Taxpayer is an out-of-state
corporation that does business in Indiana. Taxpayer is a manufacturer of
products. Taxpayer files its Indiana adjusted gross income tax returns on a
consolidated basis with its subsidiaries and affiliates. Taxpayer filed its 2007
Indiana corporate income tax return on a consolidated basis, including several
related companies and subsidiaries.
The Indiana Department of Revenue
("Department") conducted an audit of Taxpayer for the 2007 tax year.
The Department determined that Taxpayer's method of reporting was not
accurately reflecting income sourced to Indiana.
…
The auditor concluded that the
amount reported as Indiana source income could not be accurately reflected
utilizing Taxpayer's method of reporting. The Department based its
determination on several factors, including, but not limited, to: (1) a
circular flow of funds between the related companies; (2) the expenses for
services performed by one related company for another were not allocated; (3)
substantial intercompany "overriding royalties;" (4) among the
different affiliates, there was little or no salary and wage deductions and
associated expenses; (5) all sales of the affiliates involved in production
related activities were intercompany; (6) the affiliates involved in production
related activities accounted for over half of the reported federal taxable
income, but derived only a little over five percent of the groups' total
revenue; (7) and Taxpayer treated all partnerships and limited liability
companies that elected partnership treatment as unitary with their respective
partner and utilized factor relief.
In the audit reports, three methods
were suggested for reflecting Indiana sourced income, and of the three, the
combined reporting method resulted in the least amount of Indiana AGIT. The
auditor noted that it allowed Taxpayer an opportunity to provide an alternative
method as well, but one was not provided to the auditor.
Taxpayer maintains that the
Department's audit report did not follow IC § 6-3-2-2(p) because it did not
show how it applied every method described in IC § 6-3-2-2(l) & (m), and,
therefore, the Department did not meet the prerequisite for a mandatory forced
combination filing.
The Department notes that IC §
6-3-2-2(p) does not require that the Department provide explanations of why
every other method does not fairly reflect Indiana income. IC § 6-3-2-2(l) and
(m) permit the Department to employ "any other method to effectuate an
equitable allocation and apportionment of" Taxpayer's income in order to
fairly reflect and report the income derived from sources within the state of
Indiana. Meanwhile, IC § 6-3-2-2(q) imposes a limitation which the Department
"may not require that income, deductions, and credits attributable to a
taxpayer and another entity... be reported in a combined income tax return for
any taxable year, unless the department is unable to fairly reflect the taxpayer's
adjusted gross income for the taxable year through use of other powers granted
to the department by subsections (l) and (m)." The Indiana Supreme Court's
recent decision in Indiana Dept. of State Revenue v. Rent-A-Center East, Inc.
has confirmed that the Department does not carry such an evidentiary burden.
As mentioned above, the Department's
audit considered potential alternatives to fairly reflect Taxpayer's income
derived from sources within Indiana pursuant to IC § 6-3-2-2(l) and (m), and
concluded, the "method[s] result[ed] in a greater Indiana adjusted gross
income tax than utilizing the combined reporting method." Taxpayer did not
offer any tenable alternatives after receiving the auditor's e-mail. Taxpayer
has now come forward with a method that "reallocates" Head Office and
general and administrative expenses. However, Taxpayer does not explain how
this method more fairly reflects Taxpayer's income, nor does Taxpayer explain
how its method addresses the Department's concerns regarding the factors that
led the Department to conclude that Taxpayer is required to file combined
returns and readjust Taxpayer's 2007 corporate income tax assessment.
... IC §
6-3-2-2(l) provides that the Department may require "in respect to all or
any part of the taxpayer's business activity, if reasonable," one of
several methods to fairly represent the taxpayer's Indiana source income. The
clause "if reasonable" qualifies the methodology used to fairly
represent the taxpayer's income from Indiana business activities, but it does
not impose any order on which methodology must be used first, or second, or
third, and so on. This point is underscored by IC § 6-3-2-2(m), which speaks to
an entirely different set of circumstances than is addressed under IC §
6-3-2-2(l) or (p).
Taxpayer further argues that forced
combination is a last resort and distorts Taxpayer's Indiana source income.
Taxpayer refers to the forced combination "as arbitrary, intrusive, and
unfair," as well as "novel and highly controversial." Taxpayer
maintains that its 2007 return was filed in the same manner in which it has filed
its returns for decades, by only including in its consolidated return
Taxpayer's companies that have nexus with Indiana. Taxpayer argues that the
profits from its lucrative production related businesses that operate outside
of Indiana are unfairly "pulled" into the calculation of Indiana
sourced income.
IC § 6-3-2-2 requires that the
Department be unable to fairly reflect Indiana income using other methods
before requiring a combined filing. The Department provided an explanation in
the audit report concerning the interwoven nature of the entities' activities
and demonstrated at least three circular flows of monies. The Department
requested that Taxpayer suggest alternative methods that could be used, and
Taxpayer did not provide an alternative method until after the hearing. The
Department explained that it tried alternatives methods and was unable to
otherwise fairly reflect Taxpayer's Indiana income and required combined
filing, as allowed under IC § 6-3-2-2(l). Thus, the Department considered
combined filing as a last resort, as required by 45 IAC 3.1-1-62.
Pursuant to IC § 6-8.1-5-1(c),
taxpayer has failed to meet its burden of rebutting the presumption that the
original audit decision was correct. Taxpayer has failed to demonstrate that
combined filing requirement would distort the amount of income taxpayer
received from conducting business within this state.
