Taxpayer filed a 2010 Indiana corporate income tax return. The Indiana Department of Revenue ("Department") disallowed two deductions–royalty income and foreign dividends.
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Taxpayer's protest letter states that it is protesting "the amount of tax, penalty and interest assessed to [Taxpayer] in the amount of $13,829.82 for tax year 2010...." (Note: at other times Taxpayer references other tax years; as will be seen below, 2009 and 2010 are the years impacted). The two issues are royalty income and foreign dividends. Regarding the former, Taxpayer states that it holds intangibles for affiliate stores. Taxpayer states that the royalties are charged at an arm's length price. In its protest letter, Taxpayer states:
The first issue is the handling of the intangible expenses. Each year [Taxpayer] received royalty income from its subsidiaries and affiliates for certain intangibles that [Taxpayer] licenses. Several [Taxpayer] affiliates file an Indiana Corporate Tax Return and as a result needs [ sic] to add back to income any royalty expense paid to [Taxpayer] as per Indiana Code §6-3-1-3.5(b)(9) and §6-3-2-20(b). Therefore, the affiliates are paying tax on the disallowed royalty expense. Conversely, [Taxpayer] should not pay tax a second time on the royalty income received from the affiliates, and therefore the royalty income should be excluded from [Taxpayer's] income.
In other words, Taxpayer is asserting that the intangible income has already been subjected to tax on its affiliate's returns. Taxpayer asserts this, but did not establish that its affiliates had in fact been subjected to Indiana corporate income tax, or had added back royalty expenses.
Despite Taxpayer's protest, there is not an Indiana statutory mechanism available for Taxpayer (the recipient) to deduct the royalty income. ...
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None of the options outlined in IC § 6-3-2-20(c) are applicable to Taxpayer's facts. Additionally, the Department notes, Taxpayer bears the burden of proof under IC § 6-8.1-5-1(c). Taxpayer has not met its burden regarding it taking the deduction. However, it appears the Department not only disallowed the deduction, but added an amount equal to the claimed deduction to Taxpayer's income. Taxpayer should have had no deduction and no addback (Taxpayer did not incur any royalty expenses subject to IC § 6-3-2-20, thus the proper amount of the addback is zero). This appears to have impacted 2009 and 2010, and should be corrected by the Department.
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Taxpayer also protests "the treatment of the foreign gross up." Taxpayer's protest letter states:
Each year [Taxpayer] receives a dividend from its foreign subsidiary in the [...]. A deemed dividend calculated per Section 78 of the Internal Revenue Code is included in [Taxpayer's] income for Federal income tax purposes for the amount of foreign tax credits associated with the dividend. Indiana Code §6-3-1-3.5(b)(4) allows for the exclusion of Federal Section 78 income in the calculation of Indiana taxable income. [Taxpayer] reported this subtraction as a negative modification on Form IT-20. Indiana's computer system also disallowed this subtraction modification.
At the hearing, Taxpayer reiterated that Indiana's computer system would not recognize the modification.
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Given Taxpayer's assertion that the Department's computer system caused the disallowance, the Department's Audit Division is requested to review Taxpayer's adjustment as it relates to Section 78 and the Indiana code, and to make any appropriate adjustments.
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Taxpayer protests the imposition of penalty and interest. Regarding Taxpayer's protest of the interest, the Department is barred by statute from waiving interest under IC § 6-8.1-10-1(e).
Turning to Taxpayer's protest of the penalty, the Department notes that penalty waiver is permitted if the taxpayer shows that the failure to pay the full amount of the tax was due to reasonable cause and not due to willful neglect. IC § 6-8.1-10-2.1. ...
Taxpayer's protest letter does not develop the penalty issue, and at the hearing Taxpayer asserted that it took measures that it believed were correct and in good faith. As previously noted, under IC § 6-8.1-5-1(c), Taxpayer bears the burden of proof. Taxpayer has not met its burden regarding the penalty and interest issue.
