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August 31, 2021

US IRS articulates five-factor test in determining income inclusion of reimbursement payments

In a Chief Counsel Advice Memorandum (CCA 202132009), the United States (US) Internal Revenue Service (IRS) concluded that an affiliated group's joint and several liability for the payment of a branded prescription drug (BPD) fee is not solely determinative in deciding whether the remitting member may exclude any reimbursement of the fee from its gross income. The IRS provided several factors that should be considered in determining whether the remitting member benefits from the payment of the fee and, therefore, may not exclude the reimbursement from its gross income.


Taxpayer is a US corporation and member of an affiliated group that develops, manufactures and distributes BPDs and other medical care products. The foreign members of the group manufacture the BPDs and own the intellectual property related to the BPDs. Under an intercompany agreement with the foreign members, Taxpayer distributes the BPDs in the United States and receives a fixed profit margin resulting from the sales of the BPDs.

Taxpayer's transfer pricing (TP) method allocates excess profits or losses beyond the specified operating profit margin to the foreign members.

The Patient Protection and Affordable Care Act, Public Law 111-148 (124 Stat. 119 (2010)) (ACA), imposes a BPD fee on entities that manufacture or import BPDs for sale to certain government programs. The fee is a nondeductible excise tax under Internal Revenue Code1 Section 275(a)(6). Treas. Reg. Section 51.2 requires "controlled groups to be treated as a single entity for purposes of the BPD fee" and to select a designated entity to file any reports related to the BPD fee and pay the fee. Treas. Reg. Section 51.8(d) treats all controlled group members as jointly and severally liable for the BPD fee.

Taxpayer is the designated entity for the group and pays the fee to the US Treasury on the group's behalf. Under the intercompany agreement, the foreign members reimburse Taxpayer for the BPD fee. Taxpayer has not claimed a deduction for the fee but has excluded the reimbursement amount from its gross income.


The CCA analysis began by defining gross income under Section 61 as all income from whatever source derived. The IRS then cites Old Colony Trust v. Commissioner, 279 U.S. 716 (1929), to support the notion that the payment of a taxpayer's expense by another person is includible in the taxpayer's gross income, including (but not limited to) situations in which the other person reimburses the taxpayer for the taxpayer's payment of the taxpayer's expense.

The IRS next described circumstances under which a taxpayer generally doesn't have income upon receiving various types of reimbursements. Citing Seven-Up Co. v. Commissioner, 14 T.C. 965 (1950) and Affiliated Foods, Inc. v. Commissioner, 154 F.3d 527 (5th Cir. 1998) [98-2 USTC ¶50,750], the IRS noted that a taxpayer "does not have gross income when it is reimbursed for an expense paid by the taxpayer as an agent or conduit, on behalf of the reimbursing party." When acting as an agent or conduit, the IRS pointed out, the taxpayer "does not exercise control or dominion over the amounts received and remitted."

When a taxpayer must pay a certain expense and is reimbursed by another party, the IRS determined that the reimbursement amount is not income to the taxpayer, notwithstanding any incidental or indirect economic benefit to the taxpayer, if the expense is paid for the reimbursing party's benefit, not the taxpayer's benefit. See United States v. Gotcher, 401 F.2d 118 (5th Cir. 1968) [ 68-2 USTC ¶9546]. The IRS noted that the "reimbursement is not an accession to the wealth of the taxpayer."

Relying on Revenue Ruling 84-138, 1984-2 C.B. 123 (1984), the IRS pointed out that a portion of the reimbursement may be excludable from the taxpayer's gross income even if the expense benefits both the taxpayer and the reimbursing party. The IRS determined, however, that the reimbursement amount "must be commensurate with the reimbursing party's benefit and the taxpayer must not be in the business of receiving compensation for services of the type that are reimbursed."

