C282754; C295077; C299008

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COMMONWEALTH OF MASSACHUSETTS

APPELLATE TAX BOARD

KIMBERLY-CLARK CORPORATION & v. COMMISSIONER OF REVENUE
KIMBERLY-CLARK GLOBAL SALES, INC.

Docket Nos.: C282754 Promulgated:
C295077 January 31, 2011
C299008

These are appeals under the formal procedure pursuant to G.L. c. 58A, § 7 and G.L. c. 62C, § 39 from the refusal of the appellee, the Commissioner of Revenue ("Commissioner"), to grant an abatement of corporate excise sought by the appellants for the tax years ended December 31, 2001, December 31, 2002, and December 31, 2003 ("tax years at issue").
Chairman Hammond heard these appeals. Commissioners Egan, Rose and Mulhern joined him in the decision for the appellee. Commissioner Scharaffa issued a separate opinion concurring in part and dissenting in part, disagreeing with the standard of proof applied by the majority for the tax years ended December 31, 2002, and December 31, 2003.
These findings of fact and report are made at the requests of the appellants and the appellee pursuant to G.L. c. 58A, § 13 and 831 CMR 1.32.
Philip S. Olsen, Esq. and Natasha Varyani, Esq. for the appellants.

John DeLosa, Esq. and Christopher M. Glionna, Esq. for the appellee.

FINDINGS OF FACT AND REPORT
Based on a "Stipulation of Facts and Admissibility of Exhibits," as well as testimony and exhibits entered into evidence at the hearing of these appeals, the Appellate Tax Board ("Board") made the following findings of fact.
Procedural History
During the tax years at issue, Kimberly-Clark Corporation ("Kimberly-Clark"), a Delaware corporation headquartered in Dallas, Texas, maintained corporate locations in Wisconsin, Georgia and Tennessee. Kimberly-Clark Global Sales, Inc. ("Global"), also a Delaware corporation, was incorporated in May, 2002, and was a wholly owned subsidiary of Kimberly-Clark.
On November 18, 2002, Kimberly-Clark filed a Massachusetts corporate excise return for the tax year ended December 31, 2001. Based on the results of an audit initiated by the Massachusetts Department of Revenue, the Commissioner issued a Notice of Intention to Assess Corporate Excise to Kimberly-Clark on August 19, 2007, for the 2001 tax year. On October 2, 2007, the Commissioner issued a Notice of Assessment in the amount of $817,797.25, inclusive of interest. The assessment related to the Commissioner's disallowance of claimed interest expense associated with Kimberly-Clark's cash-management system. On February 5, 2008, Kimberly-Clark filed an Application for Abatement, seeking abatement of the additionally assessed corporate excise. The Commissioner issued a Notice of Abatement Determination on April 15, 2008, denying Kimberly-Clark's abatement application, and on May 29, 2008, Kimberly-Clark filed a Petition Under Formal Procedure with the Board with respect to tax year 2001.
On September 19, 2003, Kimberly-Clark filed a Massachusetts corporate excise return for the tax year ended December 31, 2002. Based on an audit, the Commissioner issued a Notice of Intention to Assess Corporate Excise to Kimberly-Clark on September 11, 2005, for the 2002 tax year. On October 25, 2005, the Commissioner issued a Notice of Assessment in the amount of $1,089,700, inclusive of interest and penalties. The assessment related to the Commissioner's disallowance of royalty expenses paid by Kimberly-Clark to an affiliated corporation, as well as interest expenses associated with its cash-management system. On December 6, 2005, Kimberly-Clark filed an Application for Abatement, seeking abatement of the additionally assessed corporate excise. The Commissioner issued a Notice of Abatement Determination on December 16, 2005, denying the abatement application, and on January 20, 2006, Kimberly-Clark filed a Petition Under Formal Procedure with the Board with respect to tax year 2002.
On September 13, 2004, Global filed a Massachusetts corporate excise return for the tax year ended December 31, 2003. Based on an audit, the Commissioner issued a Notice of Intention to Assess Corporate Excise to Global on August 19, 2007, for the 2003 tax year. On October 2, 2007, the Commissioner issued a Notice of Assessment in the amount of $1,113,418, inclusive of interest. The assessment related to certain payments among affiliated entities which the appellants had characterized as "rebate" payments, as well as interest expense incurred by Global resulting from Global's participation in Kimberly-Clark's cash-management system. On February 5, 2008, Global filed an Application for Abatement, seeking abatement of the additionally assessed corporate excise. The Commissioner issued a Notice of Abatement Determination on April 15, 2008 denying Global's abatement application and on May 29, 2008, Global filed a Petition Under Formal Procedure with the Board with respect to tax year 2003.
On the basis of the foregoing, the Board found that it had jurisdiction to hear and decide these appeals.
Factual Background
Kimberly-Clark began doing business in the 1870s, making newsprint from garments. Soon after World War I, it introduced a line of feminine products and later a facial tissue line. Kimberly-Clark became a publicly traded company in 1928 and, during the ensuing decades, substantially expanded its business through investment and acquisitions, leading to operations in more than thirty countries and sales in more than one hundred countries.
By 1995, Kimberly-Clark was a leading manufacturer of facial tissues, diapers, and adult incontinence products. Although it maintained a substantial market presence in these product segments, Kimberly-Clark had not made significant headway in the "away from home" business, which consisted of paper and tissue products that were not typically used by their purchasers, but by customers of businesses that purchased the products, such as restaurants and hotels. By this time, Kimberly-Clark had developed a significant presence in North America and Northern Europe, but had not realized similar success in Southern Europe.
To complement its market strengths and mitigate its weaknesses, Kimberly-Clark sought potential merger partners. Ultimately, the company entered into negotiations with Scott Paper Company ("Scott"), an unrelated business that produced paper towel products, facial tissue and value-priced bath tissue. Scott, which had been in business since 1922, had a substantial "away from home" business, and held a significant market share in certain European markets which had not been successfully exploited by Kimberly-Clark.
On July 16, 1995, Kimberly-Clark and Scott entered into an "Agreement and Plan of Merger" that reflected Kimberly-Clark's agreement to acquire all of the outstanding shares of Scott. Scott became a wholly owned subsidiary of Kimberly-Clark on December 12, 1995, upon consummation of the Plan of Merger effected among Kimberly-Clark, Rifle Merger Co., a wholly owned subsidiary of Kimberly-Clark, and Scott. On February 14, 1996, Scott's name was changed to Kimberly-Clark Tissue Company ("KCTC").
Cash-management System
For each of the tax years at issue, the appellants utilized a centralized cash-management system. The system had been in place since the mid-1990s and according to Kimberly-Clark was established to manage cash deposits centrally and to minimize costs among multiple legal entities. In the alternative, these entities would have managed cash deposits and borrowed independently, incurring greater expenses than within the context of a cash-management system. Thus, according to the appellants' witness, by eliminating individual company bank loans and consolidating banking arrangements, Kimberly-Clark was able to enhance efficiency and increase profitability.
Within Kimberly-Clark's cash-management system, all subsidiaries' cash receipts were deposited into a lock box maintained by Kimberly-Clark Financial Services, Inc. ("Financial") on a daily basis. The cash was swept up to Kimberly-Clark and made available to the subsidiaries from a single pool from which the subsidiaries' various expenses were paid. To the extent that the cash collected from a given subsidiary exceeded the subsidiary's expenses, a net payable was recorded from Kimberly-Clark on Kimberly-Clark's general ledger. Because the cash was swept to Kimberly-Clark through Financial, Financial recorded a receivable from Kimberly-Clark and Kimberly-Clark recorded a payable to Financial.
The movement of cash was documented with daily ledger entries, resulting in a net payable to or net receivable from each entity. Interest on the net payable or receivable was calculated on the last day of each calendar month. The interest rate was typically 130% of the monthly Applicable Federal Short Term Rate as determined under § 1274(d) of the Internal Revenue Code ("I.R.C.").
No evidence presented indicated that any subsidiary requested or received a return of advances to Kimberly-Clark which exceeded disbursements made to pay the subsidiaries' expenses ("excess advances") at any time prior to or during the tax years at issue. In fact, Kimberly-Clark was in a net borrowing position at the end of each of the tax years at issue. Thus, the Board found that the appellants failed to prove that Kimberly-Clark had any intention of repaying the excess advances received from the subsidiaries.
Mr. Michael Todd Azbell, Kimberly-Clark's Vice President and Corporate controller, who testified regarding the appellants' cash-management system, discussed an "Amended and Restated Loan Agreement" ("Loan Agreement") between Kimberly-Clark and Kimberly-Clark Worldwide, Inc. ("Worldwide") to which promissory notes were attached, all dated December 31, 1998. Mr. Azbell indicated that these agreements were representative of agreements within the cash-management system between Kimberly-Clark and its subsidiaries, except that the amount of the promissory notes varied from entity to entity. The Loan Agreement states the parties' intention and agreement to make "loans" to each other on an ongoing basis, essentially in the form of a credit line, not to exceed two billion dollars at any one time if made to Worldwide by Kimberly-Clark and three billion dollars if to Kimberly-Clark by Worldwide. Two of the promissory notes, appended to the Loan Agreement as Exhibits A and B, reflect promises to pay, on demand, the amounts agreed to in the Loan Agreement. The notes provide for interest, as discussed above, at 130% of the monthly Applicable Federal Short Term Rate.
Also appended to the Loan Agreement as Exhibit C is a promissory note in the principal sum of five hundred million dollars payable by Kimberly-Clark to Worldwide on December 31, 2003. This note provides for interest at 130% of the monthly Applicable Federal Short Term Rate. Exhibit D is a promissory note identical to Exhibit C in all material respects except that it is payable by Kimberly-Clark on December 31, 2008.
Neither the Loan Agreement nor the promissory notes contained collateral provisions, default provisions or any other security provisions. Having examined the Loan Agreement and the promissory notes, Mr. Azbell made no comment regarding the two fixed maturity date five hundred million dollar promissory notes ("Notes"). In particular, there was no testimony or other evidence presented to explain how the Notes fit within the operation of the cash-management system. Moreover, the appellants offered no evidence that the Notes were repaid by Kimberly-Clark.
Further, the Board found that the appellants failed to establish that the interest rate charged to the subsidiaries was arm's-length in each instance. No testimony was offered indicating that the various subsidiaries were equally creditworthy or that in a third-party lending transaction each would have been able to negotiate a loan at 130% of the monthly Applicable Federal Short Term Rate. In fact, Mr. Azbell testified that the company uniformly charged "the rate that would be published by the IRS as what is representative of an arm's-length transactional rate as opposed to going into individual negotiations . . . ."
Based on the evidence presented, and with substantial emphasis placed on the factors indicating the excess cash advances made within the appellants' cash-management system were not intended to be repaid, including the absence of requests for or effort toward repayment, or actual repayment in whole or in part, the Board found that the advances did not constitute bona-fide debt. This conclusion was reinforced by other factors such as the absence of security, default or collateral provisions attendant to the purported debt, as well as the appellants' failure to establish that the promissory notes represented arm's-length transactions. Accordingly, the Board upheld the Commissioner's disallowance of the claimed interest expenses associated with the appellants' cash-management system for each of the tax years at issue.
The 1996 Reorganization and Tax Year 2002 Royalty Expenses
Mr. Paul McGuire, Kimberly-Clark's assistant controller for tax accounting, testified that once the merger of Scott and Kimberly-Clark was complete, the company faced the challenge of integrating the operations of two previously large and distinct entities into a single efficient organization. Toward this end, Kimberly-Clark began to consolidate and centralize several operational functions including management, sales, distribution, and research and development.
Mr. McGuire noted that after the merger, intangible assets, including trademarks, patents, and proprietary know-how, were owned and managed by more than one entity in the Kimberly-Clark family. According to Mr. McGuire, there was an imminent need to centralize ownership and control of these assets, absent which significant inefficiencies would remain and intellectual property could be unprotected. Kimberly-Clark developed "Project Partners" to achieve the desired centralization, a plan that would result in contribution of intellectual property and certain other assets to a newly formed Delaware corporation, Worldwide, a wholly owned subsidiary of KCTC.
On December 3, 1996, Kimberly-Clark issued an internal document entitled "Project Partners Communication Guide" with a cover memo explaining that the document was an "announcement for those teams affected by the creation of [Worldwide]." The Guide, which explained in simple and direct terms the purpose of Project Partners and the structure of Worldwide, began with an overview of Project Partners. Answering the question "What is Project Partners and why are we creating it?," the Guide states, in part:
Project Partners combines our intangible assets into one company called Kimberly-Clark Worldwide. Up until now, as a result of the merger with Scott Paper, intangible assets were owned and/or managed by several different companies in the Kimberly-Clark Family. This change centralizes the ownership of intangible assets of three companies - Kimberly-Clark, Kimberly Clark Tissue Company and Kimberly-Clark Worldwide . . . into one company. . . .

