Related Party Transactions

17 State Tax and Business Developments You May Want to Know - Sept 5, 2017

The following are state tax and business developments I have curated since August 26th, and posted in the LEVERAGE SALT LinkedIn group:

  1. NC market discount income from US govt bonds is not interest

  2. CORPORATE CLOSE-UP: THE FTB’S SMALL CAP SOLUTION TO ALLEGED FINANCIAL AND NON-FINANCIAL COMBINED REPORTING APPORTIONMENT DISTORTION

  3. COST, EY & State Tax Research Institute Study: Total State and Local Business Taxes (fy16)

  4. Oregon revenue online educational services sourced faculty costs

  5. State Rundown 8/31: Modernizing Taxes is Sometimes a Sprint, Sometimes a Marathon

  6. Oral Arguments Heard in South Dakota’s Challenge to Quill

  7. Net Operating Loss Carryforward & Carryback Provisions by State

  8. Indiana Files Lawsuit to Defend Out-Of-State Sales Tax Law

  9. Amended Colorado Regulations Address Combined and Consolidated Filing and Apportionment

  10. Massachusetts DOR Issues Technical Information Release on Policy Change Regarding Treaty-Exempt Income

  11. Oregon Tax Court Explains that Only Direct Costs are Relevant in Determining Where Greater Proportion of Costs of Performance Was Incurred

  12. Indiana Attorney General Responds to Suit Filed by Trade Groups Regarding Enforcement of New Remote Seller Economic Nexus Law

  13. Limited-Time Voluntary Disclosure Program for Out-of-State Sellers Having Click-Through Nexus Runs through November 21 in New Jersey

  14. Rhode Island Division of Taxation Explains New Information Reporting and Notice Requirements on Some Remote Sellers - Including Marketplace Facilitators

  15. Seattle high-income resident income tax enacted

  16. Texas appellate court upholds subcontractor exclusion while reversing and remanding on COGS methodology

  17. VA Supreme Ct rules subject to tax exception post apportionment

The above represents 'general curating' of state tax developments into one spot. If you still feel overwhelmed by the volume of state tax developments, please consider my 'custom curating' service. Meaning, clients hire LS to daily curate state tax developments relating to a specific industry, state(s), tax type and issueYou can make it as granular as you prefer. This allows you to reduce information overload, and only get the information you need to help your clients or company. This service is provided on a fixed-fee or subscription basis. Contact me at strahle@leveragesalt.com.

29 State Tax & Business Developments You May Want to Know - August 21, 2017

The following are state tax and business developments I have curated since August 14th, and posted in the LEVERAGE SALT LinkedIn group:

  1. Resistance is not Always Futile: New Decision in Ongoing Delaware Unclaimed Property Audit Litigation

  2. MTC Voluntary Disclosure Initiative for Online Marketplace Sellers (i.e., Amazon FBA program)

  3. A State Tax Administrator's Perspective on Partnership Taxation

  4. Illinois Court Upholds Cook County’s Beverage Tax Finding It Passes Constitutional Muster and Related Developments

  5. Webinar: August 24th - Best Practices in Achieving Obsolescence Adjustments for Complex and Commercial Properties

  6. State Corporate Income Tax Rules for Sourcing of Revenue for Law Firms

  7. Nationwide Sales/Use Tax Update - September 12, 2017

  8. Credits Can No Longer Be Applied Against Oregon’s Minimum Tax

  9. Total Solar Eclipse Won’t Black Out State Taxes

  10. South Carolina going after Amazon (the marketplace facilitator) for not collecting sales tax on behalf of the businesses that use the marketplace to sell products to SC residents

  11. Summary of New York Corporation Tax Legislation Enacted after the 2016-2017 Budget

  12. New York Amendments Regarding Sales Tax Rules for Transactions between Certain Related Entities and for Purchases Made by Nonresident Businesses

  13. Technology Company State Tax Guide from Moss Adams (Very Nicely Done)

  14. Illinois Amends Rule Regarding Alternative Apportionment

  15. Amazon’s Marketplace Business Isn’t a Tax Avoidance Scheme

  16. A comparison of enterprise zone programs in Illinois, Indiana, and Wisconsin

  17. MTC National Nexus Program Adds 2 More Participating States to Online Marketplace Seller Voluntary Disclosure Initiative

  18. Rhode Island DOT Announces that it Will Accept Applications for Recently Enacted Amnesty Program Beginning December 1

  19. California FTB Issues Draft Proposed New Pass-Through Entity Withholding Regulation

  20. Minnesota Tax Court Holds that Taxpayer May Apply NOL Carryovers from an Acquired Entity to Full Extent Permitted under IRC § 382

