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Transfer Pricing Issues in the State Arena

Transfer Pricing Issues in the State Arena. Robert E. Weyman Denise M. Obrochta 16 May 2014. Background . Transfer Pricing: Overview. Authority to Make Transfer Pricing Adjustments. IRC § 482 – The Federal Model.

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Transfer Pricing Issues in the State Arena

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  1. Transfer Pricing Issuesin the State Arena Robert E. WeymanDenise M. Obrochta 16 May 2014

  2. Background

  3. Transfer Pricing: Overview

  4. Authority to Make Transfer Pricing Adjustments

  5. IRC § 482 – The Federal Model • Internal Revenue Code (“IRC”) §482 and supporting and extensive regulations • IRC §482 – Allocation of income and deductions “In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. In the case of any transfer (or license) of intangible property (within the meaning of section 936(h)(3)(B), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible.”

  6. IRC § 482 – The Federal Model (continued) • Purpose of IRC §482: • Clearly reflect income • Attributable to controlled transactions, and • To prevent avoidance of taxes regarding such transactions • Places controlled taxpayer on tax parity with uncontrolled taxpayer by determining true taxable income • Not restricted to case of: • improper accounting, • fraudulent or sham transactions, or • to case of device designed to reduce or avoid tax by shifting or distorting income, deductions, credits, or allowances • Extends to any case in which taxable income of controlled taxpayer is other than it would have been had taxpayer been dealing at arm’s length with uncontrolled taxpayer • Section 4.11.5.2 Audit Manual (Nov. 1, 2004) Overarching policy goal/theme

  7. IRC § 482 – The Federal Model (continued) • This issue may arise when one entity: • Makes loan or advance and charges no interest or non-arm's-length interest rate • Performs services without charge or at non-arm’s-length charge • Leases property at non-arm's-length rental charge • Sells property at non-arm's-length sales price • Leases intangible property for no royalty fee or non-arms-length fee • Enters into cost sharing arrangement to share costs to develop intangibles but all related costs are not shared • Section 4.11.5.2 Audit Manual (Nov. 1, 2004)

  8. IRC § 482 – The Federal Model (continued) • Treas. Reg. § 1.482 establishes guidelines for determining arm’s length pricing under IRC § 482 – Extensive and well-developed regulations • “Best Method Rules” – Specific methods available for tangible goods, intangible goods, and services; but method to be used is “facts and circumstances” dependent based on “most reliable measure.” See Treas. Reg. §1.482-1(c).”

  9. Extension of the Principles of the Federal Model • Other countries largely subscribe to The Organization for Economic Co-operation and Development’s (“OECD”) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration • International association of 34 member countries, including the U.S. • Mission “is to promote policies that will improve the economic and social well-being of people around the world” • http://www.oecd.org/ctp/transfer-pricing/

  10. Extension of the Principles of the Federal Model (continued) • U.S. state taxing authorities • Incorporation of IRC §482 • §482-type statute • Forced combination statutes • Related party expense addition modification Remember overarching policy goal/theme!

  11. State Incorporation of §482

  12. State Related Party Expense Addition Modifications • 23 states have this modification:

  13. State Related Party Expense Addition Modifications (continued) • Exceptions to addition modification for arm’s length pricinggenerally coupled with “lacks tax avoidance” component • Legal tension between §482 and addback requirements

  14. State 482 Problem: Reliance • New York Example • Forced combination power before unitary theory. N.Y. Comp. Codes R. & Regs. tit. 20, § 6-2.1 (2007). • Analysis required three prongs with third prong, §482 pricing, most critical: • taxpayer owns or controls substantially all of stock of another corporation; • group of corporations is engaged in unitary business; and • distortion of income would result if the corporations reported separately • Judicial Evolution • In re The Sherwin-Williams Company, DTA No. 816712 (N.Y.S. Div. of Tax Appeals June 7, 2001); In re The Sherwin-Williams Company, DTA No. 816712 (N.Y.S. Div. of Tax Appeals June 5, 2003) • In re Lowe’s Home Centers, Inc., DTA No. 818411 (N.Y.S. Div. of Tax Appeals Sept. 30, 2004) • In re Hallmark Marketing Corporation, DTA No. 819956 (N.Y.S. Div. of Tax Appeals Jan. 26, 2006 • Compare, Comptroller v. Gannett Co., 741 A.2d 1140 (Md. Dec. 9, 1999)

