Mandatory Combined Reporting as a Counter to Corporate Tax Avoidance Strategies

Many multi-state corporations operate in states that do not require combined reporting and that employ one or more tax-avoidance strategies to reduce their overall tax liability, causing significant declines in corporate tax revenues for the states. Mandatory combined reporting counters such strategies by treating businesses composed of multiple entities, such as a parent corporation and its subsidiaries, as a single entity for tax purposes.

This commentary discusses the merits of mandatory combined reporting as a solution to problems states experience in determining the true earnings of multi-state corporations or unitary businesses. The commentary first analyzes the nature and scope of the problem: many multi-state corporations operating in states that do not require combined reporting and that employ one or more tax-avoidance strategies to reduce their overall tax liability, causing significant declines in corporate tax revenues for the states. Second, this commentary examines how mandatory combined reporting works and the implications of a state's enacting such a system. Finally, this commentary discusses North Carolina's pending legislation that, if enacted, will add the state to the growing list of states requiring combined or unitary reporting.

Author Andrew Swain writes: In addition to negating tax avoidance strategies such as the use of passive investment companies (PICs) or REITs, mandatory combined reporting also counters a related tax-avoidance strategy called transfer pricing,' in which a parent corporation sells its products to an out-of-state subsidiary, which in turn sells them to the final customers. Corporate manipulation of transfer prices paid to subsidiaries in tax-haven states will not affect state corporate tax revenues in a combined reporting state [s]ince the profits of a corporation's components are added together to determine the corporation's taxable base[.]

Mandatory combined reporting proves to be a better means of nullifying tax-avoidance strategies than the tactics currently used in non-combined reporting states such as ad hoc litigation or targeted legislation intended to close specific tax loopholes and their resulting tax shelters. Though these measures are useful stop-gaps, they are costly, time consuming, and ultimately inadequate. 

Combined reporting is not without its problems. States that rely on mandatory combined reporting may still experience declining corporate tax revenues. The combined-reporting laws themselves can contain loopholes or other deficiencies.  In addition, most combined-reporting states are still vulnerable to tax shelters created and maintained outside the United States.

Despite these flaws, some states have successfully employed combined reporting for many years, and the U.S. Supreme Court has twice upheld its legality. 24 As of October, 2007, 21 states had mandatory combined reporting and another seven states, including North Carolina, were considering enacting a combined reporting requirement.

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On February 18 of this year, the General Assembly of North Carolina passed the Current Operations and Capital Improvements Appropriations Act of 2009... If this act becomes law, North Carolina should reap benefits like those, discussed above, that are enjoyed by other combined reporting states.

Some North Carolina businesses and their lobbying organizations have protested the unitary reporting provision of the pending legislation, claiming that [it will] result in some companies leaving the state or shunning [North Carolina] for new investment. It recently published by the Center on Budget and Policy Priorities, however, found these concerns to be unwarranted. The study found that at least 60 of the 75 largest North Carolina manufacturers examined maintain facilities in at least one combined reporting state. The study concluded in part that the compliance burdens' and tax liabilities arising from combined reporting cannot be that great if these manufacturers or the parent corporation that controls their decision-making have willingly maintained a facility in one or more combined reporting states [in some cases for nearly 20 years].

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Should its governor sign the Current Operations and Capital Improvements Appropriations Act of 2009 into law, North Carolina will become one of over 20 states that have transitioned from separate reporting to mandatory combined reporting for multi-state corporations. North Carolina, like other combined reporting states, will be better positioned to capture corporate tax revenues that more accurately reflect the business activity of the multi-state corporations that operate within its borders without risking the loss of current or future manufacturing investment in the state.

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