Indiana Releases Combined Reporting and Transfer Pricing Studies

Indiana has released two separate studies, one on combined reporting and one on transfer pricing. The studies were a requirement of SB 323 that was amended on January 28, 2016 to study combined reporting instead of adopt combined reporting, as I reported earlier. 

Combined Reporting

The combined reporting study discusses all of the reasons why states adopt combined reporting - to stop base erosion from taxpayers using intellectual property holding companies, captive real estate investment trusts, captive insurance subsidiaries and overseas management affiliates, etc. However, the study also explains that combined reporting creates new problems that separate reporting states do not have to deal with, such as determining the unitary group, and additional administrative burdens during the transition to combined reporting. 

The study also asserts that the impact of combined reporting on state revenues is mixed, according to evidence from other states. Similar to most state tax laws, implementing combined reporting would provide additional revenue from some taxpayers and less revenue from other taxpayers. Consequently, the question remains as to what the overall revenue impact would be. The study suggests combined reporting would increase revenue in the short term, but be neutral in the long term.

Regardless of the revenue impact, the study confirmed that separate reporting does allow taxpayers with more opportunity to create favorable business structures and utilize intercompany transactions to shift income from affiliates based in high-tax states. Despite this fact, the study appears to be leaning towards a recommendation to not enact combined reporting.

Transfer Pricing

The transfer pricing study is a great report to review if you want to learn more about transfer pricing. The conclusion of the report explains the realities of related party transactions that exist due to complex business structures dominated by parent companies with affiliates in multiple states and countries. As a result, scrutinizing intercompany transactions is a necessity.

The study confirms that transfer pricing examinations and analysis are complex and expensive, and asserts that if a transfer pricing study is not conducted in an efficient and effective manner, it could be detrimental to the taxpayer. To reduce the amount of disputed transactions, Indiana requires the addback of deductions taken for royalties, intangible related-party expenses and intercompany interest. However, other states currently have broader addback provisions or have enacted combined reporting.

So What?

Indiana has had many cases and rulings that reflect the complexities and burdens of analyzing and resolving the proper treatment of intercompany transactions and transfer pricing studies. Consequently, Indiana and taxpayers have spent resources (time and money), which both the state and taxpayers do not have, to resolve these matters. Hence, in my opinion, Indiana should adopt combined reporting to reduce the amount of disputes involving intercompany transactions and transfer pricing studies. The whole question of whether an intercompany transaction is at arms-length doesn't matter when intercompany transactions are eliminated in a combined return. Albeit, there may be some entities that are not a part of the group and the issue could still occur. In addition, combined reporting will create new issues to deal with, such as what entities are part of the unitary group. However, I believe it is less of a burden for states and taxpayers to manage the issues related to combined reporting versus the issues related to transfer pricing studies and analyzing related party transactions.

Transfer Pricing, Treasures in the Attic and Using Social Media

Next week I will be attending the Paul J. Hartman State and Local Tax Forum in Nashville. A few of the sessions on Tuesday that I am extremely interested in are:

1. Transfer Pricing - MTC - ALAS program by Carley Roberts and Marshall Stranburg. The MTC program has been struggling to gain traction among the states. With all of the other activity around transfer pricing (i.e., BEPS, IRC Sec. 385 regulations, etc.), I wonder if traction will be found or will states remain in pause mode waiting for the dust to settle from other initiatives? For more info, check out my previous post - State Tax Transfer Pricing - What's Next?
2. Treasures in the Attic - Tried and True Legal Principles in SALT by Janette Lohman and Brian Kirkell. This should be a good session to refresh our knowledge of principles that we can use to help clients avoid and resolve controversy. If this interests you, you may like my previous post - Should the Federal Government Pre-empt A State's Taxing Power?
3. Ethics and Social Media for Tax Professionals by Brett Carter, Mark Holcomb and Glenn McCoy. I have a personal interest in this session as I have used social media for the last 8 years. Personally, social media has been a great tool to meet new people all over the country and help more companies, firms, publishers and policy organizations. If you haven't read it, here is a link to an interview I did for Bloomberg BNA about blogging.  For more history on my blogging adventure, check out this post.

Other sites I have used as a resource during my blogging years are:

Real Lawyers Have Blogs

Lawyerist

The Greatest American Lawyer

Amazing Firms, Amazing Practices

In Search of Perfect Client Service

Cordell Parvin Blog

Seth Godin Blog    

Adrian Dayton

*Please note that I am not an attorney, just so happens that most of the resources or people blogging when I started in 2009 were lawyers, not accountants.

Nonresident Withholding 'Nightmare'

In a prior life, I worked in a tax department where we managed the filing of multistate income tax returns and the flood of notices received for over 500 pass-through entities. The group of entities included multi-tiered partnerships, limited liability companies with single-member limited liability companies and S corporations with Q-subs. Consequently, nonresident withholding was a major issue for us and the state tax departments with which returns were filed.

If you or your client operates within a pass-through entity such as a S corporation, partnership or limited liability company, then you know what nonresident withholding is.

In basic terms, nonresident withholding is when a state requires a pass-through entity to withhold state income tax (or make a state tax payment) on a nonresident shareholder's pro rata share of the pass-through entity's income sourced to the specific state. In other words, it is a mechanism for states to better ensure that state tax will be paid by nonresident shareholders.

Now, if you or your client operates within a multi-tiered structure of pass-through entities, then nonresident withholding can become a compliance nightmare for both you and state taxing authorities. Most states have difficulty tracking nonresident withholding when it passes through multiple layers before it gets to the ultimate taxpayer. Therefore, state tax notices upon state tax notices can become an unwelcome, but familiar friend.