  15. State 482 Problem: Reliance

  16. In what type of state tax statutes might IRC§482 transfer pricing concepts arise? • Forced combination statutes • Intangible/interest expense addition modification statutes • Discretionary authority to allocation items of income/expense statutes • All of the above

  17. In what type of state tax statutes might IRC§482 transfer pricing concepts arise? • Forced combination statutes • Intangible/interest expense addition modification statutes • Discretionary authority to allocation items of income/expense statutes • All of the above

  18. Enforcement Trends

  19. Audit Trends—Third Party Auditors

  20. Audit Trends—Multi-State Tax Commission Program?

  21. Audit and Appeal

  22. Assessment Issues

  23. Working with the auditor and positioning self for appeal • Can you use prior DOR positions against them • Earlier audits of your company • Audits and litigation for other taxpayers • Ongoing litigation? • Has the Department argued to increase transfer price for an in-state entity • Does statutory authority require determination of “correct” price—potential for increasing the price? • Avoiding time and document intensive appeals

  24. Case Study—Massachusetts

  25. Other Issues to Consider

  26. Contact Information Robert E. Weyman p-215.851.8160 rweyman@reedsmith.com Denise M. Obrochta p-312.207.2773 dobrochta@reedsmith.com

  27. Reed Smith LLP – State Tax Practice Chicago ▪ Los Angeles ▪ New York Philadelphia ▪ San Francisco ▪ Washington, D.C. Lee A. Zoeller 215 851 8850 lzoeller@reedsmith.com Adam P. Beckerink 312 207 6528 abeckerink@reedsmith.com Brent K. Beissel 215 851 8869 bbeissel@reedsmith.com Stephen J. Blazick 215 8518877 sblazick@reedsmith.com A. Sonali Carlson 212 549 0433 acarlson@reedsmith.com Marty H. Dakessian 213 457 8310 mdakessian@reedsmith.com Daniel M. Dixon 215 851 8854 ddixon@reedsmith.com Frank J. Gallo 215 851 8860 fgallo@reedsmith.com Jennifer Goldstein 212 521 5406 jsgoldstein@reedsmith.com David J. Gutowski 215 851 8874 dgutowski@reedsmith.com Christine M. Hanhausen 215 851 8865 chanhausen@reedsmith.com Michael A. Jacobs 215 851 8868 mjacobs@reedsmith.com Kenneth R. Levine 215 851 8870 klevine@reedsmith.com Sara A. Lima 215 851 8872 slima@reedsmith.com Michael I. Lurie215 241 5687mlurie@reedsmith.com Erin J. Mariano 415 659 4750 emariano @reedsmith.com Paul E. Melniczak 215 851 8853 pmelniczak@reedsmith.com John R. Messenger 415 659 5992 jmessenger@reedsmith.com Kelley Miller 215 851 8855 kmiller@reedsmith.com Jeffrey A. Mills 412 288 5724 jmills@reedsmith.com Denise M. Obrochta 312 207 2773 dobrochta@reedsmith.com Michael P. Penza215 851 8851mpenza@reedsmith.com Jamie S. Reichardt 215 851 8165 jreichardt@reedsmith.com Alexandra E. Sampson 202 414 9486 asampson@reedsmith.com Mike Shaikh 213 457 8044 mshaikh@reedsmith.com Kyle O. Sollie 215 851 8852 ksollie@reedsmith.com Brian W. Toman 415 659 5994 btoman@reedsmith.com Jack Trachtenberg 212 521 5414 jtrachtenberg@reedsmith.com Jennifer C. Waryjas 312 207 6470 jwaryjas@reedsmith.com Shirley J. Wei 213 457 8217 swei@reedsmith.com Robert E. Weyman 215 851 8160 rweyman@reedsmith.com Michael J. Wynne 312 207 3894 mwynne@reedsmith.com Aaron M. Young 212 521 5478 ayoung@reedsmith.com Gordon Yu 212 521 5476 gyu@reedsmith.com

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