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Jamie C. Yesnowitz
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The North Carolina Department of Revenue is offering a voluntary initiative for corporate taxpayers to expedite the resolution of corporate intercompany pricing issues.1
The initiative began on Aug. 1 and will conclude by Dec. 1, 2020. Taxpayers who wish to participate in the initiative must submit an election to the Department by Sept. 15, 2020.
In addition to providing a settlement agreement, the Department will waive any applicable penalties.
Adjustments of income
If the Department has reason to believe that a corporate taxpayer does not accurately report its North Carolina net income properly attributable to its business conducted in the state by using transactions that lack economic nexus or are not at fair market value between members of an affiliated group, the Department may request relevant information from the taxpayer.2
If the Department determines that the taxpayer’s intercompany transactions lack economic substance or are not at fair market value, the Department may adjust the taxpayer’s net income that is properly attributable to its business carried on in the state.3
The purpose of the initiative is “to fairly and consistently expedite the resolution of corporate Intercompany Pricing Issues subject to [the adjustment statute], provide certainty and uniformity to taxpayers, reduce time in disputes, and form an efficient basis for resolution of this corporate tax issue for all open tax years.”
Eligibility to participate
The initiative is available to all taxpayers that have filed corporate income tax returns within the statute of limitations that have intercompany transactions that would be subject to adjustment under North Carolina law. Eligible participants include taxpayers in the request to review process, currently under audit, notified of a future audit, and unidentified taxpayers with related party intercompany pricing.
To participate in the initiative, taxpayers must submit an “election to participate” form with the Department by Sept. 15, 2020.4
Taxpayers must provide the required transfer pricing and tax documentation to the Department by Oct. 16, 2020.5
Within 31 days of receiving the documentation, the Department will provide the taxpayer with a proposed adjustment that includes a summary of the Department’s methodology and conclusions. Taxpayers may offer modifications to the proposal, but an agreement must be reached with the Department within 15 days. If an agreement is reached, the Department and taxpayer will enter into a settlement agreement that resolves the transfer pricing issue. The Department will waive applicable penalties as well as rights to assess any additional tax, interest or penalties except for adjustments relating to federal corrections.6
Taxpayers waive all rights to review or refund of any amounts paid during the relevant period except for refunds due as a result of federal corrections.7
If an agreement is not reached, the Department and taxpayers may pursue their statutory rights and remedies.
The issue of controlling the tax effects of intercompany transactions through transfer pricing has received considerable attention from state tax authorities. States reportedly are losing substantial tax revenue because taxpayers are using what are perceived to be improper intercompany transfers to avoid tax. Conversely, taxpayers may be overpaying their taxes because they do not have proper transfer pricing in place. As a reflection of the states’ interest with respect to this issue, a recent article indicates that 12 states, including North Carolina, are regularly meeting to address transfer pricing concerns and coordinate audits.8
Also, Indiana recently became the first state to formally offer an advance pricing agreement (APA) program that is similar to the program that historically has been offered by the Internal Revenue Service.9
After the Indiana Department of Revenue and a taxpayer agree on a transfer pricing method, the agreement covers two audit cycles or six years. Participants in the program are not subject to audit during this period. While Indiana is the only state currently formally offering an APA, it is possible that other states may consider similar APA programs in the future.10
With the advent of a temporary initiative, North Carolina is trying a different approach to address the transfer pricing issue. The new initiative is essentially a tax amnesty program intended to encourage the resolution of transfer pricing issues. By offering to waive penalties, the Department is providing taxpayers with an incentive to participate. This program may be more appealing to taxpayers currently under audit, as existing transfer pricing issues are likely to arise during the course of an audit. Participation in the program may speed resolution of such issues as well as provide certainty for prospective filings.
There are benefits to the initiative, but participation may lead to additional scrutiny of other positions on tax returns. Because North Carolina is coordinating efforts with other states, there is a possibility that other states might contact participating taxpayers on transfer pricing issues, or potentially fold transfer pricing issues into existing audits. Additionally, the waiver of a taxpayer’s right to refunds except for a refund due to a federal change may be a significant factor for consideration. While the Department is similarly waiving its right to re-audit the returns, the entire income and franchise tax returns for open years may be reviewed. It is not clear if the Department may propose other adjustments unrelated to transfer pricing during the course of the review. For these reasons, taxpayers are advised to carefully consider their participation in this initiative.
Because applications must be filed by Sept. 15, 2020, taxpayers interested in the initiative must act quickly.
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