Recent media reports reflect that transfer pricing in the state tax area is gaining more scrutiny and attention due to international tax developments like OECD BEPS, but also the Multistate Tax Commission's Arms-Length Adjustment Service (ALAS) initiative, previous state litigation and growing interest in tax haven legislation.
A nice presentation delivered by Michael Bryan, Karl Frieden, Jeff Friedman and Marshall Stranburg at the Federation of Tax Administrators Annual Meeting on June 13, 2016, provides good background information on the basics and importance of transfer pricing while describing the current environment.
The presentation defines transfer pricing as "the pricing of transactions between related entities for goods, intangible assets, services, and loans." Transfer pricing is "designed to prevent tax avoidance among related entities by requiring pricing equivalent to prices available with an uncontrolled party:
- Transactions must (generally) be at arm’s length
- Non-arm’s length intercompany transactions can impact the clear reflection of income in states where income is reported on a separate or partial combination basis
- Tax evasion or avoidance generally not a pre-requisite for making a transfer pricing adjustment"
According to the presentation, the "key intercompany transactions subject to transfer pricing" are:
- Transfer and licensing of intangible assets
- Providing and charging for common services
- Factoring accounts receivables
- Sale of tangible goods that contain a trademark or other intangible
- Purchase and resale of tangible goods
The presentation ends with a question - "What's Next?" This is the most important question.
What should companies do now? How can companies plan? What path will states take to combat this perceived abuse? Will states piggyback off of BEPS? Will states get involved with the MTC initiative? Will states actually enact and enforce tax haven legislation? Or will states simply adopt worldwide combined reporting? Worldwide combined reporting seems to be a simpler approach. However, as I have noted before, making a simple general rule may not be beneficial to a state if applied to taxpayers across the board.
Consequently, it makes more sense for states to have discretionary authority and make case-by-case adjustments so they can better control the impact on revenue. Therefore, I think states will continue to use a combination of all of the tools that will allow them to retain discretionary authority and control.
For more information, check out my previous post on the MTC ALAS program.