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.
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.
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.
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.