax periods beginning on or
				  after January 1, 2000, related expense includes both directly related expense
				  and indirectly related interest expense. The portion of interest expense
				  indirectly related to allocable interest, other than interest from securities
				  of states and their political subdivisions, dividends, rents and royalties
				  shall be determined by multiplying the net amount of interest expense, after
				  deducting interest directly related to an item of income, by a ratio. The
				  numerator of the ratio is the average value of investments which produce or are
				  held for the production of allocable interest, other than interest from
				  securities of states and their political subdivisions, dividends, rents and
				  royalties. The denominator is the average value of all assets of the taxpayer,
				  less securities of states and their political
				  subdivisions.
{Hunt-Wesson, Inc. v. Franchise Tax Board of
				  CaUfornia,
No. 98-2043 (U.S. Sup. Ct., filed February 22,
				  2000)).
A "directly related expense" shall mean an expense which can
				  be specifically attributed to an item of income. Interest expense shall be
				  considered directly related to a specific property which generates, has
				  generated, or could reasonably have been expected to generate gross income if
				  the existence of all of the facts and circumstances described below is
				  established. Such facts and circumstances are as follows:
(1) the indebtedness on which the interest
				was paid was specifically incurred for the purpose of purchasing, maintaining,
				or improving the specific property;
(2) the proceeds of the borrowing were
				actually applied to the specified purpose;
(3) the creditor can look only to the
				specific property (or any lease or other interest therein) as security for the
				loan;
(4) it may be reasonably
				assumed that the return on or from the property will be sufficient to fulfill
				the terms and conditions of the loan agreement with respect to the amount and
				timing of payment of principal and interest; and
(5) there are restrictions in the loan
				agreement on the disposal or use of the property consistent with the
				assumptions described in (3) and (4) above.
A deduction for interest may not be considered definitely
				  related solely to specific property, even though the above facts and
				  circumstances are present in form, if any of such facts and circumstances are
				  not present in substance. Any expense directly or indirectly attributable to
				  allocable interest, dividends, rents and royalties shall be deducted from such
				  income to arrive at net allocable income.
EXAMPLE (i): For purposes of this example, it is assumed that
				  the taxpayer has nonbusiness rental income. The taxpayer invests in a 20-story
				  office building. Under the terms of the lease agreements, the taxpayer provides
				  heat, electricity, janitorial services and maintenance. The taxpayer also pays
				  the property taxes. Construction of the building was funded through borrowings
				  which meet the criteria of a direct expense under the provisions of this
				  paragraph. The directly related expenses to the operation of the property
				  are:
Interest expense
$1,200,000
Property taxes
500,000
Depreciation
500,000
Electricity
300,000
Heat
200,000
Insurance
150,000
Janitorial services
100,000
Repairs
50,000
Total expense
$3,000,000
The directly related expense of the allocable nonbusiness
				  rental income is $3,000,000.
EXAMPLE (ii): For purposes of this example, it is assumed
				  that the taxpayer has nonbusiness income. The taxpayer is a muhistate
				  manufacturer of processed foods. It has a nonbusiness investment portfolio
				  which is managed by an investment firm for a fee. The fee paid for the
				  management of the portfolio is a directly related expense to the dividends and
				  interest income received. The fee is attributed to the various types of income
				  on the ratio that the various types of income bear to the total income
				  produced.
EXAMPLE (iii): Same as example (ii), except that in addition
				  to the investments described, the taxpayer also has investments in oil
				  properties. The depletion expense is a directly related expense to the oil
				  royalty income.
This rule is intended to implement Iowa Code section
				  422.33.