While joint and several liability is relevant to determining which parties are legally liable for an expense, it does not determine the ultimate beneficiary of an expense. If a taxpayer is jointly and severally liable for a fee, the IRS noted, the taxpayer generally may exclude any reimbursement amount from its gross income when, as previously described, the reimbursing party benefits from the payment and the taxpayer's benefit is incidental.

Accordingly, the IRS concluded that the existence of joint and several liability "does not result in a per se exclusion from Taxpayer's gross income of reimbursements of all or a portion of the BPD fee by" the foreign members. The IRS also concluded that several factors must be considered when determining whether Taxpayer is the beneficiary of the BPD fee, including whether: (1) the foreign members were intended to bear the economic burden of the BPD fee; (2) Taxpayer must remit the amount received from the foreign members as the BPD fee payment; (3) Taxpayer benefits from the amount received and paid; (4) "Taxpayer claims the amount received as its own"; and (5) Taxpayer receives the amount in exchange for services it provides.


In analyzing whether the Taxpayer had income, the CCA cites case law that has developed in the reimbursement context between related parties, including payments made by a parent corporation for an expense initially incurred by a subsidiary. In this regard, considerable case law addresses treatment of deductions in the context of intra-group payments and this aspect of the reimbursement analysis also warrants careful analysis.

Treas. Reg. Section 1.162-1(a) provides that business expenses deductible from gross income include the ordinary and necessary expenditures directly connected with or pertaining to the taxpayer's trade or business. Thus, if a parent corporation pays the expenses of a subsidiary corporation, the payor corporation generally may not deduct those expenses, as they are not directly connected with the payor's trade or business. That is, the separate identities of a parent company and its subsidiary are generally respected for tax purposes. The costs relate to the subsidiary's trade or business, not the parent's. See, e.g., Interstate Transit Lines v. Comm'r, 319 U.S. 590 (1943); South American Gold & Platinum Co. v. Comm'r, 8 TC 1297 (1947) and Specialty Restaurants Corp. v. Comm'r, 63 TCM 2759 (1992). In that case, a parent's payment of a subsidiary expense is typically treated as a capital contribution followed by the subsidiary's payment of the expense, entitling the subsidiary to any deduction of the expense. See e.g., Revenue Ruling 84-68, 1984-1 C.B. 31. When an expense incurred by a subsidiary directly relates to and proximately benefits the business of its parent and the parent pays or reimburses the expense, the courts have allowed the parent to recognize the deduction (i.e., direct-and-proximate-benefit principles). See e.g., Coulter Electronics, Inc. v. Comm'r, 59 TCM 350 (1990) and Fall River Gas Appliance Company, Inc. v. Comm'r, 42 T.C. 850 (1964), aff'd, 349 F.2d 515 (1st Cir. 1965). In that case, the subsidiary does not recognize income from the parent's payment of the expense.

The five-factor test articulated in the CCA is helpful because it provides insight in how the IRS may analyze intracompany reimbursements.2 The five-factor test does not articulate new principles; instead, it distills authorities from the reimbursement doctrine, capital contribution principles, and direct-and-proximate-benefit principles on which taxpayers rely when analyzing reimbursement payments. Although the CCA focused on whether a reimbursement was includible in gross income, the five-factor test may also be helpful in determining whether the reimbursing party or the party receiving the reimbursement may claim a deduction for the reimbursed expense.


For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP (United States), National Tax – Accounting Periods, Methods and Credits

Ernst & Young LLP (United States), International Tax and Transaction Services



  1. All “Section” references are to the Internal Revenue Code of 1986, and the regulations promulgated thereunder.
  2. CCA 202132009 is similar to PLR 201904004 (2 Feb. 2019) with respect to its facts and overall analysis; however, PLR 201904004 does not extend its analysis to the extent of articulating a multi-factor test in assessing which party(ies) benefit from the payment of an expense.

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting or tax advice or opinion provided by Ernst & Young LLP to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader's specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The reader should contact his or her Ernst & Young LLP or other tax professional prior to taking any action based upon this information. Ernst & Young LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.


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