  21. New North Carolina Law Includes Changes to Intercompany Expense Addback Statute, Added Franchise Tax Base Deduction, and Definition of Business Income

  22. Texas Court of Appeals Upholds Subcontractor Exclusion While Reversing and Remanding on Taxpayer COGS Methodology

  23. Memo Explains Recent New York Law Changes on Transactions Involving TPP Resold Between Certain Related Entities

  24. California Supreme Court Denies Rehearing in Recent Case Involving Taxation of a Transfer of Legal Entity Interests

  25. Washington DOR Reissues Emergency Amended B&O Tax Rule on Financial Institution Apportionment to Conform with MTC Changes

  26. Three Big Problems with Sales Taxes Today — and How to Fix Them

  27. Should Online Platforms Collect Sales Tax For Third-Party Sellers?

  28. The United States Of Unicorns: Every US Company Worth $1B+ In One Map

  29. Are Remote Retailers and Marketplace Providers in the 'Path of Totality'?

The above represents 'general curating' of state tax developments into one spot. If you still feel overwhelmed by the volume of state tax developments, please consider my 'custom curating' service. Meaning, clients hire LS to daily curate state tax developments relating to a specific industry, state(s), tax type and issueYou can make it as granular as you prefer. This allows you to reduce information overload, and only get the information you need to help your clients or company. This service is provided on a fixed-fee or subscription basis. Contact me at strahle@leveragesalt.com.

Not All Intercompany Transactions Are Created Equal

For any group of affiliated entities, intercompany transactions, such as intercompany purchases, loans, licensing, services, and management, are a way of life. Even though those transactions are a part of normal business operations, they have created problems and opportunities in states that have not adopted combined reporting. States have sought to disallow the deduction of related-party expenses under the presumption that the transactions were not entered into with business purpose or economic substance, or that they distorted the true reflection of income earned in the state.

It could be argued that taxpayers abused the positive effect of ‘‘true’’ intercompany transactions by using special purpose entities such as sales companies, finance companies, and the infamous intangible holding company to shift income from one entity to another or from one state to another. The use of those types of entities and transactions exploded in the 1990s. Since then, states have worked to end that perceived abuse by enacting related-party expense addback legislation or adopting combined reporting. As a result, the ability to use intercompany transactions to shift income has become very difficult.

Taxpayers argue that economic substance and business purpose other than tax savings have always been integral parts of any state tax planning (even in the 1990s). However, taxpayers today approach state tax planning in terms of focusing on the business objective first, and then seeking to implement that objective in a tax-efficient manner. Some practitioners refer to that as business alignment planning. I like to describe it as not putting the cart before the horse.

To read more, check out my article from Tax Analysts State Tax Notes on October 28, 2013. 

Don't forget to sign up to attend the free Bloomberg BNA webinar tomorrow that I am co-presenting: "State Tax Planning for Related-Party Transactions." 

I hope you can join me to discuss:

  • Triggers which create problems and opportunities (in regards to related-party transactions)
  • Common inter-company transactions
  • 6 ways states may respond to related-party transactions (including recent developments and how to analyze, defend and plan)

The Tightrope of Acceptable Intercompany Transactions

The following are excerpts from my January 6, 2014 article in Tax Analysts State Tax Notes. 

The Tightrope
An Indiana taxpayer paid factoring fees to a related entity that was not included in its Indiana income tax return. The taxpayer subcontracted the collection of its accounts receivable to the related entity by factoring the accounts to the entity. According to the taxpayer, the entity charged an arm’s-length rate based on a transfer pricing study prepared in accordance with IRC section 482 and related regulations. An independent third party prepared the study, and the factoring fees reported on the federal returns fell within the range of acceptable prices listed in the study. A portion of the receivable factoring expense that the taxpayer paid came back to it as dividends and loans from the related entity.

After an audit investigation, the Indiana Department of Revenue disallowed more than $57 million of the factoring fees the taxpayer paid to the related entity, which represented the portion of the fees paid to the entity that exceeded its expenses for providing the factoring services. The DOR argued that the taxpayer group, as an economic entity, did not achieve any business or operational advantage that it did not have before the taxpayer started factoring its receivables. The in-house factoring did not result in lower financing costs, the most common reason for factoring. The same departments, such as accounting, credit and collection, and customer service, that existed before the receivable factoring was put in place still existed.However, the functions became part of the operations of the related entity, which didn’t file in Indiana. Thus, the major benefit of the factoring operations was the minimization of state income tax. According to the DOR, that distorted the reported Indiana adjusted gross income without benefiting the whole organization. The factoring entity reported more income than all other entities in the consolidated group, including the taxpayer, which is supposed to be the most dominant entity.

