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North Carolina OAH invalidates the denial of franchise tax affiliate receivables deduction

January 2022

In brief

The North Carolina Office of Administrative Hearings (OAH) recently concluded that the franchise tax deduction for receivables made to affiliated corporations violated the dormant Commerce Clause of the US Constitution because the deduction only was allowed regarding affiliates doing business in North Carolina. This constituted a burden on interstate commerce that was not applicable to intrastate commerce and, therefore, the deduction denial was unconstitutional as applied to this taxpayer.

Action item: Companies with significant amount of intercompany receivables that were not deducted from their capital stock base when calculating the North Carolina franchise tax in prior tax years should consider filing a protective refund claim if the holding in the OAH case is applicable. 

[Philip Morris USA, Inc. v. NC Department of Revenue, North Carolina Office of Administrative Hearings, No, 20 REV 04215 (12/30/21)

In detail


During the 2012 to 2014 tax years at issue, Philip Morris USA, Inc. was commercially domiciled in Virginia and authorized to do business in North Carolina. Philip Morris borrowed money from and lent money to members of its affiliated group. Following an audit, the Department determined that Philip Morris understated its franchise tax capital stock base by not including amounts borrowed from its affiliated corporations. Additionally, the Department did not allow a deduction for amounts loaned to affiliated corporations. 

Philip Morris appealed to the OAH asserting that it should be allowed the deduction for any amounts loaned to affiliates because the Department’s treatment violated the US Commerce Clause as applied.

North Carolina franchise tax

During the years at issue, corporations domiciled outside North Carolina paid the franchise tax for the privilege of doing business in the state. The tax is imposed on a separate-entity basis.

One measure of the franchise tax, the capital stock base, provides for the following two adjustments: (1) an addback for amounts owed to affiliates and (2) a deduction for amounts owed to the taxpayer by affiliates, but only to the extent that the corresponding debt is included in the tax base of the debtor corporation (“Affiliate Receivables” adjustment).

Commerce Clause violation claim

Philip Morris claimed that the Affiliate Receivables adjustment discriminated against interstate commerce by allowing subtractions only regarding affiliates doing business in North Carolina. According to Philip Morris, the result was a burden on interstate commerce that is not applicable to intrastate commerce.

OAH rules deduction unconstitutional as applied

The OAH noted that Philip Morris was denied deductions for some of its Affiliate Receivables while a corporation loaning only to affiliates doing business in North Carolina would be able to deduct all of its Affiliate Receivables. The OAH recognized that the Affiliate Receivables deduction is needed to prevent double taxation where the debtor corporation is subject to the Franchise Tax, since a debtor corporation subject to the Franchise Tax must add back the receivables as Affiliate Payables in calculating its capital stock base. However, “limiting the deduction to Affiliate Receivables owed by debtor corporations subject to the Franchise Tax is not necessary to achieving the legislative intent to prevent double taxation or otherwise preserve the integrity of the Franchise Tax.”

The OAH found that Philip Morris was treated differently solely on the interstate element of its business. Philip Morris was burdened when its deductions were denied, whereas similar deductions would have been allowed to corporations engaged solely in intrastate lending.

Accordingly, the OAH held that, as applied to Philip Morris, “the denial of the Affiliate Receivables deduction is a violation of the dormant Commerce Clause.”

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National SALT Practice Leader, PwC US

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