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| Eric Tresh |
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| Jonathan Feldman |
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| Justin Brown |
While these initiatives may be attractive to some taxpayers, other taxpayers are likely to think twice before participating. This article discusses the pros and cons of participating in these and similar programs.
North Carolina's Transfer Pricing Resolution Initiative
North Carolina's transfer pricing resolution initiative was launched on Aug. 1, to "fairly and consistently expedite the resolution of corporate intercompany pricing issues ... provide certainty and uniformity to taxpayers, reduce time in disputes, and form an efficient basis for resolution of this corporate tax issue for all open years."[1]
The initiative provides for a short time frame, requiring taxpayers to agree in writing to participate in the initiative by Sept. 15 and provide all documentation to the Department of Revenue by Oct. 16.[2]
The Department of Revenue is required to provide a proposed adjustment within 31 days of receipt of the taxpayer's documentation after which time the taxpayer has 15 days to accept the proposal or reach a settlement with the department.[3] Any penalties with respect to agreed-upon issues will be waived as part of the initiative.[4]
In an FAQ document regarding the initiative, the department stated that taxpayers that believe no adjustments to their transfer pricing are necessary are permitted to participate in the program.[5]
This guidance further provides that taxpayers may not participate on an anonymous basis, but that a taxpayer that participates in the initiative and is unable to reach an agreement with the department will not have its statutory rights to appeal affected in any way.[6]
At the recent conference of the Southeastern Association of Tax Administrators, the director of the Corporate Tax Division for the North Carolina Department of Revenue, John Seibert, stated that his view is that when businesses have viable documentation to support intercompany transactions, including a transfer pricing report, settlement and mediation of transfer pricing adjustments is generally preferable to litigation.
Seibert went on to say that the process should be a cooperative give and take and North Carolina's new initiative is intended to further these efforts.[7]
Based on these comments, it would appear that the North Carolina initiative could provide a streamlined and productive process for taxpayers to settle disputes without litigation. However, Seibert also mentioned that the "commensurate with income" standard may be a more appropriate methodology to utilize when transfer pricing involves intellectual property.
This standard was recently addressed by the U.S. Court of Appeals for the Ninth Circuit in Altera Corp. v. Commissioner, where the Ninth Circuit upheld a treasury regulation requiring the inclusion of stock-based compensation costs as part of cost-sharing agreements for developing intangible property, even though unrelated parties do not share such costs.[8]
Many see the Altera decision as potentially emboldening states to push the boundaries of the long-standing arm's-length standard.[9] Seibert's reference to the commensurate-with-income standard raises the question of how North Carolina will apply the arm's-length standard to related-party transactions. Other states have raised similar issues.
Indiana's Advance Pricing Agreements
Indiana's informal transfer pricing initiative is styled as an advance pricing agreement process.[10] While Indiana's initiative is more focused on providing certainty for future periods, the department has indicated that it is interested in settling transfer pricing disputes involving past periods.
Under Indiana's initiative, taxpayers may voluntarily approach the department to negotiate an agreement to select the appropriate transfer pricing method and set of comparables to be used on in future periods.
Indiana has stated that advance pricing agreements under this initiative will typically apply for two audit cycles, or six calendar years. Indiana's willingness to engage in an advance pricing agreement process is indicative of the Indiana Department of Revenue's evolved approach to transfer pricing.[11]
Previously, the department unsuccessfully attempted to make transfer pricing adjustments by asserting distortion without regard to the principles established under Internal Revenue Code Section 482 and without regard to transfer pricing documentation provided by taxpayers.[12]
Other states, particularly in the Southeast, have informal policies regarding the settlement of transfer pricing issues which allow taxpayers to negotiate an agreed upon transfer price for a period of years. These informal agreements have typically been reached as part of the audit process. However, in recent years states have agreed to adopt agreements that cover future tax periods.[13]
These transfer pricing settlements mark a significant departure from some states' previous attempts at forced combinations and intercompany addbacks as a remedy to perceived distortion. This is not to say that states, notably South Carolina and Georgia, no longer assert forced combination or require intercompany addbacks, but rather to note that agreements on appropriate transfer pricing amounts have become more common than in the past.
To Participate or Not to Participate, That Is the Question
While states' evolved thinking regarding their approaches to transfer pricing is a positive development and one that we encourage, these initiatives do raise the threshold question of whether a company that believes that its transfer pricing complies with Section 482 should consider participating in a state's voluntary settlement initiative in the first place.
In other words, if the taxpayer has a Section 482-compliant transfer pricing study, should that be the end of the discussion? Many states continue to say no. As noted during the Southeastern Association of Tax Administrators conference, states continue to take issue with the transfer pricing methods used by many taxpayers, even when a taxpayer has documentation in support of its position.
