Bloomberg BNA’s 2015 Survey of State Tax Departments demonstrated a continued lack of uniformity among the states, as they craft tax policies to maximize revenue in an evolving, multi-jurisdictional economy and still balance constitutional limitations on taxation under the commerce and due process clauses. The murkiness of state income tax regimes is only amplified when standard apportionment methods and filing methodologies do not fairly reflect a corporation’s income in a specific state and a state, if authorized, turns to alternative apportionment or forced combination.
Last month, Indiana issued four Letters of Findings resulting from administrative appeals where the department had employed forced combined reporting after concluding that the original returns did not fairly reflect the income derived from conducting business in Indiana. Based on these rulings, Indiana has been aggressive in attempting to force combined reporting or separate accounting when the department believes the default filing rules have produced distortive results.
Letters of Findings 02-20140599 involved a manufacturer of consumer and industrial products who had filed separate returns for tax years 2007 - 2009. The audit concluded that taxpayer and its subsidiaries, should report their income on a combined basis, based on the authority provided under Ind. Code Ann. § 6-3-2-2(m), and the taxpayer filed a protest.
On administrative appeal, the taxpayer’s protest was denied. The Letter of Findings noted the stark profit disparity between the taxpayer’s subsidiary, which had received more than 250 percent profit on it intercompany sales, while the taxpayer received less than 5 percent profit on the sales of its products.
In Letters of Findings 02-20140139, the department exercised its authority to achieve the opposite result. The taxpayer, a group of 20 affiliates, reported its income by filing Indiana “consolidated” income tax returns. Twelve of the affiliated companies reported profits between tax years 2003 and 2011; however, the taxpayer ultimately reported losses for those same tax years because three of the consolidated companies incurred substantial losses.
The audit concluded that the taxpayer should have reported its income on a consolidated, separate accounting basis. As the auditor explained, the separate computation sought to “neutralize the ability of the huge apportionment numbers of three companies to distort the 100 percent apportionment of the majority of the affiliates and therefore ‘fairly reflect’ Indiana source income.”
The taxpayer challenged the justification underlying the audit and resulting tax increase, citing Wabash, Inc. v. Department of State Revenue, 729 N.E.2d 620 (Ind. Tax Ct. 2000) for the proposition that the department prefers the standard method of apportionment. The letter acknowledged that “[t]he lesson from Wabash is that both the law and the Department favor the standard, “simple” consolidated calculation “unless the Department proves that income attributed to Indiana from using that formula is out of proportion to the business transacted in Indiana.”
The department did not come out ahead in all four letters, though, with taxpayers prevailing in two cases. The common theme for both taxpayer victories was that the department had failed to meet its burden of establishing that the taxpayer’s return produced a distortion of income.
In Letters of Findings 02-20140660, the taxpayer, an out-of-state utility company selling its services to customers inside and outside of Indiana, filed Indiana consolidated returns for 2008 - 2010 to report the income of 17 subsidiaries. In sustaining the taxpayer’s protest of the audit of those returns, the decision found that “[t]he audit report may be entirely correct in its summarization, but [it]…does not meet the burden of demonstrating that the originally filed consolidated returns produced an ‘incongruous’ result...”
The taxpayer in the fourth and final ruling is an entity that both manufactures and sells services, engaging in retail only in Indiana. An audit of tax years 2010 – 2012 concluded that the taxpayer engaged in intercompany transactions and should file on a combined return basis with its subsidiaries. In its protest, the taxpayer admitted to engaging in intercompany transactions but argued that the auditor did not show distortion.
Letters of Findings 02-20140588 found that the intercompany transactions were used as the sole basis for requiring mandatory combined reporting, the taxpayer’s protest was sustained because “[t]he audit did not present facts or otherwise demonstrate that these transactions distorted or unfairly reflected the Taxpayer’s Indiana income.”
When there are significant intercompany transactions or related entities that do not file in Indiana under default methodology, taxpayers and their advisors should be prepared to defend the results of such structures from Indiana tax authorities.
Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: do the results of these Indiana Letter of Findings indicate a change in the Indiana Department of Revenues stance on combined reporting?
Additional discussion of forced combination and unitary combined reporting can be found in Bloomberg BNA's State Tax Portfolio: 1130-2nd T.M., Income Taxes: Consolidated Returns and Combined Reporting.
by Cannon-Marie Green
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