Indiana Tax Court – Department erred in adjusting corporation’s tax base

Tax Insights
from State and Local Tax Services
Indiana Tax Court – Department
erred in adjusting corporation’s tax
base
December 23, 2015
In brief
The Indiana Tax Court concluded on summary judgment that adjustments to a company’s tax base were
improper because the Department of State Revenue could not exercise its alternative apportionment
powers to alter the tax base, the company’s transfer pricing studies showed that intercompany
transactions were conducted at arm’s-length, and that the department’s adjustments were otherwise
unreasonable. [Columbia Sportswear USA Corporation, v. Indiana Department of State Revenue, Ind.
Tax. Ct., No. 49T10-1104-TA-00032 (12/18/15)]
The decision, coming on the heels of the Rent-A-Center decision earlier this year highlights the continued
importance of transfer pricing studies. Also, taxpayers whose tax base has been adjusted should examine
whether such adjustments were made pursuant to the state’s alternative apportionment authority, which
the tax court notes cannot be used to adjust the tax base.
In detail
Facts
Columbia Sportswear
(Columbia) sold and distributed
apparel, footwear and
accessories for its parent and
affiliate. The parent corporation
engaged an independent
accounting firm to conduct a
transfer pricing study to
determine the arm’s-length
pricing for its sales. During the
tax years at issue, Columbia
filed a separate company
Indiana return and later,
claimed a refund on an
amended return. On a
subsequent audit, the
department, stating that the
intercompany transactions
distorted Columbia’s source
income, adjusted Columbia’s net
income and issued an
assessment. The department did
not recalculate Columbia’s
apportionment percentage. The
assessment was upheld after an
administrative hearing, and this
appeal followed.
Alternative apportionment
On the parties’ cross motions for
summary judgment before the
tax court (court), the
department argued that IC Sec.
6-3-2-2(l) authorized its
adjustments. That section
provides that if the statutory
allocation and apportionment
methods do not fairly represent
the taxpayer's income derived
from sources within the state,
the taxpayer may petition, or the
department may require, any
other method to effectuate an
equitable allocation and
apportionment of taxpayer’s
income. However, the court
noted that the law involves the
division of the tax base, not the
calculation of the base itself.
The court observed that
Indiana’s alternative
apportionment statute generally
follows the language of The
Uniform Division of Income for
Tax Purposes Act (‘UDIPTA’).
Although the state has not
formally adopted UDIPTA, the
plain language of UDITPA (Sec.
18) deals only with the question
of the fairness of the allocation
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and apportionment of income, not the
base.
The court added that the state’s
allocation and apportionment
provisions are distinct from the tax
base provisions. “Therefore, to
concluded that Indiana Code §6-3-22(l) authorizes the Department to
make changes outside the context of
allocation and apportionment would
be like trying to pound a square peg
into a round hole,” said the court.
Indiana’s §482 authority
Nearly identical to IRC §482, Sec. 6-32-2(m) provided during the years at
issue that “in the case of two (2) or
more organizations, trades, or
businesses owned or controlled
directly or indirectly by the same
interests, the department shall
distribute, apportion, or allocate the
income derived from sources within
the state of Indiana between and
among those organizations, trades, or
businesses in order to fairly reflect
and report the income derived from
sources within the state of Indiana by
various taxpayers.” Arguing that its
adjustments were proper, the
department stated that Columbia’s
state tax treatment of its
intercompany transactions improperly
reduced its profits by two-thirds and
that its net income must be distorted
because the effective tax rate for
Columbia’s consolidated group
decreased despite an increase in gross
profit and net income.
Columbia presented three transfer
pricing studies as evidence that its
intercompany transactions were
conducted at arm’s-length rates and
that its income was fairly reflected
under the state’s sourcing rules. The
department argued that the studies
cannot rebut that the assessments are
correct because IRS § 482 does not
apply in Indiana and that the studies
contain a disclaimer, stating that they
“do not reach any conclusions
regarding state tax issues.” Regarding
the first claim, the court incorporated
and referred to its decision in Rent-ACenter East, and regarding the
second, the court said that it was not
persuaded that the disclaimer renders
the studies irrelevant as to whether
Columbia’s income is fairly
apportioned. Such disclaimer
language is standard and designed to
limit the accounting firm’s
professional responsibility to only
whether the purchase price paid
between related entities satisfies the
requirements of §482. The court
noted that the department did not
take exception to the comparable
profits method utilized in the transfer
pricing studies or provide any
evidence to show that Columbia’s
studies were invalid because they
failed to comply with IRC §482.
The court found that Columbia’s
intercompany transactions were
conducted at arm’s length rates and,
therefore, the state’s sourcing rules
fairly reflected Columbia’s Indiana
source income.
Lastly, even if the state’s sourcing
rules distorted Columbia’s Indiana
source income, the court found the
department’s adjustments
unreasonable. The adjustments
attributed over 99% of the group’s
gross income to Columbia without
adjusting its apportionment
percentage. The attribution of nearly
all the group income to Columbia was
found to be out of all appropriate
proportion to its Indiana activities as
evidenced by its property, payroll, and
sales factors.
The takeaway
In this decision, the court found fault
with the department for using its
alternative apportionment authority
to adjust the tax base and for
disregarding Columbia’s transfer
pricing studies. Further, as also
discussed in the Rent-A-Center case,
the department's reallocation
authority bears a direct relationship to
IRC §482. This decision highlights for
businesses with intercompany
transactions the importance of
transfer pricing studies.
Taxpayers issued assessments as a
result of tax base adjustments should
examine the statutory authority under
which the department acted.
This decision, along with the Rent-ACenter case, could further the
likelihood that the General Assembly
will consider a unitary combined
reporting system in the upcoming
legislative session, potentially with the
support of the department. One of the
arguments put forth by the state in
these cases is the practical inability for
the department to administer and
enforce its discretionary authority if it
is forced to contest transfer pricing
studies.
Let’s talk
If you have any questions about the
Columbia Sportswear decision, please
contact:
Michael Ralston
Director, Indianapolis
+1 (317) 940-7301
[email protected]
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