This project is another example of our continuing effort to improve our financial returns. It will produce better asset management and operational, administrative and financial efficiencies, including significant tax savings. (Emphasis added).

Pursuant to the Project Partners plan, effective November 30, 1996, Kimberly-Clark and KCTC each executed substantially similar agreements with Worldwide as follows: 1) an "Agreement for Conveyance of Assets and Appointment of Trademark Agent," by which each company contributed substantially all of its patents and proprietary know-how that it had developed and owned (collectively, the Patents") to Worldwide. The agreements also provided for appointment of Worldwide as the exclusive agent with respect to all of Kimberly-Clark's and KCTC's "trademarks," which included, inter-alia, trademarks, tradenames, service marks, and logos (collectively, the "Trademarks") ownership of which was retained by Kimberly-Clark and KCTC; 2) a "Trademark License and Assistance Agreement" granting Worldwide a non-exclusive license to the Trademarks to use in manufacturing operations. The agreement also granted an exclusive license to sublicense the Trademarks owned by Kimberly-Clark to KCTC and those owned by KCTC to Kimberly-Clark and to sublicense the Trademarks worldwide. The license grants made under these agreements were royalty-free; 3) an "Asset Contribution Agreement" by which certain real property and operations
were transferred to Worldwide; and 4) a "License and Technical Assistance Agreement" whereby Worldwide granted to Kimberly-Clark and KCTC licenses to the Patents that had been contributed to Worldwide and a sublicense to the Trademarks which had been licensed to Worldwide and for which Worldwide had been appointed exclusive agent by Kimberly-Clark and KCTC. In consideration of the patent license and trademark sublicense, Kimberly-Clark was to pay Worldwide a royalty of three percent of "sales," as defined in each agreement, and KCTC a royalty increasing from 3.1% of "sales" for the month of December, 1996, to 3.3% for the periods commencing January 1, 1999. The royalty difference reflected the conclusion that Kimberly-Clark's trademarks were more valuable than those belonging to KCTC, and thus KCTC should pay more for Kimberly Clark's trademarks under the licensing arrangement.
Following these transactions, Worldwide had numerous employees, substantially all of whom had previously been employees of affiliates of Kimberly-Clark. The employees were involved in manufacturing, research and development, and patent and legal protection services. As reflected in the cited agreements, Worldwide owned and managed the Patents that had previously belonged to Kimberly-Clark and KCTC and managed Kimberly-Clark's and KCTC's Trademarks.
Notably, the appellants explained in great detail the need to consolidate the Patents and Trademarks within one newly created entity, Worldwide. Yet despite the articulated "reasons" for consolidation, there was no explanation offered for the rationale underlying the retention of the Trademarks by Kimberly-Clark and KCTC. Presumably, the appellants could have achieved their stated goals of increasing efficiencies and enhancing protection of the intellectual property by employing similar arrangements for both the Trademarks and the Patents. Yet for no apparent reason, the Patents were transferred to Worldwide, thereby generating substantial royalty payments and consequent expense deductions for Kimberly-Clark, while the Trademarks were not. The Board thus found that Kimberly-Clark's unexplained inconsistent treatment of the Patents and the Trademarks undermined its assertion that tax reduction was not a principal purpose underlying the 1996 reorganization. The Project Partners Communication Guide, which explicitly references "significant tax savings" as an "efficiency" that will be realized as part of the reorganization further reinforces other facts supporting the inference that tax reduction was inextricably tied to the reorganization.
The Board also found significant the extent to which those involved in company tax matters were responsible for development, implementation and oversight of the reorganization. For example, not only did Mr. McGuire sign the cover memorandum of a draft of the "Project Partners Communication Guide," but he was the signatory to an inter-office document entitled "Project Partners Work Plan," which delineates some 348 tasks associated with implementation of Project Partners. Many of these tasks relate directly to tax considerations and were to be completed by company tax personnel and representatives of Ernst & Young. Further, in his testimony, Mr. McGuire confirmed Ernst & Young's ongoing involvement with Project Partners as it related to the multiplicity of tax issues intertwined with the reorganization. In contrast, the record does not reflect any level of planning or oversight of the reorganization by operational personnel, corporate managers or even employees responsible for addressing intellectual property issues, the very issues the appellants claim were the driving force for the reorganization. Moreover, just as tax personnel played the principal role in the development and execution of Project Partners, the only witnesses presented in support of the appellants' case in these appeals held positions within Kimberly-Clark as director of tax defense, assistant controller for tax accounting, and controller; no witness responsible for the appellants' business operations or intellectual property management was offered by the appellants.
Next, despite statements by the appellants to the contrary, the record does not indicate that Worldwide negotiated or entered into third-party licensing agreements with respect to the Patents or the Trademarks. While the license agreements relating to this property purported to be non-exclusive, there was no evidence to suggest that Worldwide sought out or entered into agreements with third-party licensees. Absent such licensing activity, the Board found that the license agreements among Kimberly-Clark, Worldwide and various affiliated entities were de facto exclusive licenses. The Board thus found that these licenses were not arm's-length transactions.
Finally, although Kimberly-Clark and KCTC ostensibly paid a royalty to Worldwide for the use of intellectual property they had transferred to Worldwide, as well as for the licensed trademarks, these payments were immediately returned to Kimberly-Clark by virtue of the operation of the company's cash-management system. The Board found that such a circular flow of funds undermined the appellants' assertion that the 1996 reorganization was supported by economic substance.
On the basis of the foregoing, the Board found that the appellants did not provide clear and convincing evidence to demonstrate that reduction of tax was not a principal purpose underlying the 1996 reorganization; neither did the appellants sustain their burden of demonstrating that the add back of royalty expenses associated with the transfer and license-back transactions at issue for tax year 2002 was unreasonable within the meaning of G.L. c. 63, § 31I. Accordingly, the Board found that the Commissioner properly disallowed these royalty expenses.
Tax Year 2003 - Purported Rebate Payments
Mr. Richard Beauvais, Kimberly-Clark's director of tax defense and assistant treasurer, testified that as part of the corporate consolidation and streamlining process following the merger with Scott, Kimberly-Clark undertook to examine and improve its "supply-chain management," the process of purchasing raw materials, manufacturing product, maintaining inventory, and selling and distributing product. According to Mr. Beauvais, following the merger, individual entities bought their own raw materials, attempted to determine their own production needs, to match those needs with customer demand, and controlled the sale and distribution of the product. This arrangement resulted in several inefficiencies including overproduction, excess inventory, and inefficient shipping. Beginning in Europe in 2000, and subsequently in the United States, Kimberly-Clark sought to centralize and increase efficiencies associated with its supply-chain management. The Company purchased and put in place an "SAP information system," a software system that provided Kimberly-Clark with a central information source for the entire supply-chain management process that replaced thirty loosely connected systems.
Mr. Beauvais testified that the SAP system would only work if the entire process, from procurement to ultimate sale, was coordinated from within a single entity. To accomplish this in the United States, Global was formed in May of 2002, and a series of agreements, effective January 1, 2003, was executed by and among Kimberly-Clark,
Worldwide and Global. Ultimately, during 2003, Global was responsible for controlling Kimberly-Clark's entire supply-chain management process and had several thousand employees. Global sold, marketed and distributed Worldwide branded products, provided centralized administration services, and operated national distribution centers. Global also owned raw materials, work in progress and finished goods.
Within the new operating structure, manufacture was performed on a contract basis, primarily by Kimberly-Clark, but also by Worldwide and other affiliated entities qualified by Worldwide as "certified suppliers." Each of the certified suppliers was guaranteed a return for the manufacturing services performed equal to the costs of manufacturing plus a mark-up on assets of approximately 11%. Global was also guaranteed a return of approximately 3.9% on its distribution costs, 6% on its costs of carrying inventory and 4% on any incurred engineering costs. The rates of return were initially determined by Kimberly-Clark and were adjusted somewhat based on a Transfer Pricing Analysis performed by KPMG in December of 2003.
Under the various agreements relating to the 2003 reorganization, neither Kimberly-Clark nor any other certified supplier paid a royalty, defined or described as such, for the use of the Patents for which Worldwide had previously been compensated. Rather, the sole identified royalty within this new structure was paid by Global to Worldwide in the annual sum of approximately one million dollars. Global, in turn, sublicensed the technology to the certified suppliers without specified charge.
Unlike the prior royalty arrangement, no evidence was submitted regarding how the royalty paid by Global, which represented a tiny fraction of the royalty payments made by Kimberly-Clark for use of the same property during 2002, was derived or why it represented an arm's-length payment for the technology.
Pursuant to First Amended and Restated Supply and Service Agreements, each certified supplier, having received its guaranteed return, was to remit payment to Global in the amount of any "cost savings." These savings were realized by the suppliers through use of the Patents. The First Amended and Restated Supply and Services Agreements define "cost savings" as "any cost efficiencies obtained by [a certified supplier] in manufacturing, producing, converting, packaging, supplying or delivering [][p]roducts to [Global] including, but not limited to reduced input costs, increased volume, and increased efficiency" derived from the use of the Patents. At the end of each month, the cost savings were paid by the suppliers to Global, which accounted for the savings as part of its cost of goods sold and remitted them to Worldwide in the form of "rebate" payments.
By way of example, payments relating to sales of goods under the "rebate program" flowed as follows. Kimberly-Clark or another certified supplier produced a product for Global. Global sold the product to a customer for ten dollars and then, using the agreed-upon mark-up, calculated its rate of return to be two dollars. The remaining eight dollars was remitted to the certified supplier, and the supplier's guaranteed return was calculated to be five dollars based on the pre-determined mark-up. The remaining balance of three dollars was characterized by the appellants as "cost savings" and was returned by the supplier to Global, which paid the sum to Worldwide as a "rebate" payment.
Throughout 2003, Worldwide continued to own and manage the Patents. Worldwide also had ongoing manufacturing operations and funded research and development. Worldwide was the only entity in the 2003 reorganization that was not guaranteed a rate of return. According to the appellants, this structure was designed to remove business risk from Kimberly-Clark, other contract manufacturers, and Global. In turn, Worldwide was intended to and did assume all of the risk associated with product sales.
The appellants assert that the "rebate" payments were not related to the certified suppliers' use of Worldwide's Patents, and therefore cannot be characterized as a royalty or intangible expense within the meaning of G.L. c. 63, § 31I. Rather, according to the appellants, the "rebate" payments represent compensation paid to Worldwide for its assumption of business risk. The Board found that these assertions lacked credibility.
The Board found untenable the appellants' claim that Worldwide bore all the business risk associated with the sale of products, or lack thereof, within the appellants' multi-faceted operational structure. Kimberly-Clark is a publicly traded corporation, and the risks and rewards of its business activities and those of its affiliates, which are almost exclusively derived from the manufacture and sale of its products, flow directly to Kimberly-Clark and are periodically reported in various public documents. The Board therefore found implausible the appellants' assertion that Kimberly-Clark and other affiliated entities were isolated from these risks, which as of 2003 were purportedly borne by a single subsidiary with significant albeit limited activity.
Moreover, beginning with the 1996 reorganization and continuing throughout 2002, Worldwide was compensated at a rate of between 3% and 3.3% of billions of dollars of sales for use of the Patents, a sum which the appellants characterized as reflecting fair value. During 2003, that property was used by substantially the same entities to perform the same tasks - produce Worldwide's branded products. In his testimony, Mr. Beauvais stated not only that the "manufacturing know-how" owned by Worldwide allowed the certified suppliers to "produce a product at a cost that should be less absent having the availability of [the] technology," but that the certified suppliers' production was not possible without this "know-how." Indeed, the "cost savings" and consequent "rebate" payments made to Worldwide were made possible only through use of the Patents sublicensed by Global to the certified suppliers. These facts notwithstanding, the sole declared royalty payment for 2003, made by Global to Worldwide, amounted to a tiny fraction of royalties paid to Worldwide during 2002. Further, Worldwide continued to perform much the same functions it had prior to the 2003 reorganization.
The Board found that the "rebate" payments represented payment for use of the Patents, and this use constituted an embedded royalty. These findings were based on: the effective discontinuance of substantial royalty payments during tax year 2003, which the appellants' had previously characterized as fair compensation for use of Worldwide's Patents; the certified suppliers' continued use of the Patents, without which production would not have been possible; and the appellants' untenable assertion that the "rebate" payments represented compensation to Worldwide for its full assumption of risk associated with the sale of products.
Based on the Board's finding that the nature of the "rebate" payments was fundamentally mischaracterized by the appellants, and that the payments also constituted embedded royalties, the Board also found that the add-back provisions of G.L. c. 63, § 31I applied to the payments. The appellants, having unequivocally denied that the "rebate" payments represented royalties paid for use of the Patents, presented no evidence to support the assertion that the payments qualified for an exception from add back under § 31I. Absent such evidence, the Board found that the Commissioner's add back of the sums associated with the purported rebate payments was proper.

