Taxpayer is in the business of supplying medical implants, instruments, and cutting tools. The Indiana Department of Revenue ("Department") conducted a corporate income tax audit of Taxpayer's business records and tax returns.
Taxpayer filed consolidated federal and Indiana income tax returns. According to Taxpayer, it used "the standard (traditional) method of apportionment" in filing those returns. The Department's audit concluded that Taxpayer's method of apportionment did not fairly represent Taxpayer's Indiana source income. As an alternative, the Department determined that Taxpayer's should calculate its adjusted gross income using a "stacked" or "separate accounting" method. The recalculation of Taxpayer's adjusted gross income resulted in an assessment of additional income tax.
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For the three years at issue, including all five entities, and using the standard three factor method of apportioning Taxpayer's adjusted gross income for Indiana, Taxpayer reported $4,720,290 in losses and – of course – owed zero Indiana taxes.
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The audit noted that "[Technologies] and [Medical Instrument] had very little connection to Indiana. Neither corporation had any Indiana property during the audit period. Medical Instrument had little or no Indiana payroll and less than one-half of one percent Indiana sales. Technologies had very minor Indiana payroll and actually reported "negative sales." If the Department had simply excluded from the consolidated return the two entities with "de minimis" contact with Indiana, the result would have been additional income tax of approximately $133,914. Instead of eliminating Technologies and Medical Instrument from the consolidated return on the ground that the contact with the state was marginal, the Department employed a "stacked" method.
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It should be noted that the "stacking" method is specifically listed as an alternative method in IC § 6-3-2-2 (l)(1) where its identified as "separate accounting."
Was the audit justified in taking the course it did? … Under the standard apportionment methodology, two companies – each of which have only minimal ties to this state – would placed the entire consolidated entity into a "loss" position. Taxpayer's original return had the effect of converting three combined companies – each of which had substantial ties with Indiana with over $1,000,000 in Indiana source income – into a consolidated entity with several million dollars in loss. That substantial amount of loss would have been on the inclusion of the entities each of which had only a few thousand dollars of actual Indiana losses. The net effect of Taxpayer's approach would have been to "import" substantial losses generated outside Indiana into Indiana. For instance, what would have been a 2009 $52,000 Indiana loss for Technologies would have become, in effect, a $6,000,000 Indiana loss as part of the consolidated group.
The Department is unable to agree that these results would "fairly represent the taxpayer's income derived from sources with the state of Indiana...." IC § 6-3-2-2(l). Given the alternatives, the audit chose an alternative method of apportioning Taxpayer's income specifically permitted under statute, and the decision to do so was entirely reasonable.
