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  Legislative Issue Update:  "Forced Combination" for Corporate Tax Returns

BACKGROUND

On September 5, 2006, the Revenue Laws Study Committee convened to consider various matters regarding revenue and taxation.  One of the key topics raised by the Department of Revenue was the issue of possible revenue "leakage" resulting from corporation's use of tax frameworks and inter-company transactions that shift revenue between NC corporations and operating entities incorporated in other states.

The DoR contends companies are using such frameworks to avoid paying $300 million in taxes to North Carolina.  DoR reported it has made administrative rulings (based on its interpretation of NC statutes) to force selected companies to file combined state tax returns. The DoR has recommended that the legislature revise the statutes to require consolidated and/or combined tax returns for all corporations operating in North Carolina.

The business community has expressed concern with DoR's policy of forcing combination retroactively and with the lack of guidelines regarding permissible inter-company transactions.  Most businesses assert that the preponderance of inter-company transactions used to move revenues between operating entities are legitimate.  They want guidelines that will provide clarity.

MY INITIAL THOUGHTS

This section contains my initial thoughts based on the research I have completed to date.

• If a business makes a decision to shift income based on inter-company transactions that do not pass generally accepted and published guidelines for nexus, it should pay taxes for the related income in North Carolina.

• The current DoR policy based on its interpretation of existing statutes presents a challenge for many businesses.  Statutes dating back more than 60 years and current DoR published policy do not appear to provide the clarity businesses need to make a decisions regarding acceptable inter-company transactions.

• The lack of clarity puts business leaders in a difficult position.  On the one hand, if a business implements an aggressive tax policy to maximize profitability and shareholder value (two legitimate goals), it risks an audit that may lead to a restatement of earnings and a negative perception in the marketplace.  On the other, if a business implements a conservative policy in order to avoid this outcome, it may leave money on the table, which diminishes its profitability and shareholder value (also leading to a negative perception in the marketplace).

• The state must provide clarity as to the types of inter-company transactions that are not permissible for income shifting.  It seems unfair to only provide clarity after the fact in the context of an audit.

• The current statutes (some of which were enacted in the 1940's) contain provisions that raise legitimate questions as to fairness/clarity.  For example, the burden of proof regarding challenges to audits appears to heavily favor the State over the business.

• Given that only a few of the most populated states have implemented the policies recommended by the DoR, we need to understand the broader consequences of mandatory consolidation and combined returns.

• If the implementation of changes results in significant net-new revenue, these revenues should be used to offset decreases in North Carolina's corporate tax rate (NOT to fund net-new spending).

I intend to focus on this issue when I begin my term in 2007, and I will confer with fellow legislators, businesses, and staff to gain a broader understanding of the issues.  In the meantime I welcome your feedback (supporting or opposing) regarding my initial views.  You can either send me an email in the link below or you can send a confidential/anonymous message.  CLICK this link to send a confidential message.  I would also appreciate any information you may have on the issue.  With your approval it will be added to the website.

RELATED MATERIALS

If this is an issue of interest to you or your company, I highly recommend that you download and read the following documents.  These documents* were presented in the September 5, 2006 committee meeting.

2006 Finance Law Changes

2006-09-05 - DoR Committee Presentation - Summary

2006-09-05 DoR Committee Presentation - Corporate Income Tax

2006 PwC Point of View - Combined Article (Mike Hanna)

2006 PwC Point of View - Hannah Remarks to Committee5

OTHER RESOURCES

The following websites provide additional details and links to other relevant resources.  Just CLICK the underlined text to access the linked site.

Access the Revenue Laws Study Committee website

Receive email notices/reminders for future Revenue Laws Study Committee meetings.

Access the State of North Carolina Legislative website

INTERESTED IN FUTURE UPDATES?

Let me know if you found this information helpful and if you would like future updates on this subject.  CLICK this link to Send an email to provide feedback and to request future updates on this issue.