BP Products Seeks Summary Judgment Ruling Chainbridge Assessment Invalid

The Bloomberg BNA Tax Management Weekly State Tax Report filters through current state developments and analyzes those critical to multistate tax planning.

By Dolores W. Gregory

Chainbridge Software LLC “unlawfully violated the fundamental purpose” of tax code Section 482 in a transfer pricing study it conducted for the District of Columbia, BP Products North America Inc. charged in a motion for summary judgment filed recently in D.C. Superior Court (BP Products North America Inc. v. District of Columbia, D.C. Super. Ct., No. 2011 cvt 10619, motion for summary judgment filed 9/24/12).

BP Products is seeking to vacate a $722,585 assessment by the D.C. Office of Tax and Revenue (OTR) that was based on a Chainbridge study indicating the taxpayer had shifted revenue to affiliates outside the district during tax years 2006 to 2008.

The taxpayer also is asking the court to rule that the Chainbridge approach is invalid as a matter of law and to order OTR to refund the tax paid.

In a brief in support of its motion, BP Products charged that Chainbridge committed numerous errors, including the misapplication of federal transfer pricing guidelines by improperly aggregating transactions with both related and unrelated parties.

Approximately 79 percent of the company's sales of refined products were to third parties and were “by definition” at arm's length, the company said. Nevertheless, these sales were included in the Chainbridge analysis of whether BP Products North America (BPPNA) had properly priced its transactions with related parties.

“This inclusion of sales to third parties in the analysis is a fatal flaw in the methodology and invalidates the entire assessment as arbitrary,” the company said in its brief.

BPPNA counsel James McBride of Baker Donelson Bearman, Caldwell & Berkowitz PC told BNA Oct. 24 that the parties are seeking to delay a pretrial conference scheduled for Nov. 9.

“We just filed a joint motion to adjust the scheduling order to allow Judge [John] Campbell time to rule on the summary judgment motion before we have to go through the pre-trial procedures,” McBride said. “That motion also would give OTR until early in November to respond to the summary judgment motion.”

Chainbridge Controversy

Chainbridge is a Fairfax, Va. contractor that conducts state transfer pricing studies with a patented method of analysis. The company has been at the center of a long-brewing multistate controversy in which taxpayers have been pushing back against massive assessments arising from its transfer pricing studies.

In previous interviews with BNA, Chainbridge founder Eric Cook defended the company's methods as consistent with federal transfer pricing regulations.

In the district, the company had conducted a number of transfer pricing studies as a subcontractor to ACS State and Local Solutions. Stephen Cordi, deputy chief financial officer with OTR, told BNA in April that the program had led to more than $10 million in collections.

BP Products is the second major multinational to challenge OTR's transfer pricing assessment in a public forum. Microsoft Corp. in late 2010 filed an administrative appeal of a $2.75 million assessment arising from a Chainbridge study, and sought summary judgment in its challenge to the assessment.

In April 2012, an administrative law judge for the D.C. Office of Administrative Hearings struck down that assessment, ruling that the transfer pricing analysis on which it was based was “useless in determining whether Microsoft's controlled transactions were conducted in accordance with the arm's length standard.”

In granting Microsoft's motion for summary judgment, Judge Paul Handy found that the method used by Chainbridge to analyze the company's transfer pricing ran counter to federal Section 482 regulations and was, therefore, “arbitrary, capricious and unreasonable.”

The Microsoft ruling is on appeal to the D.C. Court of Appeals, but the D.C. Superior Court in August rejected the district's motion to stay proceedings in BP Products pending the outcome of Microsoft.

BPPNA's brief cites the Microsoft ruling as an authority, noting that the analysis was “precisely the same” and aggregated both controlled and uncontrolled transactions into a “top line number to compare to a similar number from comparable companies.”

Method Flawed

BPPNA's brief said the Chainbridge method “assumes that it can simplistically look at overall profit levels even though, pursuant to extensive federal regulations, an analysis of whether a taxpayer has properly priced its transactions with affiliates requires a detailed, specific analysis of each taxpayer's unique facts and circumstances.”

The company noted that BPPNA is a subsidiary of the vertically integrated oil and gas company BP PLC, and is “specifically engaged” in refining and marketing of petroleum products, an activity often referred to as the “downstream” side of the business. Exploration and production--the business of other BP affiliates--is the “upstream” side.

Any facts and assumptions that might be accurate in regard to BP PLC do not necessarily apply to BPPNA, the company noted.

The taxpayer at issue is BPPNA and “not the vertically integrated parent,” the company said. “This same holds true with respect to any 'comparable' chosen.”

In its analysis, Chainbridge relied on BPPNA's total sales receipts to arrive at a net profit to sales ratio for the company. This failure to distinguish between related and unrelated parties violates a fundamental provision of federal transfer pricing guidelines, because it does not arrive at a net profit to sales ratio for any specific intercompany transactions, nor for intercompany transactions with a specific subsidiary.

'Should Have a Profit'

For tax years 2005 to 2008, Chainbridge found that BPPNA had ratios of net profit to sales ranging from negative 0.8 percent to negative 2 percent. It then compared these ratios to those of other companies in the oil and gas industry, figures it had derived from a database of financial statements. The comparables, BPPNA argues, are not similar “downstream” refining and marketing companies, but reflect the consolidated reports of entire corporate groups.

For example, in the 2008 tax year, Chainbridge compared BPPNA sales, cost of goods sold, operating expense, net profit, and net profit to sales ratio to such integrated oil and gas companies as Imperial Oil Ltd., Exxon Mobil, Chevron Texaco, Amerado Hess Corp., and others.

It determined that the bottom of the interquartile range for 15 oil and gas companies' net profit to sales ratio was 4.2 percent and the top was 12.8 percent, with a median of 8.6 percent.

Based on these calculations, Chainbridge determined that to increase BPPNA income to the median--increasing its net profit to sales ratio from negative 2.0 percent to 8.6 percent--the company's income must be adjusted upward by $12.6 billion.

“In effect, the result of the 'analysis' was that even though BPPNA had a loss for the year it should have a profit of 8.6 [percent] of its total sales.”

This income adjustment for 2008, combined with similar adjustments for 2006-07, led to the deficiency assessment of $722,585.

Failure to Identify Suspect Transactions

The adjustment was made without identifying any controlled transaction that had been improperly priced, the taxpayer said.

Without identifying suspect transactions, the Chainbridge study violates another fundamental tenet of transfer pricing--that for every adjustment upward in one jurisdiction, there is a “correlative adjustment” downward in another jurisdiction.

“The only thing the Commissioner of Internal Revenue under §482, or the Mayor in the case of the District, can do is shift revenue and expenses and the resulting income between affiliates--they cannot create income. That means that if more income is shifted to BPPNA, then necessarily the income of other members of the affiliated group must be reduced,” the taxpayer said.

Under the Chainbridge method, “correlative adjustments are impossible,” the taxpayer said.

“From an equitable standpoint, it puts BPPNA in an untenable position in which it is subject to D.C. tax on the same income that an affiliate was previously taxed, and no one, including BPPNA and Chainbridge, can identify the affiliate that necessarily reported too much taxable income.”


Copyright 2012, The Bureau of National Affairs, Inc.