OPINION

Appellants' Burden of Proof
With the exception of interest expenses associated with Kimberly-Clark's cash-management system incurred during tax year 2001, the disposition of the contested issues in these appeals is dependent upon application of G.L. c. 63, §§ 31I, and 31J (collectively, the "Add Back statutes"). Generally, and as discussed in greater detail below, the Add Back statutes, subject to certain exceptions, require a taxpayer to add back to net income deductions for related member interest and intangible expenses and costs. Id. The exceptions, in pertinent part, apply if a taxpayer "establishes by clear and convincing evidence, as determined by the commissioner, that the disallowance of the deduction is unreasonable. . ." G.L. c. 63, §§ 31I(c)(i)(A) and 31J(a)(1).
Citing the well-settled principle that courts are generally constrained to follow the plain language of a statute, see, e.g., White v. Boston, 428 Mass. 250 (1998), the appellants assert that the plain language of the Add Back statutes inevitably leads to the inference that the "clear and convincing" standard is confined to decisions made by the Commissioner and does not extend to appeals of those decisions to the Board. In support of this conclusion, the appellants note that in each instance in which the statutes reference "clear and convincing evidence," the language is followed by the qualifying phrase, "as determined by the commissioner." The appellants next contend that had the Legislature intended to extend the clear and convincing standard of proof to appeals before the Board, the qualifying phrase, which the appellants characterize as "limiting language," would not have been made part of the statute. Thus, the appellants conclude that the plain language of the statutes mandate application of the clear and convincing standard only to the Commissioner's decisions, and that the standard of proof at the Board is the "preponderance of the evidence" standard.
Unlike the appellants, the Commissioner reads the phrase "as determined by the Commissioner" as an instruction to the Commissioner to provide guidance regarding the meaning of "clear and convincing evidence" within the Add Back statutes. The Commissioner essentially argues that she is generally to determine the quality and type of evidence that will constitute "clear and convincing" evidence, and will decide whether a particular taxpayer has met that standard in the context of an abatement application. On appeal, the Board will then make an independent determination of whether the taxpayer has met the clear and convincing standard based on evidence offered at a de novo hearing.
Where, as here, a statute is "capable of being understood by reasonably well-informed persons in two or more different senses," it is ambiguous. Fred Cohen v. Liberty Mutual Insurance Company, 41 Mass. App. Ct. 748, 753 (1996). Long settled principles of statutory construction require that ambiguous statutory language be construed so as to avoid absurd or unreasonable results and to give effect to the Legislature's intent. See, e.g., EMC Corp. v. Commissioner of Revenue, 433 Mass. 568, 570 (2001); Manning v. Boston Redevelopment Authority, 400 Mass. 444, 453 (1987).
Applying these principles of construction to the relevant language of the Add Back statutes, the Board rejected the appellant's interpretation of the meaning and import of the phrase "as determined by the commissioner." First, the appellants' interpretation leads to the anomalous result that a taxpayer would bear two different standards of proof in challenging the disallowance of a deduction under the Add Back statutes, with a more demanding "clear and convincing" standard applicable during the Commissioner's review and a less onerous "preponderance" standard applicable to the appeal of the Commissioner's abatement determination to the Board. In fact, the appellants' view would effectively nullify the Commissioner's review of add-back transactions for any taxpayer willing to appeal to the Board: a taxpayer could produce scant or no evidence before the Commissioner and later receive a de novo hearing at the Board under the less burdensome preponderance of the evidence standard. This result plainly contravenes the intent of the statute and renders the "clear and convincing" language in the Add Back statutes meaningless for any taxpayer that prosecutes an appeal before the Board.
In contrast, the Commissioner's interpretation that the phrase "as determined by the Commissioner" directs her to provide guidance regarding the meaning of clear and convincing evidence is a sensible construction. The Commissioner has in fact provided such guidance, both in Technical Information Release ("TIR") 03-19 and 830 C.M.R. 63.31.1, each of which states that clear and convincing evidence is "evidence that is so clear, direct and weighty that it will permit the Commissioner to come to a clear conviction without hesitancy of the validity of the taxpayer's claim." The Commissioner's regulation adds that "[t]his evidentiary standard requires a strong showing of proof that instills a degree of belief greater than is required under the preponderance of evidence standard." 830 C.M.R. 63.31.1(2).
Because the appellants' interpretation of the phrase "as determined by the Commissioner" leads to an absurd result, while the Commissioner's interpretation is reasonable and sensible, the Board determined that the Commissioner's interpretation is correct. See Manning, 400 Mass. at 453 ("A statute or ordinance should not be construed in a way that produces absurd or unreasonable results when a sensible construction is readily available"); see also Flemings v. Contributory Retirement Appeal Board, 431 Mass. 374, 376 (2000) ("If a sensible construction is available, [courts] shall not construe a statute to make a nullity of pertinent provisions").
Moreover, "[a] statute 'must be interpreted according to the intent of the Legislature ascertained from all its words construed by the ordinary and approved usage of the language, considered in connection with the cause of its enactment, the mischief or imperfection to be remedied and the main object to be accomplished, to the end that the purpose of its framers may be effectuated.'" Wheatley v. Massachusetts Insurers Insolvency Fund, 456 Mass. 594, 601 (2010)(quoting Hanlon v. Rollins, 286 Mass. 444, 447 (1934)). The Add Back statutes were enacted in part in response to the Supreme Judicial Court's decision in The Sherwin-Williams Co. v. Commissioner of Revenue, 438 Mass. 71 (2002). See 830 C.M.R. 63.31.1. In Sherwin-Williams, discussed in greater detail below, the Court upheld the transfer and license-back of intangible property to a related corporate member, focusing on whether the disputed transactions "had any practical economic effects beyond the creation of . . . tax benefits." Sherwin-Williams, 438 Mass. at 85. Approximately five months after the Court's decision in Sherwin-Williams, the Legislature strengthened the judicially sanctioned inquiry, presumptively disallowing deductions for expenses paid to related parties, including those considered by the Court in Sherwin-Williams. The Add Back statutes require a taxpayer to demonstrate by clear and convincing evidence that add-back adjustments are unreasonable, and the Legislature explicitly "clarif[ied] its original intention that the taxpayer is required to possess for a transaction, both: (1) a valid, good-faith business purpose, other than tax avoidance; and (2) economic substance apart from the asserted tax benefit in order to claim a deduction, exemption or other tax benefit." St. 2003, c. 4, § 84; G.L. c. 63 §§ 31I(c) and 31J(b).
Against this backdrop, the notion that the Legislature would have intended that appeals relating to disputed add-back transactions be considered under a standard of proof more favorable to a taxpayer than upon review by the Commissioner is without logical support. In passing the Add Back statutes, the Legislature explicitly incorporated a heightened standard of proof into the review of transactions involving related member interest and intangible expenses and costs. Inclusion of the heightened standard of proof evinces an unmistakable intent to subject the transactions to closer scrutiny and provides a mechanism to effectuate this purpose. Yet, if the appellants' view were to prevail, a taxpayer could easily frustrate the Legislature's intent simply by offering the Commissioner nothing and then appealing an adverse decision from the Commissioner to meet a preponderance of the evidence standard at the Board. Further, as tax deductions are a matter of legislative grace, see, e.g., South Boston Savings Bank v. Commissioner of Revenue, 418 Mass. 695 (1994), the Legislature could have repealed the deductions affected by the Add Back statutes in their entirety. Instead, the Legislature chose to impose a higher standard in an area marked by significant abuse and litigation. See, The TJX Companies, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2007-790, 881, aff'd in part, remanded in part, Mass. App. Ct., No. 07-P-1570, Memorandum and Order under Rule 1:28 (April 3, 2009), aff'd, Mass. App. Ct., No. 09-P-1841, Memorandum and Order under Rule 1:28 (July 23, 2010); Cambridge Brands, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports, 2003-358, aff'd, 62 Mass. App. Ct. 1118 (2005); The Sherwin-Williams Co. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2000-468, rev'd 438 Mass. 71 (2002); Syms Corp. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2000-711, aff'd 436 Mass. 505 (2002).
The appellants also emphasize that when the Legislature passed the Add Back statutes, it left unchanged the Board's enabling statute, G.L. c. 58A, § 8, which allows the Board to determine its own rules of practice and procedure. The appellants then conclude that the Commissioner has asked the Board "to introduce a higher standard of proof to proceedings before the Board that the Legislature saw fit to leave unchanged."
General Laws, chapter 58A, section 8 provides, in relevant part, that proceedings before the Board "shall be conducted in accordance with such rules of practice and procedure as the board may make and promulgate." G.L. c. 58A, § 8. It does not dictate a standard of proof to be applied in proceedings before the Board. Rule 1.37 of the Board's Rules of Practice and Procedure is instructive in this regard and provides, in pertinent part:
Except as herein otherwise provided, the practice and procedure before the Board shall conform to that heretofore prevailing in equity causes in the courts of the Commonwealth prior to the adoption of the Massachusetts Rules of Civil Procedure; but the Board reserves the right to make hearings and proceedings as informal as possible, to the end that substance and not form shall govern . . . .