Oftentimes, states argue that notwithstanding Section 482 compliance, intercompany transactions can still create distortion which may require addbacks or forced combination to cure.[14] Several cases in multiple states are pending with respect to this issue. Additionally, the Ninth Circuit's recent decision in Altera has the potential to open up a fresh line of attack from the states.[15]
All this information provides taxpayers with a decision point. Either participate in initiatives like those put in place by North Carolina and Indiana in an effort to compromise; wait until audit and attempt to settle, when and if audited; or, in states that adopt Section 482 and where the taxpayer believes its transfer pricing is at arm's-length, stand firm upon audit and litigate the issue.
For taxpayers that choose to litigate, coordinating a strategy across states, including considerations regarding the timing for certain states, may be especially important.
For certain taxpayers, the initiatives offered by North Carolina, Indiana and other states may be very attractive. Taxpayers that desire to establish certainty of their tax liability pertaining to intercompany transactions for purposes of financial reporting may be willing to reach a settlement in exchange for the certainty that such initiatives provide.
Taxpayers may also be enticed by the prospect of avoiding costly litigation or a drawn-out audit and appeal process. This is especially true of the North Carolina initiative, given the short timeline for reaching an agreement under the initiative. Additionally, the potential to avoid penalties by participating in one of these initiatives may also be appealing to taxpayers.
On the other hand, there are a number of reasons why taxpayers may be hesitant to participate in such initiatives. First, it is likely that participation in these programs will lead to the payment of tax, even where transfer pricing documentation is fully compliant with Section 482. Second, proactively approaching a state may raise issues that may have otherwise gone unchallenged. Third, providing the amount of information required to participate in these programs may not be any less burdensome than participating in an audit.
Finally, there is uncertainty about how aggressive states will be in negotiating their positions in the course of these programs. However, for taxpayers that are already under audit, there may be little downside to participating in the programs.
As outlined above, there are many considerations and ultimately much of the decision will be made based on the taxpayer's individual facts and circumstances. In many cases, the decision will turn on the quality of the company's transfer pricing study and other documentation, its willingness to pay to obtain certainty and the perceived level of aggressiveness of state departments of revenue under these programs.
Eric Tresh and Jonathan Feldman are partners, and Justin Brown is an associate, at Eversheds Sutherland.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] North Carolina Department of Revenue, "Important Notice: North Carolina Announces Voluntary Corporate Transfer Pricing Resolution Initiative," (Jul. 30, 2020) available at: https://files.nc.gov/ncdor/documents/files/Important-Notice-Transfer-Pricing-Resolution-Initiative.pdf.
[2] Id.
[3] Id.
[4] Id.
[5] North Carolina Department of Revenue, "Transfer Pricing Resolution Initiative Frequently Asked Questions," available at: https://files.nc.gov/ncdor/documents/files/TPRI-FAQs.pdf.
[6] Id.
[7] We note that North Carolina had a similar program years ago, which focused on combined reporting.
[8] Altera Corp. v. Comm'r, 926 F.3d 1061 (9th Cir. 2019), cert. denied, 2020 WL 3405861 (Jun. 22, 2020). For more information on the Altera decision and its potential impact at the state level, See Eric Tresh, Maria Todorova, and Justin Brown, "Altera Could Bolster State Transfer Pricing Scrutiny," Law360, Jul. 2, 2020.
[9] See Maria Koklanaris, "3 State Tax Takeaways from the Altera Transfer Pricing Case," Law360, Jul. 24, 2020.
[10] Indiana has not released formal guidance regarding its initiative, but has made practitioners aware of the initiative via informal presentations beginning in late 2019.
[11] For more background on the evolved approach to transfer pricing being taken by Indiana and other states, See Eric Tresh, Maria Todorova, and Justin Brown, "The Growing Trend of State Transfer Pricing Scrutiny," Law360, Aug. 26, 2019.
[12] See Columbia Sportswear USA Corporation v. Indiana Dep't of Revenue
, 45 N.E.3d 888 (Ind. Tax Ct. 2015); Rent-A-Center East, Inc. v. Indiana Dep't of Revenue , 42 N.E.3d 1043 (Ind. Tax Ct. 2015).[13] We note that a number of these states have engaged third-party experts to assist with their transfer pricing efforts, in some instances on a contingency-fee basis. Among Southeastern states, we are aware of the use of outside transfer pricing consultants in Alabama, Georgia, Louisiana, Mississippi, and North Carolina.
[14] See, e.g., Utah State Tax Comm'n v. See's Candies, Inc., 435 P.3d 147 (Utah 2018). In their attacks on transactions between related parties, states often intermingle issues of transfer pricing, business purpose and economic substance, and nexus.
[15] See, e.g., Eric Tresh, Maria Todorova, and Justin Brown, "Altera Could Bolster State Transfer Pricing Scrutiny," Law360, Jul. 2, 2020; Maria Koklanaris, "3 State Tax Takeaways from the Altera Transfer Pricing Case," Law360, Jul. 24, 2020.
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