The Indiana Department of Revenue ("Department") conducted an audit of Taxpayer for the years 2007, 2008, 2009, and 2010 (the "Tax Years"). As a result of the audit, the Department required Taxpayer to make several proposed adjustments including requiring Taxpayer to file a combined return with its parent ("Parent") and two other affiliates. These adjustments resulted in the assessment of additional income tax as well as interest and penalty.
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Parent, a Delaware corporation, is in the business of producing, acquiring, and distributing cable and satellite programming nationally – including within Indiana – and internationally. According to the audit report, the Parent was the most profitable division in the company and that more than 80 percent of domestic television viewers receive programming from Parent.
Taxpayer is a wholly-owned Delaware subsidiary of Parent that derives revenue from performing production services for Parent by producing events directly or coordinating and administering the production of events with third party producers. Parent then reimburses Taxpayer for the production of its product. Taxpayer also receives subscription and advertising revenue from a magazine it owns. During the Tax Years, Taxpayer filed Indiana returns but Parent did not. Aside from the Parent and the Taxpayer, the audit reviewed another subsidiary ("Sub 1"), that is also a wholly-owned Connecticut subsidiary of Parent that provides cable and satellite programming. That programming primarily consists of replaying the programming originally produced by Taxpayer and originally distributed by Parent. This entity also did not file Indiana returns during the Tax Years.
Finally, the audit reviewed another Delaware subsidiary ("Sub 2") that was also wholly-owned by the Parent. Sub 2 develops new products and businesses using the group's brand and assets, including mobile phone applications provided by various phone carriers. Sub 2 receives a fee for each subscriber that adds the service. This entity also did not file Indiana returns during the Tax Years. (Parent, Taxpayer, Sub 1, and Sub 2 are collectively referred to as the "Companies").
These entities form an interrelated media organization that provides television, cable, and satellite programming services and receives revenues from fees charged to cable, satellite and telecommunications service providers and from the sale to advertisers of advertising time during network programs for commercial announcements. The ability to sell time for advertising announcements and the amount of income received are dependent on the size and nature of the audience that the network can deliver to the advertiser. (Parent organization 2010 10-K at 2). According to sample contracts provided by the Companies, the Companies received a fixed fee based on the number of subscribers that purchase the Companies' media output. (See Exhibit C, at 15; Exhibit D, at 8-9 (provided by the Taxpayer in its June 26, 2013 letter to the Department)).
According to documents submitted to the Securities and Exchange Commission by the parent company of the Taxpayer, Parent, Sub 1, and Sub 2, the Parent had approximately 100 million domestic subscribers while Sub 2 had approximately 41 million domestic subscribers. (Parent organization 2010 10-K at 3). The 10-K notes that these figures were calculated by relying upon the Nielson Media Research figures. Id. Finally, the parent organization's 10-K states that the Parent, Taxpayer, Sub 1, Sub 2, and Sub 3 operate as consolidated subsidiaries. (Parent organization 2010 10-K at 68).
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During the Tax Years, the Parent, the Taxpayer, Sub 1, and Sub 2 generated adjusted gross income derived from sources in Indiana as a result of conducting business in Indiana. Specifically, these entities were doing business in Indiana by rendering services to Indiana residents in the form of television, cable, and satellite programming services that generated revenues from fees charged to cable, satellite and telecommunications service providers and from the sale of advertising time during network programs for commercial announcements.
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Nevertheless, The Department found that Taxpayer did not include Parent, Sub 1, and Sub 2 in its Indiana tax returns during the Tax Years. The Department determined, under the authority of IC § 6-3-2-2(a), that Taxpayer's failure to include these related entities distorted Taxpayer's reported income. For example, the audit report noted that Taxpayer received 87 percent of its Gross Receipts from the Parent, and without the content purchased from Taxpayer, the Parent would lack media output to provide to its subscribers in Indiana. By failing to include Parent, Sub 1, and Sub 2, Taxpayer's tax returns provide an incomplete picture of the true business being conducted in this state. Taxpayer's operations do not represent a distinct business enterprise. The collective activities of the four entities are directly responsible for providing media content to Indiana customers, and, therefore, those four entities should be included in a combined tax return.
Furthermore, even assuming, arguendo, that only Taxpayer was directly engaged in business activities in Indiana, the unitary nature of these Companies requires that all four entities' activities be included on the Indiana tax return. Indeed, the Department's audit describes Parent, Taxpayer, Sub 1, and Sub 2 as forming a unitary business that produces, acquires, and distributes cable and satellite programming. The operations of these four entities are intertwined. Parent pays for the filming rights, then contracts with Taxpayer and Sub 2 to record the events and receives income from the licensing of the rights to broadcast these events. Sub 1 then generates revenue from rebroadcasting these events at a later date. Because these entities are interdependent upon each other to generate revenue, these four entities form a unitary business and should be included in an Indiana combined tax return.