830 CMR 1:37. Practice and procedure in equity causes prosecuted in Massachusetts prior to adoption of the Massachusetts Rules of Civil Procedure in 1973 generally required that the party with the burden of proof establish that the relevant facts were more likely true than not. See Sullivan v. Hammacher, 339 Mass. 190, 194 (1959); Black v. Boston Consolidated Gas Co., 325 Mass. 505, 508 (1950). Thus, pursuant to Rule 1.37, a taxpayer appearing before the Board typically bears the burden of proving its case by a "preponderance of the evidence." See, e.g., Bayer Corp. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports, 2005-491. However, general equity practice and procedure do not control in the presence of a specific legislative mandate regardless of whether the statute requires a result contrary to the rule generally used before the statute was enacted. See Hurley v. Flanagan, 313 Mass. 567, 572 (1943) (noting that the burden of proof on a particular issue was traditionally on the plaintiff, but adopting a statutory rule that placed the burden on the defendant); see also Keith Mengel v. Justices of the Superior Court, 313 Mass. 238, 244 (1943) (adopting a statute's accelerated appeals process for injunctions in labor cases because the statute created a new procedure superseding the prevailing practice in equity).
In the instant appeals, the Add Back statutes provide an explicit statutory mandate requiring that a taxpayer who disputes the add back of related member interest or intangible expenses provide clear and convincing evidence to sustain its burden of proof. This specific statutory mandate controls notwithstanding the general application of the preponderance standard under equity practice.
Further, the Board has previously applied a heightened standard of proof without modifying its rules. Under U.S. Supreme Court and Supreme Judicial Court precedent, when disputing application of Massachusetts apportionment law, "the taxpayer has the 'distinct burden of showing by "clear and cogent evidence" that [the state tax] results in extraterritorial values being taxed.'" The Gillette Company v. Commissioner of Revenue, 425 Mass. 670, 680 (1997)(quoting Container Corporation of America v. Franchise Tax Board., 463 U.S. 159, 164 (1983)). The Board has applied this heightened standard on many occasions. See, e.g., W.R. Grace & Co.-Conn. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports, 2009-261; Advance Logic Research, Inc v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2008-19; NES Group, Inc. & Robert J. Tomsich v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports, 2008-1242; The Gillette Company v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports, 1996-362. It cannot be reasonably suggested that the Board should have ignored a clear judicial mandate and refused to apply a heightened standard of proof in those appeals by declaring that its rules only allowed it to apply the preponderance standard applicable in equity cases. It would be equally unreasonable for the Board to ignore the clear legislative mandate in these appeals.
In sum, neither G.L. c. 58A, §8, the Board's enabling statute, nor Rule 1.37 prevents the Board from applying the clear and convincing standard of proof prescribed by the Add Back statutes. Moreover, there is ample precedent to show that the Board has not hesitated to apply a heightened standard of proof pursuant to applicable judicial precedent.
Finally, the appellants argue that by seeking application of the clear and convincing standard at the Board, the Commissioner seeks to limit the discretion granted the Board by the Legislature. Noting that a proceeding before the Board is a de novo hearing of the facts and issues in dispute, see Commissioner of Corporations and Taxation v. J.G. McCrory Company, 280 Mass. 273 (1932), the appellants claim that, contrary to the Board's obligation to conduct a de novo hearing in the present appeals, the Commissioner "would have the Board confine its examination to a review of her determination that the appellants did not sustain their burden of proof by 'clear and convincing' evidence."
The Board found that its obligation to conduct a de novo hearing is entirely consistent with application of the clear and convincing standard. In J.G. McCrory Company, the Court considered the Commissioner's contention that the function of the Board was limited to a review of the Commissioner's action, and that the Board was not entitled to try a matter anew. Id. at 277. The Court disagreed, finding that a taxpayer's appeal to the Board meant "a full new trial or an entire rehearing upon all matters of fact and questions of law." Id. The Court made no mention of the standard applicable to proceedings before the Board. Indeed, there is no precedent to support the conclusion that application of the clear and convincing standard by the Board to the evidence presented by the appellants in these appeals would in any way impair "a full new trial or an entire rehearing upon all matters of fact and questions of law." The Board in fact conducted a de novo hearing in the present appeals and did not merely review the propriety of the Commissioner's action. Rather, having considered all the testimony and exhibits presented at the hearing of these appeals, together with the parties' stipulation of facts, the Board ruled that the appellants failed to produce clear and convincing evidence in support of their claims for abatement.
Based on the foregoing, the Board found and ruled that the "clear and convincing" standard applies to appeals involving application of the Add Back statutes.
Cash-management System
Pursuant to G.L. c. 63, § 30(4), a corporation's net income generally consists of gross income less the deductions, but not credits, allowed under the I.R.C. Pursuant to I.R.C. § 163(a), a corporation may deduct "all interest paid or accrued within the taxable year on indebtedness." For each of the tax years at issue in these appeals, the parties dispute whether claimed interest expenses associated with the appellants' cash-management system should be allowed.
There is no dispute that G.L. c. 63, § 31J, ("§ 31J") which presumptively disallows interest expense "paid, accrued or incurred to a related member," is applicable to claimed interest deductions relating to tax years 2002 and 2003. The deductions for tax year 2001, which precedes the effective date of the Add Back statutes, must be considered under prior law.
Tax Year 2001
For a transaction to give rise to a valid interest deduction, the transaction must constitute true indebtedness. Knetsch v. United States, 364 U.S. 361, 364-365 (1960). "Related but separate entities can freely enter into contracts including debt transactions, like any corporations or individuals." Overnite Transportation Company v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 1999-353, 370 (citing Bordo Products Co. v. United States, 476 F.2d 1312, 1323 (Ct. Cl. 1973)). However, courts examine these transactions with greater scrutiny because the transactions "do not result from arm's length bargaining." Overnite Transportation Company, Mass. ATB Findings of Fact and Reports at 1999-370 (citing Kraft Foods Co. v. Commissioner, 232 F.2d 118, 123-124 (2nd Cir. 1956)); see also, Overnite Transportation Company v. Commissioner of Revenue, 54 Mass. App. Ct. 180, 186 (2002) ("When 'the same persons occupy both sides of the bargaining table, form does not necessarily correspond to the intrinsic economic nature of the transaction, for the parties may mold it at their will with no countervailing pull'")(quoting Fin Hay Realty Co v. United States, 398 F.2d 694, 697 (3d Cir. 1968)). Under these circumstances, which are present in the current appeal, less emphasis is placed on the formal indicia of a debt instrument, which can be "meticulously made to appear" at the sole discretion of the parent. Id. at 697. Furthermore, the parties' characterization of the debt instrument in their books and records is not a controlling factor because the records are a product of the parties and are therefore not necessarily "a reliable reflection of the true nature of the transaction." New York Times Sales, Inc. v. Commissioner of Revenue, 40 Mass. App. Ct. 749, 753 (1996). "Rather, 'the indebtedness must be indebtedness in substance and not merely form.'" Overnite Transportation Company, Mass. ATB Findings of Fact and Reports at 1999-371 (quoting Midkiff v. Commissioner, 96 T.C. 724, 735 (1991)).
While "the issue of whether transfers between a subsidiary and its parent constitute debt has been extensively litigated, courts have not established a bright-line rule for making such a determination but have instead employed a case-by-case analysis based on the specific facts and circumstances of a particular case." The TJX Companies, Mass. ATB Findings of Fact and Reports at 2007-881. "The Board must review the facts and circumstances surrounding a purported inter-company loan to determine whether a true debt obligation exists." Id. at 882. Within the context of this review, "[i]t is well settled that a distribution by a subsidiary corporation to its parent is a loan and not a dividend if, at the time of its payment, the parties intended it to be repaid. Whether the parties actually intended the transaction to be a loan or dividend is an issue of fact. To resolve the issue, the courts apply a multi-factor analysis. No single factor is determinative; rather, all the factors must be considered to determine whether repayment or indefinite retention is intended." New York Times Sales, 40 Mass. App. Ct. at 752. (internal citations omitted).
In New York Times Sales, the Massachusetts Appeals Court upheld the Board's decision that sums transferred from a subsidiary to its parent were dividends and not loans. The Board had determined that the parties did not intend the transaction to be a loan in light of factors previously set forth in Alterman Foods, Inc. v. U.S., 505 F.2d 873 (5th Cir. 1974), and Alterman Foods, Inc. v. U.S., 611 F.2d 866 (Ct. Cl. 1979), and on appeal, the court sanctioned the Board's reasoning involving:

[S]everal factors [which] demonstrated that the parties intended that the cash transactions be dividends and not loans. They included (1) the amounts transferred were not limited in any manner; (2) there was no repayment schedule and no fixed dates of maturity; (3) the amounts 'upstreamed' to Times Company were intended to remain with the Times Company for use in fulfilling its various corporate purposes; (4) no interest was charged; (5) no notes or other evidences of indebtedness existed; (6) the transferred cash was not secured in any manner; (7) at no time did Times Sales request repayment; (8) there was no evidence that Times Sales had any expectations of repayment; and (9) at no time did Times Company make any effort to repay the amounts transferred to it by Times Sales.

