On October 6, 2014, the Multistate Tax Commission (MTC) held the first day of a two-day meeting intended to educate state revenue authorities on corporate income tax issues surrounding intercompany transactions, and further refine a path forward for states interested in collaborating on audit and compliance strategies. This first day focused entirely on presentations by specialists in transfer pricing and related intercompany transaction issues. Two important themes and one blatant omission regarding future enforcement emerged from the first day: (1) suggestions for increased disclosure and substantiation requirements; (2) safe harbor options and (3) a lack of discussion of how to prevent the risk of double taxation.
Taxpayers should be particularly concerned with the stress placed by the specialists on increased disclosure and substantiation requirements. Most of the specialists emphasized the importance of getting information into the hands of revenue authorities. Several suggested adding questions to the tax return itself such as “does the taxpayer use intangible property owned by an affiliate?” These questions would be used to identify potential audit targets and focus audit inquiries. Separately – but in a similar vein – several specialists suggested that taxpayers be required to create contemporaneous documentation substantiating their intercompany pricing at the state level. An example provided was the Organisation for Economic Co-operation and Development proposal that a taxpayer provide a country-by-country analysis. This example provoked at least one attendee to compare it to the infamous “50-state spreadsheet.” Some specialists even suggested that states create special penalties for failure to properly disclose or create the required substantiation.
As some commentators acknowledged, a substantial concern with both the disclosure and substantiation suggestions is the risk of a significant increase in the cost of compliance for taxpayers. State authorities should carefully consider the risk/rewards of any such action. Increased state disclosure requirements, such as modeling the federal uncertain tax position rule, have not yet widely caught on among the states despite spurts of activity. This is partially because of the administrative burden on taxpayers and partially because states receive a great deal of information from the Internal Revenue Service. It is clear, however, that the states continue to be frustrated with the perceived tax planning problem. The specialists expressed near-unanimous agreement that states need more information to properly enforce intercompany transaction issues.
The second theme of the day was the concept of safe harbors. This theme took different forms but could be something that both taxpayers and state revenue authorities would support. For example, some specialists suggested that for low-value transactions, safe harbor rules be created to provide increased certainty to taxpayers. This might include providing limits on the percentage profit that could be made from certain types of intercompany transactions. Other commentators and some states suggested, however, that additional safe harbor protections are unnecessary because state add-back statutes effectively provide safe harbor protection.
In a glaring omission, specialists failed to recognize or address the need to avoid double taxation. Although several specialists noted that in the international area, most of the action happens [...]