KRS 141.205 — Disallowance of certain deductions for affiliated entities or related parties

(1) As used in this section:
(a) "Intangible property" means franchises, patents, patent applications, trade
names, trademarks, service marks, copyrights, trade secret s, and similar types
of intangible assets;
(b) "Intangible expenses" includes the following only to the extent that the
amounts are allowed as deductions or costs in determining taxable net income
before the application of any net operating loss deduction provided under
Chapter 1 of the Internal Revenue Code:
1. Expenses, losses, and costs for, related to, or in connection directly or
indirectly with the direct or indirect acquisition, use, maintenance,
management, ownership, sale, exchange, or any other di sposition of
intangible property;
2. Losses related to, or incurred in connection directly or indirectly with,
factoring transactions or discounting transactions;
3. Royalty, patent, technical, and copyright fees;
4. Licensing fees; and
5. Other similar expenses and costs;
(c) "Intangible interest expense" means only those amounts which are directly or
indirectly allowed as deductions under Section 163 of the Internal Revenue
Code for purposes of determining taxable income under that code, to the
extent that the amounts are directly or indirectly for, related to, or connected
to the direct or indirect acquisition, use, maintenance, management,
ownership, sale, exchange, or any other disposition of intangible property;
(d) "Management fees" includes but is no t limited to expenses and costs paid for
services pertaining to accounts receivable and payable, employee benefit
plans, insurance, legal, payroll, data processing, purchasing, tax, financial and
securities, accounting, reporting and compliance services or similar services,
only to the extent that the amounts are allowed as a deduction or cost in
determining taxable net income before application of the net operating loss
deduction for the taxable year provided under Chapter 1 of the Internal
Revenue Code;
(e) "Affiliated group" has the same meaning as in KRS 141.201;
(f) "Foreign corporation" means a corporation that is organized under the laws of
a country other than the United States and that would be a related member if it
were a domestic corporation;
(g) "Related member" means a person that, with respect to the entity during all or
any portion of the taxable year, is:
1. A person or entity that has, directly or indirectly, at least fifty percent
(50%) of the equity ownership interest in the taxpayer, as d etermined
under Section 318 of the Internal Revenue Code;
2. A component member as defined in Section 1563(b) of the Internal
Revenue Code;
3. A person to or from whom there is attribution of stock ownership in
accordance with Section 1563(e) of the Internal Revenue Code; or
4. A person that, notwithstanding its form of organization, bears the same
relationship to the taxpayer as a person described in subparagraphs 1. to
3. of this paragraph;
(h) "Recipient" means a related member or foreign corporation to whom the item
of income that corresponds to the intangible interest expense, the intangible
expense, or the management fees, is paid;
(i) "Unrelated party" means a person that has no direct, indirect, beneficial or
constructive ownership interest in the recipient; and in which the recipient has
no direct, indirect, beneficial or constructive ownership interest;
(j) "Disclosure" means that the entity shall provide the following information to
the Department of Revenue with its tax return regarding a related party
transaction:
1. The name of the recipient;
2. The state or country of domicile of the recipient;
3. The amount paid to the recipient; and
4. A description of the nature of the payment made to the recipient;
(k) "Other related party transaction" means a transaction which:
1. Is undertaken by an entity which was not required to file a consolidated
return under KRS 141.201;
2. Is undertaken by an entity, directly or indirectly, with one (1) or more of
its stockholders, members, partners, or affiliated entities; and
3. Is not within the scope of subsections (2) and (3) of this section;
(l) "Related party costs" means intangible expense, intangible interest expense,
management fees and any costs or expenses associated with other related party
transactions; and
(m) "Entity" means any taxpayer other than a natural person.
(2) An entity subject to the tax imposed by this chapter shall not be allowed to deduct
an intangible expense, an intangible interest expense, or a management fee directly
or indirectly paid, accrued or incurred to, or in connection directly or indirectly with
one (1) or more direct or indirect transactions with one (1) or more related members
or with a foreign corporation as defined in subsection (1) of this section, or with an
entity that would be included in the affiliated group based upon ownership interest
if it were organized as a corporation.
(3) The disallowance of deductions provided by subsection (2) of this section shall not
apply if:
(a) The entity and the recipient are both include d in the same consolidated
Kentucky corporation income tax return for the relevant taxable year; or
(b) The entity makes a disclosure, and establishes by a preponderance of the
evidence that:
1. The payment made to the recipient was subject to, in its stat e or country
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; and
2. The recipient is engaged in substantial business activities separate and
apart from the acquisition, use, licensing, management, ownership, sale,
exchange, or any other disposition of intangible property, or in the
financing of related members, as evidenced by the maintenance of
permanent office space and full -time employees dedicated to the
maintenance and protection of intangible property; and
3. The transaction giving rise to the intangible interest expense, intangible
expense, or management f ees between the entity and the recipient was
made at a commercially reasonable rate and at terms comparable to an
arm's-length transaction; or
(c) The entity makes a disclosure, and establishes by preponderance of the
evidence that the recipient regularly engages in transactions with one (1) or
more unrelated parties on terms identical to that of the subject transaction; or
(d) The entity and the Department of Revenue agree in writing to the application
or use of an alternative method of apportionment under KRS 141.120.
(4) An entity subject to the tax imposed by this chapter may deduct expenses or costs
associated with an other related party transaction only in an amount equal to the
amount which would have resulted if the other related party transaction had been
carried out at arm's length. In any dispute between the department and the entity
with respect to the amount which would have resulted if the transaction had been
carried out at arm's length, the entity shall bear the burden of establishing the
amount by a preponderance of the evidence.
(5) Nothing in this section shall be deemed to prohibit an enti ty from deducting a
related party cost in an amount permitted by this section, provided that the entity
has incurred related party costs equal to or greater than the amounts permitted by
this section.
(6) If it is determined by the department that the amou nt of a deduction claimed by an
entity with respect to a related party cost is greater than the amount permitted by
this section, the net income of the entity shall be adjusted to reflect the amount of
the related party cost permitted by this section.
(7) For tax periods ending before January 1, 2005, in the case of entities not required to
file a consolidated or combined return under subsection (1) of this section that
carried on transactions with stockholders or affiliated entities directly or indirectly,
the department shall adjust the net income of such entities to an amount that would
result if such transactions were carried on at arm's length.