Due to the interdependent nature of the Companies, the resulting income generated from conducting business in Indiana is unitary in nature. Therefore, it was proper for the Department to require that these unitary entities file a combined Indiana tax return for the Tax Years. According to IC § 6-5.5-1-18(a), a "'[u]nitary business' means business activities or operations that are of mutual benefit, dependent upon, or contributory to one another, individually or as a group[.]" (Though IC § 6-5.5-1-18 falls under the Taxation of Financial Institutions article of the Indiana code, the Tax Court has relied upon this statute in a previous adjusted gross income tax decision for purposes of defining a "unitary business." See May Dep't Stores Co. v. Indiana Dep't of State Revenue, 749 N.E.2d 651, 657 n. 8 (Ind. Tax Ct. 2001)). A unitary business may consist of a single business entity or multiple legal entities which is referred to as a "unitary group." IC § 6-5.5-1-18.
Unitary groups may include numerous types of legal entities, such as LLCs or partnerships, without affecting the unitary nature of the business. IC § 6-5.5-1-18(a). The only element that must be met in order to apportion income from a unitary business in Indiana is that the unitary group must conduct business "wholly or partially within Indiana." Id.
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The undisputed facts demonstrate that the Companies meet the definition of a unitary business. As noted in the audit report, Parent had direct or indirect ownership of 100 percent of Taxpayer, Sub 1, and Sub 2, which constituted "unity of ownership." Taxpayer's protest letter also confirmed the "unity of ownership" by admitting that Taxpayer, Sub 1, and Sub 2 were "wholly-owned subsidiar[ies]" of Parent. The audit report continued the presumptive unitary analysis by explaining that there was unity of use between the Companies due to the fact that the Parent provided centralized management functions such as human resources, accounting, legal, tax reporting and compliance, treasury, information technology, risk management and similar services. Additionally, the audit report noted that unity of operation was evidenced by the inter-company interest charges, royalties, and research and development activities. For these reasons, the Companies meet the definition of a unitary business.
Taxpayer claims that because Parent, Sub 1 and Sub 2 purportedly have no physical location or personnel in Indiana, Taxpayer should not be taxed on income received from these subsidiaries. Taxpayer cites to the sample agreements it provided to the Department between Parent and unrelated cable operators ("Operators"). Relying on these sample contracts, Taxpayer asserts that it does not receive revenue from providing programming services. Further, Taxpayer's protest asserts that the sale of advertising is "usually" done by third party agencies.
The Department cannot agree with Taxpayer's argument. Taxpayer's assertion fails to account for the fact that the Companies receive a fixed fee based on the number of subscribers purchasing the Companies' media output in Indiana. See Exhibit C, at 15; Exhibit D, at 8-9 (provided by Taxpayer in its June 26, 2013 letter to the Department). In other words, the Companies' income is directly linked to the number of subscribers that purchase the Companies' content in a given state. Thus, the Operators are merely a conduit for subscribers to access the Companies' media output. Furthermore, Taxpayer's assertion that it does not sell advertising is flawed. First, Taxpayer admits that this work is "usually" done by third party agencies. Given that the term "usually" is vague and imprecise, little if no weight can be assigned to this statement. Further, the fact that third party agencies are negotiating the sales is not relevant. The Companies would still benefit financially from the sale of advertising slots and Taxpayer admits that they incorporate the advertising into the media content provided to the subscribers.
Taxpayer has not overcome its burden of establishing that the Department's audit's inclusion of Parent, Sub 1, and Sub 2 into Taxpayer's return was wrong.
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Taxpayer protested the Department's proposed assessment of additional income tax based on the use of the "audience factor" apportionment methodology in lieu of a "cost of performance" apportionment methodology Taxpayer utilized. Taxpayer argues that the "audience factor" method has not been adopted in Indiana either by statute or regulation. Taxpayer argues that IC § 6-3-2-2(f) "clearly and unambiguously" requires that companies which earn revenue from sales – other than sales of certain intangible property or tangible personal property – apportion that revenue using a cost of performance methodology. Taxpayer also cites to 45 IAC 3.1-1-62 for the premise that the Department did not have the authority to apply the equitable remedial powers under IC § 6-3-2-2(l). Taxpayer states in its August 23, 2012, protest letter:
This regulation, by its own terms, applies only where the standard allocation and apportionment provisions do not result in a division of income that fairly represents taxpayer's income from Indiana sources. In addition to satisfying this prerequisite, the Department must demonstrate that the standard formula works a hardship or injustice upon the taxpayer, results in an arbitrary division of income, or in other respects does not fairly attribute income to the State.[] Second, the Department must show that the situation to which it wants to apply this special allocation and apportionment provision arises under limited and unusual circumstances that are unique and non-recurring.[].
However, Taxpayer interprets the regulation too narrowly. The regulation states that "[the Department] anticipate[s] that these situations will arise only in limited and usual circumstances (which ordinarily will be unique and non-recurring)." Id. The regulation's language of anticipation is not the language of limitation that Taxpayer suggests. The regulation's language of anticipation does not preclude the Department from applying its remedial powers, but instead provides guidance that the Department generally expects not to use its remedial powers and cautions the Department from implementing its remedial powers broadly. Nevertheless, as the regulation states, when the standard formula "works a hardship or injustice upon the taxpayer, results in an arbitrary division of income, or in other respects does not fairly attribute income to this state or other states," the Department will use an alternate method. Id.
