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February 11, 2022

North Carolina violated US Constitution by basing deductibility of debt owed by affiliated corporations on whether affiliates are subject to state franchise tax

In Philip Morris USA, Inc.,1 the North Carolina Office of Administrative Hearings (NC OAH) determined that the North Carolina Department of Revenue (NC DOR) violated the US Constitution's Commerce Clause to the extent it denied a franchise tax deduction for debt owed to an out-of-state corporation by affiliated corporations not doing business in North Carolina but allowed the deduction for debt owed by affiliates that conducted business in the state.


The taxpayer, Philip Morris USA, Inc. (Philip Morris), is a Virginia corporation and was authorized to do business in North Carolina for the franchise tax years 2012 through 2014 (tax periods at issue). During these years, Philip Morris borrowed and lent money to related members of its affiliated group. Some of these affiliates did not conduct business in North Carolina and were therefore not subject to North Carolina's franchise tax.

For the tax years at issue, North Carolina's franchise tax was calculated as a percentage of the greater of (1) the corporation's North Carolina apportioned capital stock, surplus and undivided profits (capital stock base); (2) 55% of the appraised value of the corporation's real and tangible personal property located in North Carolina; or (3) the corporation's total investment in tangible property in North Carolina.2

Philip Morris calculated its franchise tax for each of the tax periods at issue using the capital stock base and adjusted its net worth by factoring in the debt owed to its affiliates.3 It also adjusted its capital stock base by deducting the debt owed by all its affiliates (affiliate receivables) (to the extent that the affiliate receivables were not included in the capital stock base in the first adjustment). Citing N.C. Gen. Stat. Section 105-122,4 the NC DOR disallowed Phillip Morris's deduction of affiliate receivables for affiliates not doing business in North Carolina because North Carolina's franchise tax does not apply to them.

Limit on deduction found unconstitutional

The NC OAH focused on whether denying the deduction of affiliate receivables only for affiliates not doing business in North Carolina violated the US Commerce Clause by unconstitutionally discriminating against interstate commerce. The NC OAH observed that state law permits a North Carolina Corporate Franchise taxpayer to reduce its franchise tax liability by deducting debt owed to it by affiliates doing business in North Carolina; in contrast, a North Carolina Corporate Franchise taxpayer making loans to affiliates that are not North Carolina franchise taxpayers in the state could not deduct those receivables. This limitation, the NC OAH found, violates the Commerce Clause because it discriminates against, and imposes an unconstitutional burden on, interstate commerce. Therefore, denying the deduction of affiliate receivables for affiliates not doing business in North Carolina is unconstitutional.


Taxpayers with significant intercompany receivables that were not deducted from the capital stock base when calculating the North Carolina franchise tax for tax years prior to 2021 should consult with their tax advisors and preparers about how this decision could affect their prior North Carolina franchise tax liabilities and whether they may be eligible for refunds.


Contact Information
For additional information concerning this Alert, please contact:
State and Local Taxation
   • Kerry Matthews Funderburk (
   • Errett Roth (
   • Emily Thompson (
   • Patrick Ryan (
   • Tom Funderburk (


1 Philip Morris USA, Inc. v. NC Dept. of Rev., No. 20 REV 04215 (N.C. Off. Admin. Hearings Dec. 30, 2021).

2 N.C. Gen. Stat. Section 105-120(b). The 2021 Appropriations Act (2021-2022 N.C. Sess. Laws, ch. SL 2021-180, Senate Bill 105) simplifies the franchise tax calculation. Effective for a corporation's franchise tax calculated on its 2022 income tax returns filed in 2023, the franchise tax is calculated using only a corporation's North Carolina apportioned net worth.

3 See N.C. Gen. Stat. Section 105-122 for capital stock adjustments.

4 Id.