Cost of Transfer Pricing Expertise Drives States' Interest in Joint Section 482 Audits

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By Dolores W. Gregory  


Competition for qualified transfer pricing auditors and economists is part of the drive behind the Multistate Tax Commission's discussions about establishing a joint Section 482 audit program, a New Jersey official said Aug. 9.

The MTC's Joint Audit Program currently conducts corporate income, sales and use, franchise, and gross receipts tax audits on behalf of member states. It is studying the cost of hiring additional staff to work exclusively on transfer pricing issues.

“This is an immensely complex area of the law and it is difficult to attract and recruit talent in this area at the compensation levels that I can provide in state government,” Michael Bryan, director of the New Jersey Division of Taxation, told BNA.

The ideal recruit for New Jersey would be someone retiring from the Internal Revenue Service who specialized in tax code Section 482 issues and wants to keep working for a few more years, Bryan said. But those individuals are quickly snatched up by Big Four accounting firms and law firms with transfer pricing practices.

“You can work for New Jersey for $90,000 or $100,000 a year or work for Ernst & Young or Baker & McKenzie for three or four times that,” he said. “That's what we're competing against.”

Costs Not Yet Clear

Joe Huddleston, executive director of the MTC, told BNA that the agency is now looking into the cost of hiring outside auditors and other experts.

“We are trying to determine what our next steps need to be, what our budget concerns need to be in terms of the costs of hiring personnel to do this or training personnel,” he said.

“We are leaning towards hiring new personnel--at least two auditors, an attorney, a consulting economist, and in all likelihood, a disclosure officer,” he said.

If the MTC established a dedicated transfer pricing audit program, Huddleston explained, the agency would be requesting and receiving federal tax information, which involves compliance with federal regulations on confidentiality. That would make a full-time disclosure officer a necessary position, he said.

He declined to speculate about the overall budget of such a program, but said it would not work economically unless at least six states signed on and agreed to support it. There would need to be a multiyear commitment among those states, he said, and only participating states would share the costs.

Huddleston said he hopes to have a concrete proposal for the MTC's December executive committee meeting in New Orleans.

“To put in place a program as complicated as this one would be, we are looking at 2014 sometime,” he added.

Supplement State Efforts

Bryan told BNA that an MTC transfer pricing program would help to supplement work of New Jersey audit staff, which numbers about 300 examiners in the state and across the country. Staff auditors deal with transfer pricing, he said, but New Jersey does not have the resources to hire four or five full-time staffers dedicated solely to Section 482 issues.

Under a joint program of the MTC, states could share the costs of a dedicated team and might be able to offer more competitive salaries than they could on their own, Bryan said.

Not every MTC member state would have a need for the program, however. Bryan said transfer pricing is more of an issue for separate filing states--such as New Jersey--in which each company with nexus in the state files its own return, regardless of whether it is part of a group of related companies.

Separate filing has come under scrutiny in recent years because it allows multistate taxpayers to structure their activities so that profits can be shifted to low- or no-tax states. Consequently, a number of states--roughly half--have moved to combined filing, under which related companies are required to calculate their corporate income tax based on the activities of the entire group.

Stephen P. Kranz, partner with McDermott Will & Emery, told BNA that a transfer pricing audit program at the MTC would be a sensible way for states to share the cost of such audits, which tend to be more complex and expensive. Smaller states, in particular, may benefit from a multistate approach, he said.

“My only concern is that if the MTC is going to do it, they need to make sure the program is staffed with people who truly understand transfer pricing and what each state's law requires in that regard,” he said.

Bruce Ely, partner with Bradley Arant Boult Cummings LLP in Birmingham, Ala., said he is dubious about the prospect of joint MTC transfer pricing audits, given his experience with multistate audits in other areas.

“My primary concern is more global,” he said. “The MTC is attempting to force a square peg into a round hole, as they do with their multistate audits, by overlaying Section 482 concepts onto varying state laws, regulations, and judicial interpretations. That bothers many tax practitioners who've had to pick up the pieces following one of these multistate audits.”

He added, “Section 482 or its state equivalent is a powerful tool that needs to be handled with caution by state governments and MTC officials, including compliance with the various state administrative procedure acts.”

Chainbridge Method

Kranz suggested that state interest in a joint MTC transfer pricing audit program might reflect a growing disenchantment with the use of contractor auditors such as Chainbridge Software LLP, which has been involved in controversies around the country. The company had come under fire for its patented method of analysis, which practitioners say improperly aggregates controlled and uncontrolled transactions.

“If the states are going to adequately address Section 482 transfer pricing issues through audits, they need to build a mechanism that understands transfer pricing and how to audit within each state's law for transfer pricing issues,” he said.

Kranz represented Microsoft Corp. in its successful challenge to a $2.75 million assessment by the District of Columbia, which relied on a transfer pricing study by Chainbridge. A District of Columbia administrative law judge found that Chainbridge's method was “useless in determining whether Microsoft's controlled transactions were conducted in accordance with the arm's length standard” (85 DTR H-1, 5/3/12).

Another taxpayer, BP Products North America Inc., has a suit pending over similar issues in D.C. Superior Court that is scheduled for trial in February. Even though the District lost the Microsoft case, it has renewed its contract with Chainbridge (84 DTR K-1, 5/1/13).

Kranz noted that New Jersey is one of several states that had worked with Chainbridge in the past but dropped the contract after taxpayers complained about the company's methods. Chainbridge had been a subcontractor for Teradata Operations Inc., and had generated $72 million in assessments and more than $15 million in collections (67 DTR J-1, 4/9/12).