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By employing an audience factor, the Department reasonably addressed Taxpayer's failure to provide the requisite documentation. Taxpayer's books and records could have provided the information that would have permitted the Department to use three-factor apportionment. Because Taxpayer failed to provide the information, the auditor could not ensure that Taxpayer and its affiliates' Indiana source income could be fairly represented by use of a three-factor apportionment. The auditor therefore used "the best information available," i.e., the ratio of Indiana cable and satellite subscribers (which ultimately make Taxpayer's broadcasts valuable) to all cable and satellite subscribers nationwide. Further, given that Parent is arguing that it had no Indiana source income – despite the fact that filings with the Security and Exchange Commission establish that Parent had nearly 100 million subscribers – the Department believes that such an argument is an "unusual" situation. Under the circumstances, it was appropriate for the auditor to use the Indiana subscriber base to derive a ratio by which to apportion Taxpayer's income.
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Taxpayer argues that the Department's employment of the audience factor violates the state's Administrative Procedure Act ("APA"). IC § 4-22-2-3(b) defines a "rule" as "the whole or any part of an agency statement of general applicability that: (1) has or is designed to have the effect of law; and (2) implements, interprets, or prescribes: (A) law or policy; or (B) the organization, procedure, or practice requirements of an agency." Taxpayer argues that the apportionment method applied by the Department during the audit constituted rule making under this definition. In further support of this argument, Taxpayer cites to state supreme court cases from Maryland and New Jersey where the courts upheld an argument similar to Taxpayer's (See CBS Inc. v. Comptroller, 575 A.2d 324 (Md. 1990) and Metromedia, Inc. v. Director, Division of Taxation, 478 A.2d 742 (N.J. 1984).
The Taxpayer's argument is flawed. First, the Taxpayer attempts to apply a statutory standard to the Department from which the Department is exempt. IC § 4-21.5-2-4(a)(9). Even if the Department were subject to the provisions of the APA, the Taxpayer's argument is still without merit. The Department has been granted the authority to apply IC § 6-3-2-2(l) in order to ensure a fair and appropriate apportionment of a taxpayer's income. That is exactly what the Department has done in this particular situation. Taxpayer presented a unique apportionment methodology that would have ensured that Taxpayer and its affiliates avoid taxes on money generated from Indiana income producing activities. Given Taxpayer's unique interpretation of the apportionment statute, the Department applied a different methodology to ensure that the income would be apportioned in a manner that fairly reflects the Taxpayer's business activities within Indiana. Furthermore, other state courts' interpretations of their laws have no binding precedential value in Indiana. Moreover, the facts in the cases cited by the Taxpayer do not reinforce the Taxpayer's argument. For example, the administrative agency in the Metromedia decision was not exempt from the APA. In fact, the court in Metromedia overturned the decision to use an agency-based apportionment method because the decision to use the method had not complied with the APA. As the Department is statutorily exempt from the APA, Metromedia is of no value.
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The Department has twice considered alternative apportionment methods in order to properly reflect and apportion the Companies' Indiana sourced income. First, the auditor considered applying a "separate accounting" methodology as well as adding or subtracting various factors. After reviewing the nature of the Companies' business, the auditor determined that alternative methods would not cure the distortion in the Companies' Indiana income. After considering these alternative methods, the auditor determined that an audience factor based approach would cure the distortion. Given that the sample contracts provided by Taxpayer indicate that the Companies' revenue is based on the number of subscribers accessing the Companies' programming content, the auditor's decision was reasonable.
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Taxpayer protests that the adjustments to its adjusted gross income tax return violate the Constitution. Notwithstanding that an administrative hearing is not the appropriate venue to address such assertions, the Department notes that the adjustments made to its adjusted gross income tax returns are in fact constitutional.
The Department employed its statutory authority to apportion the Companies' income in a manner that fairly reflects the Companies' business activities conducted in this state. The Department is required by statute to apportion a taxpayer's multi-state income in a manner that will effectuate an equitable apportionment of that income. Further, if a unique situation arises – such as a taxpayer arguing that income generated from Indiana residents that accessed the taxpayer's product in the State are not taxable in this State – then the Department may apply a unique apportionment methodology to ensure an equitable apportionment of the income. The Companies are being treated in a similar manner as all entities that do business within Indiana, and the Department is ensuring that they are liable for taxes associated with the income generated in this state. Thus, there is no Equal Protection Clause issue nor has the Companies' income been distorted by employing an audience factor based apportionment methodology.
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The Department issued proposed assessments and the ten-percent underpayment penalty for the tax years in question under IC § 6-3-4-4.1(d). Taxpayer protested the imposition of underpayment penalty.
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Taxpayer has provided sufficient documentation demonstrating that the imposition of the underpayment penalty is not appropriate.
