The New York State Department of Taxation and Finance (Department) provided another example of its longstanding eagerness to force taxpayer combination—at least in cases where it results in increased tax revenue. In the Matter of Kellwood Co., No. 820915 (N.Y. Tax App. Trib. Sept. 22, 2011).
The Department (or taxpayer) must prove three elements to require a combined report:
- Sufficient ownership
- Existence of a unitary business
Under pre-2007 law, if related entities have “substantial intercorporate transactions,” distortion is presumed. Because Kellwood and its subsidiaries were “engaged in a unitary business,” were commonly owned, and had substantial intercorporate transactions, it was up to Kellwood to rebut the distortion presumption. Generally, taxpayers can rebut distortion by illustrating arm’s-length pricing. However, when the Department also challenges the economic substance of the transactions at issue, as the Department did in Kellwood, the taxpayer must also prove that the transactions “merit tax respect.” In other words, the transactions must have sufficient business purpose and economic substance to avoid being deemed “shams.”
The Department attempted to combine an accounts receivable factoring subsidiary and a shared services subsidiary with the Kellwood parent company. The Tax Appeals Tribunal upheld the Administrative Law Judge’s determination that the factoring company lacked economic substance and was thus properly combined. However, regarding the shared services company, the Tribunal held that the taxpayer: (1) satisfied the subjective and objective prongs of the sham transaction analysis; and (2) rebutted the presumption of distortion by proving that the intercompany transactions reflected arm’s-length pricing pursuant to a transfer pricing study.
The Department is actively seeking to combine and de-combine taxpayers (depending on the circumstances). Taxpayers should review the Kellwood decision (and the burden to rebut the taxpayer’s transfer pricing analysis) if they have a forced combination risk.