In Indiana Letter of Findings 02-20120612, the DOR said corporate form will normally be respected unless the form is a sham or unreal. The DOR relied on the fact that courts have been consistent in holding that tax avoidance in and of itself is not a valid business purpose. It also relied on IC section 6-3-2-2(m) to distribute, apportion, or allocate income derived from sources in Indiana among organizations, trades, or businesses to fairly reflect income. According to the DOR, the regulations allow it to use any method to equitably allocate and apportion a taxpayer’s income.

Working Without a Net
The taxpayer argued that the independently prepared transfer pricing study provided enough support for the state to accept the intercompany transactions. However, the DOR stated in its letter of findings that the arm’s-length status of a transaction, considered in isolation, is not relevant to whether the substance of a taxpayer’s overall company structure, intercompany transactions, and consolidated group’s deductions fairly reflect a taxpayer’s consolidated group’s taxable Indiana income. According to the DOR, the problem was that the transfer pricing study was performed to analyze the arm’s-length status of the transactions for federal, not state, tax purposes. In fact, the transfer pricing study itself asserted it was not performed for state tax purposes and should not be used by the taxpayer as advice for state tax purposes.

Perhaps the most troublesome issue for the taxpayer was that a portion of the receivable factoring expense it paid came back to it as dividends and loans. The Indiana DOR has routinely provided guidance in letters of findings regarding the circular flow of funds between related parties, such as (i) when a taxpayer makes Intercompany payments and takes expenses for those payments but cannot explain the nature and substance of the underlying agreement and transactions; (ii) when the deduction of royalty and interest expenses are part of a continual circular flow of money between related entities—with the result of shifting taxable income to out-of-state entities that then return nontaxable income to the Indiana entities, calling into question the need for the transactions and resulting in an unfair reflection of the income earned from Indiana sources; and (iii) when the payment of royalties results in an intercompany circular flow of money that serves no commercial business purpose.

The taxpayer argued that its position should be sustained because the business purpose and substance of the related factoring entity were substantially similar to that of the factoring company described in Letter of Findings 02-20090805. However, the DOR argued that the taxpayers’ situations were not factually similar because there was no evidence that the other taxpayer had a circular flow of funds in the form of either loans or dividends. Letter of Findings 02-20090805 simply stated that the facts presented little to indicate that the factoring fees constituted an abusive tax avoidance scheme even though the claimed expenses significantly reduced the income subject to Indiana tax. In fact, the DOR held in Letter of Findings 02-20090805 that the related entity incurred legitimate and reasonable expenses associated with the collection of the factored Receivables. In this case, the DOR did request additional documentation regarding the circular flow of funds, but the taxpayer did not provide it. Thus, the DOR held it had legitimate concerns that the taxpayer exploited the company’s structure and the intercompany transactions to shift a substantial portion of its Indiana income outside the state.

Balancing Act
A related factoring entity can withstand audit scrutiny, but taxpayers should take proper steps to support the path to acceptance. Although each state differs, the lessons from the Indiana letters of findings can be used to substantiate the validity of the transactions. First, taxpayers should have a business or operational purpose for the creation of related entities when large intercompany transactions will occur. Second, taxpayers should realize some type of business benefit, such as liquidity or lower interest rates, for the whole organization as a result of the new entity or structure. Third, taxpayers should not rely on federal transfer pricing studies to substantiate state tax consequences of intercompany transactions. Lastly, taxpayers should avoid the circular flow of funds between related parties. Tax planning is each taxpayer’s right and obligation, but finding the balance between what is and isn’t acceptable is like walking a tightrope. As the Indiana letters of finding show, finding the balance is difficult, but not impossible.

Sidenote: Happy Valentine's Day!

State Tax Planning for Related-Party Transactions

I am pleased to be co-presenting a Bloomberg BNA Webinar this week, "State Tax Planning for Related-Party Transactions." I hope you can join me to discuss:

  • Triggers which create problems and opportunities (in regards to related-party transactions)
  • Common inter-company transactions
  • 6 ways states may respond to related-party transactions (including recent developments and how to analyze, defend and plan)

Every affiliated group has related-party transactions. They are a necessity for business and legal reasons. However, the state tax impact is complex and controversial. All phases of the tax life-cycle are impacted by related-party transactions (provision, compliance, planning and controversy). The states have responded to perceived abuses with many justifiable tools. The states may or may not soon receive additional tools from the federal government. Regardless of a state's response, taxpayers must be proactive in defending legitimate expenses and be able to analyze and plan for audit assertions and adjustments.