New York Times Sales, 40 Mass. App. Ct. at 752. In the present matters, the appellants argue that the transactions within the cash-management system reflected bona-fide debt, citing loan agreements and associated promissory notes executed by Kimberly-Clark and participating subsidiaries that contained fixed ceilings on the loan amounts and set forth terms for borrowing over a period of time similar to a credit line. The appellants also emphasize that an "arm's-length" interest rate was charged, which was tied to a federal rate that under the I.R.C. qualified as an "adequate arm's-length interest rate" for federal tax purposes. Finally, the appellants note that the transactions at issue were treated as debt on the books of Kimberly-Clark via detailed ledger entries documenting the movement of cash among Kimberly-Clark and its subsidiaries.
Observing that the Loan Agreements and associated promissory notes make no mention of the appellants' cash-management system, the Commissioner disputes their relevance to the present analysis. The Board, however, accepted the appellants' testimony that the provided documentation reflected elements of the arrangement among Kimberly-Clark and its subsidiaries within the cash-management system. This conclusion notwithstanding, the Board found and ruled that the purported intercompany loans did not constitute bona-fide debt.
In The TJX Companies, having examined the facts and circumstances surrounding certain intercompany advances, "the Board found and ruled that . . . inter-company loans were not true debt because the advances were permanent in nature, were intended to remain indefinitely with TJX, and were unsecured. Additionally, TJX never made any effort to repay the loan princip[al] and the subsidiaries never requested repayment." The TJX Companies, Mass. ATB Findings of Fact and Reports at 2007-890. These same features characterized the appellants' cash-management system and were central to the Board's finding that the claimed loans did not constitute true debt.
All cash received by the participating subsidiaries was swept up to Kimberly-Clark on a daily basis. Having issued disbursements to the subsidiaries only to satisfy their operating needs, excess balances remained with Kimberly-Clark indefinitely. Notwithstanding the appellants' assertion that on any given day a participating entity could be in a net borrowing or lending position, at the end of each of the tax years at issue, Kimberly-Clark was in a net borrowing position.
No evidence presented indicated that any entity expected or received return of excess advances made to Kimberly-Clark during the tax years at issue. Similarly, there was no evidence to support a finding that Kimberly-Clark made any effort to repay those advances. Instead, interest simply continued to accrue on outstanding payable positions. The fact that excess balances remained with Kimberly-Clark indefinitely, coupled with the subsidiaries' failure to request or receive repayment of principal, led the Board to find that the advances were permanent. Thus, the Board could not conclude on the present record that the parties intended repayment of the excess advances.
As with the taxpayer's cash transfer agreements in The TJX Companies, the Loan Agreement and associated promissory notes made no provision for security, and contained no default or collateral provisions. Thus, the repayment provisions of the notes lacked substance because the subsidiaries did not have specified recourse to compel Kimberly-Clark to repay the claimed loans. Further, "[a]lthough some loans are made 'on signature,' the absence of a provision for security in a loan of [six hundred million dollars] is telltale that a 'loan' is not real, and so, also for the absence of meaningful enforcement mechanisms." Overnite Transportation Company, 54 Mass. App. Ct. at 189-90 (internal citations omitted). Under this precedent, the demand notes between Kimberly-Clark and Worldwide, valid for sums up to three billion dollars, and the Notes representing fixed sums of five hundred million dollars each, none of which provided for security or contained enforcement mechanisms, were certainly of sufficient magnitude to justify doubt regarding their substance.
Further, although Kimberly-Clark and its affiliates executed notes that provided for interest at a rate that may have passed muster for federal tax purposes, the appellants did not provide evidence to demonstrate that an independent third party lender would have extended loans at the same interest rate and on the same terms as the rate employed among Kimberly-Clark and its subsidiaries. These facts bolstered the conclusion that the various promissory notes did not represent arm's-length transactions. See, e.g. Overnite Transportation Company, Mass. ATB Findings of Fact and Reports at 1999-371.
The Board also found the appellants' failure to offer any explanation regarding the Notes telling. The Notes, which were ostensibly part of the appellants' cash-management system, represented obligations totaling one billion dollars and had specified repayment dates that preceded the hearing of these appeals. Yet the appellants offered no evidence as to whether or when the outstanding debt was retired, and if payment was not made, why the lack of payment does not undermine the appellants' assertion that all of the purported loans made under their cash-management system constituted bona-fide debt. The Board, therefore, found that the appellants' failure to submit such evidence further reinforced the finding that the purported loan arrangements that comprised the appellants' cash-management system did not constitute bona-fide debt.
Finally, although the appellants treated the cash-management transactions as debt on their books, as noted above, "the method by which two related businesses account for cash transfers on their internal financial records is not deemed to be a controlling factor in determining the nature of the transaction . . . such records, being the product of the parties, do not necessarily constitute a reliable reflection of the true nature of the transaction." New York Times Sales, 40 Mass. App. Ct. at 753.
In sum, with primary focus on the factors which indicated the permanent nature of the excess cash advances made within the appellants' cash-management system, including the absence of requests for, effort toward, or expectation of repayment or actual repayment, the Board found and ruled that the advances did not constitute bona-fide debt. This conclusion was reinforced by other factors such as the absence of security, default or collateral provisions attendant to the purported debt, as well as the appellants' failure to establish that the promissory notes represented arm's-length transactions. Accordingly, the Board upheld the Commissioner's disallowance of the interest expenses associated with the appellants' cash-management system for the tax year 2001.
Tax years 2002 and 2003
Having concluded that the interest expenses for tax year 2001 relating to the appellants' cash-management system should be disallowed, the same result is compelled for tax years 2002 and 2003. As previously noted, the nature of the transactions within the cash-management system did not change during the tax years at issue. The only potentially dispositive change for the latter tax years, therefore, is the application of § 31J. Section 31J requires add back of "otherwise deductible interest paid, accrued or incurred to a related member," unless, as relevant to these appeals, "the taxpayer establishes by clear and convincing evidence, as determined by the commissioner, that the disallowance of the deduction is unreasonable." G.L. c. 63, §§ 31J(a) and 31J(a)(1). There is no dispute that the interest at issue was "paid, accrued or incurred to a related member" within the meaning of § 31J, and is therefore subject to add back. Neither do the parties dispute that an obligation underlying a claimed interest expense must be bona-fide debt. See, e.g., 830 C.M.R. 63.31.1(2). Here, the only additional disputed issue is the heightened standard of proof to be borne by a taxpayer under the Add Back statutes. Having ruled that the "clear and convincing" standard should apply, and given that the appellants did not prevail under the less burdensome "preponderance of the evidence" standard for tax year 2001, the Board found and ruled that the appellants' case for tax years 2002 and 2003 must also fail. Accordingly, the Board upheld the Commissioner's disallowance of the claimed interest expenses associated with the appellants' cash-management system for tax years 2002 and 2003.

Royalty Expense - Tax Year 2002
The I.R.C. allows a deduction for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." I.R.C. § 162(a). For tax year 2002, the Commissioner disallowed expenses claimed by Kimberly-Clark for royalties paid to Worldwide, its wholly owned subsidiary.
The Board and Massachusetts courts have on several occasions, and with differing results, addressed whether royalty payments paid to an affiliated entity were deductible. See The TJX Companies, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2007-790, 881, aff'd in part, remanded in part, Mass. App. Ct., No. 07-P-1570, Memorandum and Order under Rule 1:28 (April 3, 2009), aff'd, Mass. App. Ct., No. 09-P-1841, Memorandum and Order under Rule 1:28 (July 23, 2010); Cambridge Brands, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports, 2003-358, aff'd, 62 Mass. App. Ct. 1118 (2005); The Sherwin-Williams Co. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2000-468, rev'd 438 Mass. 71 (2002); Syms Corp. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2000-711, aff'd 436 Mass. 505 (2002). The analysis in each of these cases centered upon application of the "sham transaction doctrine," which the Supreme Judicial Court has affirmed "gives the commissioner the authority 'to disregard, for taxing purposes, transactions that have no economic substance or business purpose other than tax avoidance.'" Sherwin-Williams, 438 Mass. at 79 (quoting Syms Corp., 436 Mass. at 509-10). This doctrine has for decades been applied to matters in which abusive tax avoidance mechanisms have been employed and "prevents taxpayers from claiming the tax benefits of transactions that, although within the language of the tax code, are not the type of transaction the law intended to favor with the benefit." Syms Corp., 436 Mass. at 510. "[T]he application of the doctrine is, of necessity, primarily a factual one, on which the taxpayer bears the burden of proof in the abatement process." Id. at 511. "Analyzing these decisions, and applying them to subsequent appeals, thus requires careful attention to the specific facts in each appeal." Fleet Funding, Inc. & Fleet Funding II, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2008-117, 163-64.
In Sherwin-Williams, the Supreme Judicial Court applied the sham transaction doctrine to the transfer and license-back of trademarks among a parent and its wholly-owned subsidiaries and traced the history of the doctrine, beginning with Helvering v. Gregory, 69 F.2d 809 (2d Cir. 1934), "the seminal case establishing the sham transaction doctrine." Sherwin-Williams, 438 Mass. at 81. The Court discussed varying judicial approaches to the doctrine, noting that "a number of Federal courts have adopted a 'two prong' sham transaction inquiry. The first prong of the inquiry examines whether the transaction has economic substance other than the creation of a tax benefit. . . . The second prong examines whether the transaction was motivated by any business purpose other than the creation of a tax benefit. . . ." Id. at 84.(citations omitted). Declining to adopt such "a rigid two step process," the Court favored a line of cases in which courts "opt[ed] instead to treat economic substance and business purpose as 'more precise factors to consider in the application of [the] traditional sham analysis; that is whether the transaction had any practical economic effects other than the creation of income tax losses." Id. at 85 (quoting Sochin v. Commissioner of Internal Revenue, 843 F.2d 351, 354 (9th Cir.), cert denied 488 U.S. 824 (1988)). In this regard, the court stated:
We agree with those courts that have concluded that whether a transaction that results in tax benefits is real, such that it ought to be respected for tax purposes, depends on whether it has had practical economic effects beyond the creation of those tax benefits. In the context of a business reorganization resulting in new corporate entities owning or carrying on a portion of the business previously held or conducted by the taxpayer, this requires inquiry into whether the new entities are "viable," that is, "formed for a substantial business purpose or actually engaging in substantive business activity." In making this inquiry, consideration of the often interrelated factors of economic substance and business purpose, is appropriate.

Sherwin-Williams, 438 Mass. at 85-86 (internal citations omitted). Applying these standards to the facts of Sherwin-Williams, the Court found that transfer and license-back arrangements among a parent and its subsidiaries "[were] a product and intended part of a business reorganization, and their economic substance and business purpose must be assessed not in the narrow confines of the specific transactions between the parent and the subsidiaries, but in the broader context of the operation of the resultant business." Id. at 86 (citing Northern Ind. Pub. Serv. v. Commissioner of Internal Revenue, 115 F.3d 506, 512 (7th Cir. 1997)). The court then held that "the reorganization, including the transfer and licensing back of the marks, had economic substance in that it resulted in the creation of viable business entities engaging in substantive business activity." Id.
As previously noted, in March of 2003, approximately five months after the Court's decision in Sherwin-Williams, the Legislature enacted the Add Back statutes, which presumptively disallow certain transactions among related members, including the type considered in Sherwin-Williams. In so doing, the Legislature also drew an explicit contrast with the analytic approach taken by the Court in Sherwin-Williams "clarif[ying] its original intention that the taxpayer is required to possess for a transaction, both: (1) a valid, good-faith business purpose, other than tax avoidance; and (2) economic substance apart from the asserted tax benefit in order to claim a deduction, exemption or other tax benefit." St. 2003, c. 4, § 84.
General Laws chapter 63, § 31I, ("§ 31I"), which addresses the add back of intangible expenses and is relevant to the contested royalty expenses relating to tax year 2002, provides in pertinent part:

(b) For purposes of computing its net income under this chapter, a taxpayer shall add back otherwise deductible interest expenses and costs and intangible expenses and costs directly or indirectly paid, accrued or incurred to, or in connection directly or indirectly with one or more direct or indirect transactions with, one or more related members.
(c) (i) The adjustments required in subsection (b) shall not apply if: (A) the taxpayer establishes by clear and convincing evidence, as determined by the commissioner, that the adjustments are unreasonable; or (B) the taxpayer and the commissioner agree in writing to the application or use of an alternative method of apportionment under section 42.
The present appeals represent the first instance in which a taxpayer appeal relating to intercompany expense deductions has been considered under § 31I. As such, the Board, while mindful of the judicial application of the sham transaction doctrine in Massachusetts, analyzed the facts and issues presented in these appeals in the context of the explicit provisions of § 31I, with consideration given to relevant public written statements issued by the Commissioner.
Kimberly-Clark did not agree in writing to the application of an alternative method of apportionment under Section 42. Thus, to assert an exception under § 31I, the appellants must "establish[] by clear and convincing evidence, as determined by the commissioner, that the adjustments are unreasonable." G.L. c. 63, § 31I(c)(i)(A). In 830 CMR 63.31.1 (the "Regulation"), the Commissioner has provided substantive guidance regarding the applicable exception to add back as follows:
The add back will . . . be considered unreasonable where the taxpayer establishes by clear and convincing evidence that it incurred the interest or intangible expense as a result of a transaction (1) that was primarily entered into for a valid business purpose and (2) that is supported by economic substance. However, a taxpayer will not carry its burden of demonstrating by clear and convincing evidence that a disallowance is unreasonable unless the taxpayer demonstrates that reduction of tax was not a principal purpose for the transaction. . . .
830 C.M.R. 63.31.1(4)(b). In the abstract, the appellants' proffered reasons for contributing intangible property to Worldwide and executing the various agreements attendant to the 1996 reorganization could evince both economic substance and business purpose, notwithstanding that a tax benefit may have accrued to the appellants. See Sherwin-Williams, 438 Mass. at 81 (quoting Gregory v. Helvering, 293 U.S. 465, 469 (1935))("The legal right of a taxpayer to decrease the amount of what would otherwise be his tax . . . by means which the law permits, cannot be doubted."). Regardless, when the various elements of the reorganization were scrutinized and viewed as a whole, the Board found that the disputed royalty expenses were subject to add back under § 31I.
Although Kimberly-Clark and KCTC ostensibly paid a royalty for use of the Patents which they had transferred to Worldwide, as well as for the licensed Trademarks, these payments were immediately returned to Kimberly-Clark by virtue of the operation of the company's cash-management system. The Board in The Talbots Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2009-786, noted its previous finding, and the Supreme Judicial Court's affirmation that "[s]uch a circular flow of funds among related entities does not indicate a substantive economic transaction for tax purposes." Id. at 2009-815 (quoting Syms Corp., Mass. ATB Findings of Fact and Reports at 2000-760)(additional citations omitted); see also The TJX Companies, Memorandum and Order Under Rule 1:28 (April 3, 2009) at 12 (affirming the Board's finding that the circular flow of funds between TJX and its subsidiary, which "allow[ed] TJX to claim royalty-expense deductions while receiving back the funds used to pay the royalties on a tax-free basis," indicated that the transfer and license-back transaction lacked economic substance).
The Court in Sherwin-Williams focused on the absence of a circular flow of funds and placed considerable weight on the subsidiaries' ability to invest royalties received from Sherwin Williams as an indication that the reorganization had economic substance:
Sherwin-Williams relinquished control over monies it previously retained but now paid to the subsidiaries as royalties. These monies were not returned to it as dividends. They were invested (and therefore placed at risk) by the subsidiaries, under their own investment guidelines and with third parties outside of Sherwin-Williams' control.

