Taxpayer is in the business of processing and producing wheat flour. A related company is in the business of producing various food commodities. The Department of Revenue ("Department") conducted an income tax audit of both "Taxpayer" and "related company." For simplicity's sake, both entities are hereinafter referred to in this Letter of Findings simply as "Taxpayer" because the issues raised in the two audits are identical.
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Taxpayer engages in "hedging contracts" in which it buys and sells commodity futures. In preparing its Indiana corporate tax returns, Taxpayer reported the gross proceeds from the sale of these futures contracts. The amount of gross proceeds was used to determine the amount of "sales everywhere" for apportionment purposes.
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The first issue is whether the Taxpayer should only have reported the net gain from the sale of futures contracts to determine the proper everywhere sales for apportionment purposes because – as stated in the audit report – "the same capital or principal is reinvested over and over to buy and sell contracts that involve hedging the [T]axpayer's risk on the purchase and sale of the various commodities." The audit report relied on Sherwin-Williams as supporting its position. In that case, the Indiana Tax Court found that only the interest income earned from the petitioner's security investment should be included in the sales factor. Sherwin-Williams, 673 N.E.2d at 853. The court found that including the recovered principal in the apportionment fraction "would be comparable to measuring business activity by the amount of money that a taxpayer repeatedly deposited and withdrew from its own bank account." Id. at 852. (citing with approval, AT & T v. Director, Division of Taxation, 476 A.2d 800, 802 (N.J. Super. Ct. App. Div. 1984)). Taxpayer has provided evidence and documentation sufficient to establish that the futures contracts and the offsetting futures contracts are not similar to the investments at issue in Sherwin-Williams. Taxpayer's citation to federal case law establishes that futures contracts are not successive, risk-free investments, and reinvestments of the same capital; the futures contracts are a critical and integral part of the Taxpayer's business practice; federal law, the various exchange rules, and its own code of conduct preclude Taxpayer from entering into risk-free, fictional "wash transactions" which create only the illusion of true market activity. In addition, although not dispositive, the Department finds the court's reasoning in General Mills I instructive because the court found that the full sales price of General Mills' futures contracts should be included in the sales factor.
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The second issue is whether the audit was correct in concluding that it was entitled to substitute "net receipts" for "gross receipts" to determine Taxpayer's Indiana sales factor in order to "effectuate an equitable apportionment" as permitted under 45 IAC 3.1-1-50 . ("In some cases, certain gross receipts should be disregarded....") Was the audit correct in "disregarding" Taxpayer's gross receipts?
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The audit cited to 45 IAC 3.1-1-50 to justify disregarding Taxpayer's gross sales "in order to effectuate an equitable apportionment" of Taxpayer's Indiana income. The audit's decision to do so mirrors Taxpayer's own decision to report net receipts for both federal income tax purposes and SEC purposes. Having done so, there is no indication that Taxpayer's decision to report the income on a net basis worked a "hardship or injustice" upon Taxpayer, that reporting net income for federal purposes resulted in an "arbitrary division of income," or that reporting net income for federal purposes produced an "incongruous results." To the contrary, Taxpayer made an apparently reasoned decision to report its net sales for federal income and SEC purposes. The Department does not agree that for purposes of determining federal income tax, fulfilling its responsibility to report to the SEC, and determining state income tax liability serve such "vastly different objectives" that the audit was incorrect when it required – for apportionment purposes – that the Taxpayer reports its sales in a manner entirely consistent with what it reported to the federal authorities.
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http://www.in.gov/legislative/iac/20130626-IR-045130252NRA.xml.html
