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A common aspect of consolidated groups of companies is a centralized cash management function. While such a structure is a common item in corporate America, states are increasingly challenging any perceived tax benefits of such structures. Two states, Indiana and North Carolina, have taken recent actions to utilized discretionary authority with respect to alternative apportionment to force taxpayers with such structures to file combined corporate income tax returns with their out-of-state affiliates. Such aggressive action raises questions about both the statutory authority and constitutional validity of such actions.
In Letter of Finding, LOF 02-20120008, the Indiana Department of Revenue upheld the forced combination of a corporate taxpayer with its out-of-state affiliates. The auditor made the adjustments after determining that the circular flow of funds between the related entities made the standard apportionment factor ineffective for properly reflecting the Indiana income of the group and therefore justified a forced combination. The taxpayer objected to the proposed assessment on the grounds that the Department failed to demonstrate that no other alternative method accurately reflected the taxpayer's Indiana income, as is required by statute before the Department may resort to forced combination. The Department ruled that it need not provide any evidence beyond its proposed assessment of whether the standard apportionment formula unfairly reflects the taxpayer's Indiana income, citing the questionable decision of the Indiana Supreme Court in Ind. Dep't of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463 (Ind. 2012).
The North Carolina Department of Revenue has proposed rules related to forced combination just a few months after the unprecedented decision of the North Carolina Court of Appeals in Delhaize Am., Inc. v. Lay, 731 S.E.2d 486 (N.C. Ct. App. 2012) (upholding a large negligence penalty, following forced combination when no combination guidance had been provided to taxpayers), aff'g in part and rev'g in part, Dkt. No. 06 CVS 08416 (N.C. Super. Ct. Jan. 12, 2011). The proposed rules outline the methodology and procedures for filing a combined income tax return in North Carolina. Of particular concern is that, according to the proposed rules, all instances of centralized cash management will be scrutinized by the Department for reasonable business purposes and economic effects.
This trend of forced combination as a tool to combat perceived abusive corporate structures and the tax consequences of them should prompt tax executives to reconsider the merit of such structures and their ability to withstand this new line of scrutiny.
RELATED LINKS: For additional information about apportionment formulas, see:
1-3 Bender's State Taxation: Principles and Practice § 3.12 - Apportionment and Combined/Consolidated Tax Returns
1-3 Bender's State Taxation: Principles and Practice § 3.13 - Alternative Apportionment Formulas
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