Sherwin-Williams, 438 Mass. at 87. Worldwide, of course, had no such discretion, as royalties were immediately returned to Kimberly-Clark under the cash-management system. Moreover, to the extent that this return of capital exceeded operational disbursements from Kimberly-Clark, interest expense deductions indefinitely accrued to Kimberly-Clark.
Also central to the Court's holding that the reorganization in Sherwin-Williams had economic substance was that the subsidiaries to which the trademarks had been transferred "entered into genuine obligations with unrelated third parties for use of the marks." Id. Such is not the case in the present appeals. Despite statements by the appellants to the contrary, the record does not reflect that Worldwide negotiated or entered into third party licensing agreements with respect to the intellectual property it owned or managed. Absent such third party license agreements, licensing agreements among Kimberly-Clark, Worldwide and various affiliated entities were de facto exclusive licenses. As the Board found in The TJX Companies, "a transfer and license-back transaction between a parent and its wholly-owned subsidiary which results in a de facto exclusive license arrangement is not an arm's-length transaction." The TJX Companies, Mass. ATB Findings of Fact and Reports at 2007-854. See also Syms Corp., Mass. ATB Findings of Fact and Reports at 2000-767 ("If the subsidiary was truly independent, it could have licensed the Marks to whomever would pay it the highest royalty rates.").
A substantial part of the appellants' argument relating to the disputed royalties is dedicated to their assertion that the facts of the present appeal compare favorably with those in Sherwin-Williams. In particular, the appellants emphasize the following: as did the marks in Sherwin-Williams, legal title to and possession of the Patents passed to Kimberly-Clark's subsidiary; Sherwin-Williams had two part-time employees, whereas Worldwide had many; and the activities of the subsidiaries in Sherwin-Williams to which the marks had been transferred were confined to maintenance and management of intangibles by a single employee while Worldwide had several functional operating groups. The appellants assert that these comparisons indicate that the facts and circumstances of the present matter far exceed the threshold for economic substance established in Sherwin-Williams. This assertion, coupled with what the appellants characterize as sound business purposes underlying the formation of Worldwide and the transfer and licensing of the Patents and Trademarks, lead the appellants to conclude that the royalty expenses incurred by Kimberly-Clark for tax year 2002 were improperly disallowed.
Despite the appellants' attempts to draw favorable comparisons between the present case and Sherwin-Williams, they disregard countervailing considerations relevant to the analysis in Sherwin-Williams and virtually ignore the impact of § 31I.
While discussing Sherwin-Williams, the appellants make no reference to either the circular flow of funds evident between Kimberly-Clark and Worldwide during 2002 or the lack of licenses negotiated by Worldwide with independent third parties. In Sherwin-Williams, the absence of a circular flow of funds and the presence of third-party licenses were two of the three factors that the Court found supported a finding of economic substance underlying Sherwin-Williams' reorganization. This distinction is important not only because it argues strongly against a finding for the appellants under the tests articulated in Sherwin-Williams, but because those tests have been modified and strengthened by the Add Back statutes. More specifically, since passage of § 31I, to avoid add back of the royalty expenses at issue here, a taxpayer must demonstrate, by clear and convincing evidence, the presence of both economic substance and valid business purpose as well as that tax reduction was not a principal purpose of the transaction.
After the 1996 reorganization, the appellants' business structure evinced a circular flow of funds and the absence of third party license agreements entered into by Worldwide. The Board found that, taken together, these factors substantially undermine the appellants' assertion of economic substance supporting the 1996 reorganization as required by § 31I.
The Board was also influenced by the appellants' inconsistent treatment of the Patents and the Trademarks within the 1996 reorganization. The appellants provided great detail regarding their claimed need to consolidate Kimberly-Clark's and KCTC's intellectual property within one entity, as well as the need to contribute the Patents to Worldwide as part of that consolidation. Yet the record offers no explanation as to why Kimberly-Clark and KCTC contributed the Patents to Worldwide but retained ownership of the Trademarks. Had Kimberly-Clark and KCTC retained ownership of the Patents as they did with the Trademarks, the substantial royalty payments and consequent expense deductions currently at issue would not have accrued to Kimberly-Clark. The Board thus found that Kimberly-Clark's unexplained inconsistent treatment of Patents and the Trademarks undermined its assertion that a principal purpose of the 1996 reorganization was not tax reduction. This finding is buttressed by Kimberly-Clark's explicit statement in the Project Partners Communication Guide that the reorganization would result in "significant tax savings," as well as the dominant role played by company tax personnel and Ernst & Young in the development, implementation and oversight of the reorganization.
The heightened standard of proof also weighs upon the appellants. The Regulation defines "clear and convincing evidence" as "evidence that is so clear, direct and weighty that it will permit the Commissioner to come to a clear conviction without hesitancy of the validity of the taxpayer's claim. This evidentiary standard requires a strong showing of proof that instills a degree of belief greater than is required under the preponderance of evidence standard." 830 C.M.R. 63.31.1(2).
As discussed above, the present appeal is characterized by: a circular flow of funds surrounding the transfer and license back arrangement; the absence of third party license agreements negotiated by Worldwide; unexplained inconsistent treatment of the Patents and the Trademarks; and specific acknowledgement of significant tax savings attendant to the 1996 reorganization. The Board found that, cumulatively, these factors substantially impaired the appellants' assertions that the reorganization which gave rise to the disputed royalties was supported by economic substance, was motivated primarily by a valid business purpose, and lacked tax reduction as one of its principal purposes. Particularly when viewed in light of the requirement that the appellants present "clear and convincing" evidence supporting their assertions, the various and significant facts bearing negatively upon the appellants' case lead the Board to rule that the appellants failed to sustain their burden of demonstrating that the add back of the disputed royalty expense was unreasonable within the meaning of § 31I.
Purported Rebate Payments - Tax Year 2003
For tax year 2003, the appellants undertook to reduce inefficiences in their "supply-chain management" process. Toward this end, Kimberly-Clark purchased and put in place an "SAP information system" that provided the company with a central information source for the entire supply-chain management process. The SAP system was coordinated from within a single newly formed entity, Global. For tax year 2003, Global controlled Kimberly-Clark's supply-chain management process. Within the new operating structure, "certified suppliers" including Kimberly-Clark, Worldwide and other affiliated entities manufactured products on a contract basis.
Each of the certified suppliers and Global were guaranteed a specified rate of return. Worldwide alone was not guaranteed a rate of return, but received compensation based on "cost savings." These savings were designed to approximate the savings realized by the certified suppliers through use of the Patents. The purported cost savings were remitted monthly to Worldwide by Global in the form of "rebate" payments after Global and the certified suppliers had received their guaranteed returns from sales proceeds. Worldwide received this compensation, according to the appellants, for bearing the entire business risk associated with sale, or lack thereof, of products.
Not one of the certified suppliers paid a royalty, defined or described as such, for the use of the Patents. Rather, the sole identified royalty within this structure was paid by Global to Worldwide in the annual sum of approximately one million dollars. No evidence was submitted regarding how this sum was derived or why it represented an arm's-length payment for the Patents. Global sublicensed the Patents to the certified suppliers without specified charge.
The Board found the appellants' assertion that Worldwide bore the business risks associated with product sales untenable. Kimberly-Clark is a publicly traded corporation, and the risks and rewards of its business activities and those of its affiliates, which are almost exclusively derived from the manufacture and sale of its products, flow directly to Kimberly-Clark. The Board therefore found unpersuasive the argument that Kimberly-Clark and other affiliated entities were isolated from business risks, and that as of 2003 those risks were borne by Worldwide.
The Board was similarly not persuaded by the appellants' unequivocal assertion that "rebate" payments for "cost savings" were not related to use of Worldwide's Patents. Beginning with the 1996 reorganization and continuing throughout 2002, Worldwide was compensated at a rate of between 3% and 3.3% of billions of dollars of sales for use of the Patents, sums which the appellants characterized as reflecting fair value. During 2003, the Patents were used by substantially the same entities to perform the same tasks - produce Worldwide's branded products. In his testimony, Mr. Beauvais stated that the certified suppliers' production was not possible without the Patents. Similarly, the "cost savings" and consequent "rebate" payments made to Worldwide were made possible only through use of the Patents sublicensed by Global to the certified suppliers who were all affiliates of Kimberly-Clark. These facts notwithstanding, the sole declared royalty payment for 2003, made by Global to Worldwide, amounted to a tiny fraction of royalties paid to Worldwide during 2002. Further, Worldwide continued to perform much the same functions it had prior to the 2003 reorganization.

The Board found that the "rebate" payments in fact represented payment for use of the Patents based on: the effective discontinuance of royalty payments during tax year 2003, which the appellants had previously characterized as fair compensation for use of Worldwide's Patents; the certified suppliers' continued use of the Patents, without which production would not have been possible; and the appellants' untenable assertion that the "rebate" payments represented compensation to Worldwide for its full assumption of business risk associated with the sale of products.
Having concluded that the "rebate" payments were made for the use of the Patents, the Board also found and ruled that the payments were subject to add back under § 31I. Section 31I defines "intangible property" as patents, patent applications, trade names, trademarks, service marks, copyrights, mask works, know-how, trade secrets, and similar types of intangible assets." See also 830 C.M.R. 63.31.1(2). The rebate payments, which were made for use of "intangible property" as the term is defined in § 31I and the Regulation, were not identified as royalty payments by the appellants. The Regulation, however, defines an "embedded royalty" as a "portion of a cost or expense paid, accrued or incurred by a taxpayer for property received from or services rendered by a related member that relates to intangible property owned by such related member or to an intangible expense paid, accrued or incurred by said related member in a direct or indirect transaction with one or more other related members." 830 C.M.R. 63.31.1(2) and (3). Having concluded that the "rebate" payments represented payment for use of the Patents, the Board found that the "rebate" payments were embedded royalties, to which the intangible expense add back applies. See 830 C.M.R. 63.31.1(3).
The appellants, having unequivocally denied that the "rebate" payments represented sums associated with use of the Patents, presented no evidence to support the conclusion that the payments qualified for an exception from add back under § 31I. Absent such evidence, the Board found and ruled that the Commissioner's add back of the sums associated with the purported rebate payments was proper.
Conclusion
On the basis of the foregoing, the Board found and ruled as follows: for those issues involving application of the Add Back statutes, the appellants bore the burden of proving their case by "clear and convincing evidence"; interest deductions associated with the appellants' cash-management system were properly disallowed by the Commissioner under § 31J and prior law; the appellants failed to establish that royalties paid by Kimberly-Clark to Worldwide were not subject to add back under § 31I; and purported rebate payments, which the Board found were in fact embedded royalties, were properly subject to add back under § 31I.
Accordingly, the Board issued a decision in favor of the appellee in these appeals.

