For any group of affiliated entities, intercompany transactions, such as intercompany purchases, loans, licensing, services, and management, are a way of life. Even though those transactions are a part of normal business operations, they have created problems and opportunities in states that have not adopted combined reporting. States have sought to disallow the deduction of related-party expenses under the presumption that the transactions were not entered into with business purpose or economic substance, or that they distorted the true reflection of income earned in the state.
It could be argued that taxpayers abused the positive effect of ‘‘true’’ intercompany transactions by using special purpose entities such as sales companies, finance companies, and the infamous intangible holding company to shift income from one entity to another or from one state to another. The use of those types of entities and transactions exploded in the 1990s. Since then, states have worked to end that perceived abuse by enacting related-party expense addback legislation or adopting combined reporting. As a result, the ability to use intercompany transactions to shift income has become very difficult.
Taxpayers argue that economic substance and business purpose other than tax savings have always been integral parts of any state tax planning (even in the 1990s). However, taxpayers today approach state tax planning in terms of focusing on the business objective first, and then seeking to implement that objective in a tax-efficient manner. Some practitioners refer to that as business alignment planning. I like to describe it as not putting the cart before the horse.
To read more, check out my article from Tax Analysts State Tax Notes on October 28, 2013.
Don't forget to sign up to attend the free Bloomberg BNA webinar tomorrow that I am co-presenting: "State Tax Planning for Related-Party Transactions."
I hope you can join me to discuss:
- Triggers which create problems and opportunities (in regards to related-party transactions)
- Common inter-company transactions
- 6 ways states may respond to related-party transactions (including recent developments and how to analyze, defend and plan)