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Under the Michigan Business Tax Act, every taxpayer with business activity in the state is subject to the business income tax. The business income tax base, which is a taxpayer's "business income" as defined in MCL 208.1105(2), is that part of federal taxable income derived from "business activity." Although federal taxable income is the starting point for imposition of state tax, Michigan requires certain adjustments to be made, including add backs of specified items. One of the Michigan add backs involves related party expenses. Michigan has followed the lead of many other states that impose an income tax by requiring taxpayers to add back certain interest and other expenses that have been paid to persons related to the taxpayer but not included in the unitary business tax return with the taxpayer.

 

 

Author Patrick Van Tiflin writes: There has been substantial litigation in the past few years concerning the legitimacy of related party expense disallowance provisions. A recent example of such litigation is VFJ Ventures v. Surtees, 8 So. 3d 983, 2008 Ala. LEXIS 197, in which royalty payments made to a related party were required to be added back to the Alabama tax base. In the VFJ Ventures case, the Alabama Supreme Court held that an add back is unreasonable only when the tax paid would be out of proportion to the taxpayer's presence in the taxing state. The United States Supreme Court denied certiorari, thus allowing the decision of the Alabama Supreme Court to stand.

 

 

The Michigan statute requires an add back of royalty, interest, or other expense paid to a person related to the taxpayer by ownership or control for the use of an intangible asset, to the extent that those expenses were deducted in arriving at federal taxable income. The disallowance applies if the recipient of the payment is not included in taxpayer's Unitary Business Group (see LexisNexis MI Tax Practice Insight 6,659). In order to avoid application of the MBT related-party expense add back provision, numerous portals must be successfully navigated.