Wed, Oct 14, 2020
Although U.S. multi-state transfer pricing enforcement is not a new concept, the intercompany pricing of transactions between U.S. entities located in different states, and the associated support for such pricing, may not intuitively top the list of important tax considerations for many U.S. corporations. Historically, non-unitary states have used various approaches to address the potential for multi-state taxpayers to use transfer pricing to reduce state income tax burdens (e.g., forced combination, related-party addback, alternative appointment and nexus assertion) with limited success. Taxpayers, on the whole, have been successful in arguing against these states’ efforts to combat the effects of intercompany transactions on state tax burdens, and state tax authorities have consistently been required to adhere to federal transfer pricing regulations (codified under the Internal Revenue Code (IRC) section 1.482). In 2015, the Multi-state Tax Commission (MTC) created an initiative in which member states would share information and train audit teams to more successfully dispute corporations’ domestic transfer pricing practices. At that time, only 12 states had adopted the MTC’s initiative, and the MTC’s transfer pricing committee (the State Intercompany Transactions Advisory Service) had failed to gain widespread state support.
However, with COVID-19 and the resultant strain on states’ revenues and costs, the pricing of domestic intercompany transactions has once again become a focus for state tax authorities looking to ensure that income is appropriately taxed within their state. Based on an analysis by the National Conference of State Legislatures,1 state revenue from corporate taxation represented only 4.8% of the total state tax collections in 2018, down from 9.4% in 1981, with analysts predicting that states are likely collecting only about a third of what is actually owed. In the past, states have posited that the decrease in corporate tax collection was due, in part, to the tax planning of corporations, locating high value assets in subsidiaries incorporated in lower tax jurisdictions (e.g., Washington, Nevada, Wyoming, South Dakota and Ohio that do not tax corporate income). Transfer pricing, as conducted under the federal application of IRC Section 1.482 (U.S. Transfer Pricing Regulations), has historically been relegated to an alternative method to be used in challenging state corporate income tax returns, when traditional state tax methods proved unsuccessful. Given their recent losses in state tax courts,2 state tax authorities (particularly those located in the southeast) have made several changes to their approach to transfer pricing to bolster their capabilities and reach.
Most states generally provide broad discretionary powers to the State Commissioners of Revenue, allowing for adjustments that follow the principles described under the U.S. Transfer Pricing Regulations. However, state tax authorities have historically chosen a state-specific approach in the form of forced combined reporting, addback of related-party expenses, alternative apportionment, and/or nexus assertion. In addition, very few states have the experience or technical resources required to properly evaluate transfer prices. State revenue office-led transfer pricing studies, using an approach outside of the U.S. Transfer Pricing Regulations, have had difficulty prevailing against a transfer pricing study consistent with those regulations prepared by the taxpayer. As a result, states are turning their attention to the use of the U.S. Transfer Pricing Regulations as a tool to help capture lost revenue due to potential tax base erosion, and to help offset broader losses in tax revenues and increased costs associated with COVID-19. Recent actions employed by the states to this end include:
Anticipating that these initiatives will result in some level of success in capturing additional revenue from state taxpayers, we would expect additional states to employ similar initiatives and engage in even greater information sharing and cooperation.
The increased focus on multi-state transfer pricing and resulting initiatives will primarily affect corporations that file in separate reporting states, such as Alabama, Arkansas, Delaware, Georgia, Florida, Indiana, Iowa, Louisiana, Maryland, Mississippi, Missouri, North Carolina, Oklahoma, Pennsylvania, South Carolina, Tennessee and Virginia.4 Taxpayers with significant tax impacts from interstate intercompany transactions involving these states should prepare themselves for increased scrutiny and potential for dispute. As with transfer pricing strategies in general, it’s always beneficial to be proactive in your defense and be in a position to state your company’s position (i.e., “tell your own story”) before an audit situation arises, forcing you to react to the state’s position.
In anticipation of the increased scrutiny on state transfer pricing, and with indications that states are preparing to take a more aggressive and capable stance on transfer pricing enforcement, companies that prepare separate returns or that have intercompany transactions that are not eliminated through the use of a consolidated or combined state tax return should similarly review and strengthen support of their domestic transfer pricing policies.
Read Transfer Pricing Times – Third Quarter 2020
Sources
1.https://www.ncsl.org/blog/2018/09/27/the-decline-in-state-corporate-income-taxes.aspx
2.For example, courts have limited the state’s authority to reject transfer pricing studies and positions submitted by taxpayers in Columbia Sportswear USA Corp. v. Ind. Dept. of Revenue, 50 N.E.3d 147 (2016); E.I. Dupont de Nemours and Company v. Indiana Dep’t. of State Revenue, 79 N.E.3d 1016 (Ind. Tax Court 2017); and Utah State Tax Commission v. See’s Candies, Inc. 435 P.3d 147 (Utah 2018).
3.The 12 member states of the 2015 MTC initiative on transfer pricing include Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi, Missouri, New Jersey, North Carolina, Pennsylvania and South Carolina.
4.Of these states Alabama, Arkansas, Florida, Indiana, Iowa, Mississippi, Missouri, Oklahoma, South Carolina, and Virginia have an option to elect / request to file on a combined or consolidated basis.
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