THE APPELLATE TAX BOARD

By: ________________________________
Thomas W. Hammond, Jr., Chairman

Commissioner Scharaffa issued the following Opinion, concurring in part and dissenting in part:

I. Introduction
I concur in part and dissent in part, and I write separately to express my reasons because of the significant issue involved and its potential impact on numerous future tax appeals. I concur in the decision as it relates to tax year 2001 because, in making its findings and rulings for tax year 2001, the majority applied the correct standard of proof, the preponderance of the evidence standard ("preponderance standard"). However, with respect to tax years 2002 and 2003, which involve additional issues and evidence not considered for tax year 2001, I dissent from the decision because it was reached using an incorrect standard of proof. For those tax years, the majority, purporting to follow the mandate of G.L. c. 63, §§ 31I and 31J (together, "Add Back Statutes") applied a clear and convincing standard of proof ("clear and convincing standard") in making its decision. I decline to join the majority in its statutory construction as I am guided by the plain language of the Add Back Statutes, the Board's enabling statute, its own rules, and vast precedent in tax law and administrative law, which require the Board to apply the preponderance standard.
Because the majority applied the wrong standard of proof in reaching its decision with respect to the tax year 2002 and 2003 appeals, those appeals should be remanded to the Board for determination using the preponderance standard, which is the proper standard of proof.

II. The Majority's Interpretation Ignores the Plain Language of the Add Back Statutes

General Laws c. 63, § 31I ("§ 31I") provides, in relevant part: "[f]or purposes of computing its net income under this chapter, a taxpayer shall add back otherwise deductible interest expenses and costs and intangible expenses and costs directly or indirectly paid, accrued or incurred to, or in connection directly or indirectly with one or more direct or indirect transactions with, one or more related members." Section 31I further states that these adjustments shall not apply if:
(A) the taxpayer establishes by clear and convincing evidence, as determined by the commissioner, that the adjustments are unreasonable; or (B) the taxpayer and the commissioner agree in writing to the application or use of an alternative method of apportionment under section 42. Nothing in this subsection shall be construed to limit or negate the commissioner's authority to otherwise enter into agreements and compromises otherwise allowed by law. (emphasis added).

Similarly, G.L. c. 63, § 31J ("§ 31J") provides "[f]or purposes of computing its net income under this chapter, a taxpayer shall add back otherwise deductible interest paid, accrued or incurred to a related member." Section 31J further provides that a deduction shall be permitted when either:

(1) the taxpayer establishes by clear and convincing evidence, as determined by the commissioner, that the disallowance of the deduction is unreasonable, or (2) the taxpayer and the commissioner agree in writing to the application of an alternative method of apportionment under Section 42. Nothing in this subsection shall be construed to limit or negate the commissioner's authority to otherwise enter into agreements and compromises otherwise allowed by law. (emphasis added).

Section 31J also provides that the adjustments shall not apply if the taxpayer establishes several factors "by clear and convincing evidence, as determined by the commissioner," including that a principal purpose of the transaction giving rise to the payment of interest was not to avoid payment of taxes and that the interest was the result of an arm's-length transaction.
Thus, the Add Back Statutes provide that the adjustments will not apply if the taxpayer proves "by clear and convincing evidence, as determined by the commissioner" that they are "unreasonable," and both statutes provide that the adjustments will not apply if the taxpayer and the Commissioner agree in writing to an alternate method of apportionment under G.L. c. 63, § 42. In addition, the Add Back Statutes expressly state that they do not "limit or negate the commissioner's authority to make adjustments under [G.L. c. 63] sections 33 and 39A."
Likewise, G.L. c. 62C, § 3A ("§ 3A"), which the Legislature enacted along with the Add Back Statutes, provides that:
the commissioner may, in his discretion, disallow the asserted tax consequences of a transaction by asserting the application of the sham transaction doctrine or any other related tax doctrine, in which case the taxpayer shall have the burden of demonstrating by clear and convincing evidence as determined by the commissioner that the transaction possessed both: (i) a valid, good-faith business purpose other than tax avoidance; and (ii) economic substance apart from the asserted tax benefit. . . . [T]he taxpayer shall also have the burden of demonstrating by clear and convincing evidence as determined by the commissioner that the asserted nontax business purpose is commensurate with the tax benefit claimed. Nothing in this statute shall be construed to limit or negate the commissioner's authority to make tax adjustments as otherwise permitted by law. (emphasis added).

As is evident from the statutory language, the focus of the Add Back Statutes and of § 3A is on administrative stages prior to review by the Board, namely, the tax return filing stage and the Commissioner's review during the examination and abatement stages. Nothing in the language of the Add Back Statutes or in § 3A indicates an intent to raise the standard of proof in proceedings before the Board. Rather, the plain language of the statutes confines the clear and convincing standard to determinations made by the Commissioner, and the statutes must be so interpreted and applied. See White v. City of Boston, 428 Mass. 250, 253 (1998) ("The statutory language is plain and unambiguous, and we are constrained to follow it.")
The majority's use of legislative intent to buttress its interpretation is unavailing. Where, as here, the statutory language is plain and unambiguous, an inquiry into the legislative intent behind it is inappropriate. It is "[a] salient principle of statutory construction . . . that where the language of a statute is plain and unambiguous, legislative history is not ordinarily a proper source of construction." New England Medical Center Hospital, Inc. v. Commissioner of Revenue, 381 Mass. 748, 750 (1980) (citing Hoffman v. Howmedica, Inc., 373 Mass. 32, 37 (1977)).
Further, the authority cited by the majority, St. 2003, c. 4, § 84, does not support its contention. Following the Supreme Judicial Court's decision in Sherwin-Williams Co. v. Commissioner of Revenue, 438 Mass. 71 (2002), the Legislature enacted the Add Back Statutes together with § 3A, which codified the sham transaction doctrine, purportedly to "clarif[y] its original intention that the taxpayer is required to possess for a transaction, both: (1) a valid, good-faith business purpose, other than tax avoidance; and (2) economic substance apart from the asserted tax benefit in order to claim a deduction, exemption or other tax benefit." St. 2003, c. 4, § 84. That language reflects the Legislature's intent to expressly require taxpayers to demonstrate that transactions possess both economic substance and a valid business purpose, not just one or the other, a requirement which may have changed the result in Sherwin-Williams.
Although the sham transaction doctrine was developed by federal and state courts and is often referred to as part of the common law of tax, see IDC Research, Inc. et al. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2009-404, 502, aff'd, 2010 Mass. App. LEXIS 1530 (Mass. App. Ct. Nov. 30, 2010), legislative bodies may enact statutes to heighten the requirements necessary to avoid the imposition of the sham transaction doctrine. For instance, statutes may specify additional factors that must exist or be proven by the taxpayer, as in § 3A and the Add Back Statutes, and in Internal Revenue Code ("I.R.C.") § 7710(o), which Congress recently enacted to codify the sham transaction doctrine.
However, nowhere in St. 2003, c. 4, § 84, in § 3A, or in the Add Back Statutes does the Legislature express an intent to raise the Board's standard of proof in reviewing such matters from the preponderance standard to a clear and convincing standard. Assuming arguendo that the language contained in St. 2003, c. 4, § 84 reflected an intent to have a clear and convincing standard apply to the Board, the statutory language did not give effect to that intent. "Where, as here, the language of the statute is clear, it is the function of the judiciary to apply it, not amend it." Commissioner of Revenue v. Cargill, Inc., 429 Mass. 79, 82 (1999), (citing King v. Viscoloid, Co., 219 Mass. 420, 425, (1914) ("[W]e have no right to . . . read into the statute a provision which the Legislature did not see fit to put there, whether the omission came from inadvertence or of set purpose.")). If the Add Back Statutes and § 3A embody the Legislature's attempt to raise the standard of proof in certain proceedings before the Board, that attempt was botched. The plain language of the Add Back Statutes and § 3A limits the application of a clear and convincing standard to determinations made by the Commissioner, and, absent express statutory authority, it is not the place of the Courts or this Board to use a clear and convincing standard when it was not made the applicable standard of proof.
Further, the view shared by the appellee and the majority, that the language "as determined by the commissioner" is merely an instruction to the Commissioner to provide "guidance," is both novel and strained. When the Legislature intends to instruct the Commissioner to provide "guidance," it knows exactly how to do so. See G.L. c. 62C, § 37C(c) ("The commissioner shall promulgate rules and regulations to carry out the provisions of this section, which rules and regulations shall include procedures for determining and approving of all settlements."); G.L. c. 63, § 32E(d) ("The commissioner shall promulgate regulations or other guidelines as he deems necessary to implement this section."); G.L. c. 63, § 31L(d) ("The commissioner shall promulgate rules and regulations relative to the administration and enforcement of this section."). The Legislature knows how to direct the Commissioner to issue regulations or other guidance, and, contrary to the majority's view, it did not do so in the Add Back Statutes or in § 3A.
Moreover, had the Legislature intended for a clear and convincing standard to be applied in determinations other than those made by the Commissioner, it could have used less restrictive language by omitting the words "as determined by the commissioner." For example, G.L. c. 62C, § 33(f) ("§ 33(f)") allows for the abatement of tax penalties "[i]f it is shown that any failure to file a return or to pay a tax in a timely manner is due to reasonable cause and not due to willful neglect." Unlike the Add Back Statutes and § 3A, § 33(f) does not say reasonable cause "as determined by the commissioner," nor does it specify to whom reasonable cause must be shown. The absence of specific or limiting language in § 33(f) indicates that reasonable cause must be shown at each and every level of review, and the Board has in fact made determinations as to reasonable cause in numerous penalty cases. See Commissioner of Revenue v. Wells Yachts South, Inc., 406 Mass. 661, 663 (1990); Sign of the Surf, Inc. v. Commissioner of Revenue, 47 Mass. App. Ct. 830 (1999), rev. denied, 430 Mass. 1111 (1999); Littlefield Management, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2008-1160, 1166. The specific and restrictive language used by the Legislature in the Add Back Statutes and in § 3A evidences its intent to limit a clear and convincing standard to determinations made by the Commissioner. See Anderson Street Associates v. City of Boston & another, 442 Mass. 812, 817 (2004) ("Had the Legislature intended G.L. c. 121A to guarantee tax concessions to be permanent, it could have included statutory language to that effect. It has done so elsewhere."); Cargill, Inc., 429 Mass. at 82 ("Had the Legislature intended to limit the credit in the manner advocated by the commissioner, it easily could have done so."). The statutory construction employed by the majority is not supported by the language used in the Add Back Statutes or in § 3A.
III. The Majority's Interpretation Ignores The Board's Statutory Authority, its Own Rules, and Well- Established Legal Precedent