With that said, here are a few tips or questions to ask when dealing with nonresident withholding in multi-tiered structures:

1. Does the state require quarterly nonresident withholding on actual payments/distributions or on allocated income? To put it simply, some states only require quarterly nonresident withholding if a cash payment is actually made to a shareholder. If states don't require quarterly nonresident withholding, most, if not all states require annual nonresident withholding on "allocated income" whether a distribution is actually paid or not.
2. Is nonresident withholding required to be done for all nonresident shareholders regardless of the type of shareholder? Meaning, is withholding required for C corp, S corp, partnership, LLCs, individual and/or trust shareholders?
3. Does the state allow or have a mechanism for nonresident shareholders to obtain a waiver or exemption from nonresident withholding? Meaning, can a nonresident shareholder provide the pass-through entity or the state with a document to keep the pass-through entity from withholding on its share of the state's source income?
4. Is the nonresident withholding required to be done on a quarterly basis? Or can it be paid one time a year?
5. In a multi-tiered pass-through entity structure, at what level is nonresident withholding required to be done? Meaning, is the lowest entity required to do the withholding or does the state only require the entity before the ultimate taxpayer to do the withholding? This is a key question, because if it is done at the wrong level, it can cause great confusion and an explosion of notices between the state and the taxpayer.

Some of the top problem states when dealing with nonresident withholding are: California, Colorado, Indiana, and Iowa. Kansas used to be a pain, but withholding is no longer required after July 1, 2014.  These are just a few. As I stated earlier, in a multi-tiered structure, nonresident withholding is a tracking 'nightmare' for both the taxpayer and the state. Obviously, it requires meticulous record keeping to get it right.

The 'Most Significant State Tax Policy Issues'

David Brunori will be in Las Vegas this week speaking at the Council On State Taxation annual meeting (Friday morning) with Doug Lindholm, Helen Hecht, and Richard Pomp. They are leading a debate/discussion on the most significant issues in state tax policy. I can't be there, but thought I would give my two cents. 

I think some of the most significant state tax policy issues are:

• the imposition of sales tax collection obligations on remote retailers;
• expanding the sales tax base to services;
• whether states should ramp-up transfer pricing training/positions or join the MTC ALAS program;
• whether states should adopt tax haven legislation which allows them to cherry-pick the taxation of foreign income or simply adopt mandatory worldwide combined reporting;
• whether states should continue to enact unconstitutional legislation forcing taxpayers to go to court;
• whether states should continue to enact retroactive legislation;
• whether states should continue to enact legislation that benefits in-state taxpayers vs. out-of-state taxpayers (i.e., market-based sourcing, single-sales factor apportionment, credits and incentives).

What do you think are the most significant issues in state tax policy?

TEI Says Retroactive Legislation Disrupts Taxpayer Expectations

On September 20, 2016, Tax Executives Institute, Inc. (TEI) issued a new policy statement on retroactive tax legislation. The policy statement takes the position that sound tax policy and administration require governments to provide taxpayers with certainty and fairness, and these principles are not satisfied when legislatures are permitted to enact retroactive tax legislation without meaningful limits.

In TEI's statement it asserts that allowing retroactive legislation to overrule a judicial decision "disrupts taxpayer expectations." I agree. As I have stated before in several blog posts, retroactive legislation creates unnecessary uncertainty, and unintended consequences. States have an obligation to create a stable and reasonable compliance environment that doesn't keep taxpayers guessing.

Multistate Voluntary Disclosure Program?

Are you aware that a taxpayer with potential tax liability in multiple states could negotiate a settlement using a uniform procedure coordinated through the National Nexus Program of the Multistate Tax Commission (MTC)?

According to the MTC, this service is to encourage taxpayers to start filing and paying taxes in states where taxpayers have substantial nexus. The MTC believes this process is faster, more efficient, and less costly for taxpayers who have potential tax exposure in more than one state. There is no charge for participation in the program.

The program generally allows taxpayers to file a voluntary disclosure agreement for tax types such as sales/use tax, and income/franchise tax (including the Hawaii GET and Washington B&O tax). 

Prior contact between a state and the taxpayer for a specific tax type disqualifies the taxpayer from participation in the program for that tax type. "Contact" includes filing a tax return, paying tax, or receiving an inquiry from the state regarding the tax type. 

Once a taxpayer enters the program, the taxpayer is required to file returns, pay the tax due, and register with the state. In return, the state waives penalties for the duration of the look-back period. Interest is still due on unpaid tax obligations during the look-back period, unless waived by the state.

The look-back period includes the number of prior tax years, and the incomplete current tax year for which taxes and interest will be due and paid under the agreement. The look-back period is determined by the state and specified in the agreement. The look-back period is generally three or four years.

The MTC claims that it keeps the identity of the taxpayer confidential during the process. The MTC only discloses the taxpayer's identity to a state after the taxpayer has entered into an agreement with the state. 

The MTC also claims that it does not disclose the agreement or any of its terms to any other state.

An applicant is not required to disclose any information that would reveal its identity prior to the execution of an agreement.

For more details on the program, go here.

Were you aware of the MTC's Multistate Voluntary Disclosure Program?

Have you used the MTC's Multistate Voluntary Disclosure Program?

If yes, was it a good experience? Pros and cons?

Leave a comment or e-mail me at strahle@leveragesalt.com.