The majority's application of a clear and convincing standard in these appeals is erroneous because, among other reasons, it ignores the Board's statutory authority and its own rules. The Board is authorized by its enabling statute, G.L. c. 58A, § 8, to promulgate its own "rules of practice and procedure." 831 CMR 1.37 of the Board's Rules provides that "practice and procedure before the Board shall conform to that heretofore prevailing in equity causes in the courts of the Commonwealth prior to the adoption of the Massachusetts Rules of Civil Procedure." The standard rule in equity cases prior to the adoption of the Massachusetts Rules of Civil Procedure was that the party bearing the burden of proof was required to meet its burden by a preponderance of the evidence, which means that the party must show that the facts necessary to prevail in its claim were more likely true than not. See Gates v. Boston and Maine Railroad, 255 Mass. 297, 301 (1926); Black v. Boston Consol. Gas Co., 325 Mass. 505, 508 (1950); Sullivan v. Hammacher, 339 Mass. 190, 194 (1959). The Board's decisions are, in turn, reviewed for substantial evidence, that is, such evidence as a reasonable mind would accept as adequate to support a conclusion. New Bedford Gas & Edison Light Co. v. Assessors of Dartmouth, 368 Mass. 745, 749 (1975); Tenneco, Inc. v. Commissioner of Revenue, 401 Mass. 380, 383 (1987).
Further, the majority's use of a clear and convincing standard ignores both the Board's history and abundant legal precedent which clearly establish that the preponderance standard is the proper standard of proof. Created by the Legislature in 1930 as the Board of Tax Appeals, the Board was modeled on the federal Board of Tax Appeals, which was established in 1924 and is now the United States Tax Court. The preponderance standard adopted by the Board is the same standard employed by its federal counterpart, on which it was modeled, as well as the other federal courts in which tax appeals may be brought, the United States Court of Claims and the United States District Court. See Gerald A. Kafka & Rita A. Cavanaugh, Litigation of Federal Civil Tax Controversies, § 8.01 (2nd ed. 1997); U.S. Tax Court Rule 142(a); Danville Plywood Corp. v. United States, 16 Cl. Ct. 584, 601 (Cl. Ct. 1989).
Moreover, the preponderance standard is the standard of proof generally applicable in administrative proceedings in Massachusetts. Administrative decisions, like the Board's, are in turn reviewed for substantial evidence. See Craven v. State Ethics Commissioner, 390 Mass. 191, 200, 202 (1983); City of Gloucester v. Civil Service Commission, 408 Mass. 282, 297 (1990). Although the Board is exempted from the provisions of Massachusetts' Administrative Procedures Act, G.L. c. 30A, it is nonetheless "bound by 'general principles affecting administrative decisions and judicial review of them.'" New Bedford Gas & Edison Light Co., 368 Mass. at 749 (quoting Assessors of New Braintree v. Pioneer Valley Academy, Inc., 355 Mass. 610, 612, n. 1 (1969)). Consistent with these principles, and in accordance with its own rules, the Board conducts independent, de novo hearings and uses the preponderance standard in making its decisions to ensure procedural due process. Assessors of New Braintree, 355 Mass. at 612; Space Building Corporation v. Commissioner of Revenue, 413 Mass. 445, 450 (1992).
Courts have been reluctant to apply a standard of proof greater than the preponderance standard in civil proceedings. See Department of Public Health v. Cumberland Cattle Co., 361 Mass. 817, 830 (1972); Craven, 390 Mass. at 200; Herman & MacLean v. Huddleston, 459 U.S. 375, 389 (1983); Medical Malpractice Joint Underwriting Assoc. of Mass. v. Commissioner of Insurance, 395 Mass. 43, 46-47 (1985). "[T]he adoption of an intermediate standard of proof, such as the 'clear and convincing' standard, too often serves 'as the functional equivalent for the more familiar "reasonable doubt" standard.'" Medical Malpractice Joint Underwriting Assoc. of Mass., 395 Mass. at 47 (citations omitted). "[S]uch intermediate standards of proof in civil cases should not be extended." Cumberland Cattle, 361 Mass. at 830. See also P.J. Liacos, Massachusetts Evidence 201 (6th Ed. 1994). The burden of proof is typically placed on the party in possession of the facts or the party seeking relief or change. See Moore v. Kulicke & Soffa Industries, Inc., 318 F.3d 561, 571 (3rd. Circ. 2003); United States v. Denver & R.G.R. Co., 191 U.S. 84, 91-92 (1903). However, "while the difficulty of ascertaining where the truth lies may make it appropriate to place the burden of proof on the proponent of an issue, it does not justify the additional onus of an especially high standard of proof." Cooper v. Oklahoma, 517 U.S. 348, 366-67 (1996) (holding that statute which required proof of incompetence to stand trial by clear and convincing evidence violated due process).
Generally, cases in which a clear and convincing standard has been applied are cases in which the burden of proof is on the government, such as when the government is asserting that a taxpayer engaged in civil fraud or when the government is trying to prove "knowing conduct" on the part of a foundation manager, see U.S. Tax Court Rule 142(b) and (c), or cases involving exceptional - often irreversible - circumstances. For example, a third-party seeking to terminate life-sustaining treatment to an incompetent party may be required to prove by clear and convincing evidence that the incompetent person would so desire. Cruzan v. Director, Mo. Dept. of Health, 497 U.S. 261, 280 (1990). Similarly, an unemancipated, unmarried minor seeking to obtain an abortion without parental notification may be required to show by clear and convincing evidence that she is entitled to bypass parental notification. See Ohio v. Akron Center for Reproductive Health, 497 U.S. 502, 515-516 (1990). These cases illustrate that the imposition of a heightened standard of proof would raise due process concerns, and they underscore that the heightened clear and convincing standard should not be "extended" to ordinary civil cases, Cumberland Cattle, 361 Mass. at 830, but should be reserved for "a very limited number of cases where 'particularly important individual interests or rights are at stake,'" Craven, 390 Mass. at 200 (quoting Herman & MacLean, 459 U.S. at 389) (other citations omitted), or when the burden of proof is on the government.
Those circumstances were lacking in the present appeals. These appeals involve civil claims for the abatement of tax, exactly the type of claim the Board routinely decides using the preponderance standard. Moreover, the burden of proof in these appeals was not on the Commissioner, but on the appellant, which makes the use of a clear and convincing standard all the more inappropriate. Though none of the circumstances in which it is appropriate to apply a clear and convincing standard in a civil matter was present, the majority applied a clear and convincing standard because it seemed "reasonable" to do so. This was error.
As the majority correctly points out, the Board has applied a heightened standard of proof in certain previous appeals when applicable legal authority required it to do so. In appeals involving a taxpayer's constitutional challenge under the Commerce Clause on the states' apportionment method, Supreme Court and Supreme Judicial Court precedent requires the application of a heightened, although slightly different, standard of proof. See Container Corp. of Am. v. Franchise Tax Board, 463 U.S. 159, 164 (1983) (quoting Exxon Corp. v. Department of Revenue of Wisc., 447 U.S. 207, 221 (1980)) ("[T]he taxpayer has the 'distinct burden of showing by "clear and cogent evidence" that the [state tax] results in extraterritorial values being taxed.'"); See also Gillette Co. v. Commissioner of Revenue, 425 Mass. 670, 680 (1997). In the present appeals, neither the applicable statutes nor any other legal authority requires or even permits the application of a clear and convincing standard. The majority's allusion to such cases is therefore inapposite. Moreover, neither the appellee nor the majority has cited any other instance in federal or Massachusetts tax law where such a heightened standard of proof has been placed on a taxpayer seeking a tax abatement or refund.

IV. Conclusion

Accordingly, I concur in the majority's decision insofar as it relates to tax year 2001 because the majority applied the correct standard of proof. However, with respect to tax years 2002 and 2003, the majority's use of a clear and convincing standard not only misreads the plain language of the statutes at issue but also ignores the Board's statutory authority, its own rules, and decades of relevant federal and Massachusetts precedent. Because it was reached using an incorrect standard of proof, I dissent from the decision with respect to tax years 2002 and 2003.

By: _________________________________
Frank J. Scharaffa, Commissioner

A true copy,

Attest: _______________________
Clerk of the Board

For tax year 2002, Kimberly-Clark filed Schedules ABI, Exceptions to the Add Back of Interest Expenses, and ABIE, Exceptions to the Add Back of Intangible Expenses, with its corporate excise return, claiming exceptions from add back under G.L. c. 63, §§ 31I and 31J. In connection with these filings, Kimberly-Clark asserted that the add back of interest expense would result in double taxation. During opening statements relating to these appeals, the appellants conceded the add-back issue as it related to their prior assertion of double taxation. Consequently, the Board found that double taxation of interest expense was not an issue contested in the appeals.
For tax year 2003, Global filed Forms ABI and ABIE with its corporate excise return, claiming exceptions from add back under G.L. c. 63, §§ 31I and 31J. Global did not assert that the add back of any of the claimed expenses would result in double taxation.
The record in these matters reflects that for the tax years ending December 31, 2001 and December 31, 2002, Kimberly-Clark served as the manager for the appellants' cash-management system. Although the Commissioner states that Global "took over for [Kimberly-Clark] as the cash manager for the group" for the tax year ended December 31, 2003, the record does not establish Global's role for the 2003 tax year. Regardless, the evidence presented gave no indication that the nature of the transactions connected with the cash-management system materially changed during the tax years at issue.
Amounts swept up included interest and royalty "payments" made among the affiliated entities.
In certain instances, none of which were explained in detail by the appellants, the "federal mid-term or long-term rate" was to be employed.
The Loan Agreement and each of the attached promissory notes were executed by one individual, W. Anthony Gamron, in his capacity as Treasurer of Kimberly-Clark and Worldwide.
As with other assertions relating to the disputed issues, the appellants did not substantiate these claims with expert testimony or documentary evidence.
Worldwide remained a wholly owned subsidiary of KCTC until 2000, when KCTC was liquidated into Kimberly-Clark.
The sole signatory to these eight agreements, on behalf of each party, was Mr. John W. Donehower. Mr. Donehower executed the agreements in his capacity as president of Worldwide and Senior Vice President and Chief Financial Officer of Kimberly-Clark and of KCTC.
The royalty rates were based on the results of a transfer pricing study performed by Ernst & Young. The record does not reflect when or on whose behalf the study was performed. Although precise sums are not apparent from the record, sales to which the royalty was applicable totaled several billion dollars per year after the 1996 reorganization.
Neither Kimberly-Clark nor KCTC paid a royalty for use of trademarks it still owned. A portion of the royalty, however, reflected compensation for use of the other entity's trademarks.

These agreements include: a "License and Technical Assistance Agreement" by and between Global and Kimberly-Clark, as well as a first amended version of the agreement; a "Supply and Service Agreement" by and between Kimberly-Clark and Global, as well as a first amended and restated version of the agreement; a "License and Technical Assistance Agreement" by and between Worldwide and Global, as well as a first amended version of the agreement; and a "Supply and Service Agreement" by and between Worldwide and Kimberly-Clark, as well as a first amended and restated version of the agreement.
During his testimony, Mr. Beauvais stated that "we do have some production that may come from a totally unrelated party. There can be various facets of a particular product. But in this discussion, it would be probably not real material". (Tr. Vol.1, pg.123). However, he also unequivocally acknowledged that all of the certified suppliers were affiliated corporations.
The appellants did not describe the timing of these transactions or precisely how they were accounted for within the cash-management system.
In their brief, and with reference to trial testimony, the appellants state that Worldwide continued throughout 2003 to have the right to sublicense the Trademarks, implying that the Trademarks' ownership had not changed since the 1996 reorganization. The License and Technical Assistance Agreement[s] relating to the Global reorganization, however, indicate that as of January 1, 2003, Worldwide owned the Trademarks. The record does not reflect when, how or if this property was contributed to Worldwide.
Passed by the Legislature as emergency acts during 2003, the Add Back statutes were made effective for tax years beginning on or after January 1, 2002. St. 2003, c. 4, § 87.
For a transaction to be disregarded for tax purposes, some courts have required that both business purpose and economic substance be absent. See, e.g., Rice's Toyota World, Inc v. Commissioner, 752 F.2d 89, 91 (4th Cir. 1985). Others will disregard a transaction if either business purpose or economic substance is lacking. See, e.g., Coltec Industries, Inc. v. United States, 454 F.3d 1340 (Fed. Cir. 2006).
Had the appellants asserted double taxation, a different exception would have applied to the disputed expenses.
The third factor was that legal title and physical possession of the marks passed from Sherwin-Williams to its subsidiaries, as did the Patents in this matter. Sherwin-Williams, 438 Mass. at 86.


ATB 2011-2

Kimberly-Clark Corporation & Kimberly-Clark Global Sales, Inc. v. Commissioner of Revenue (January 31, 2011)

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