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Indiana Combination Is Last Resort

The Indiana Tax Court granted a motion for partial summary judgment to AE Outfitters Retail Co. and held that the Indiana Department of State Revenue may require combined reporting only after first determining that other alternative apportionment meth

December 6, 2011

The Indiana Tax Court granted a motion for partial summary judgment to AE Outfitters Retail Co. and held that the Indiana Department of State Revenue may require combined reporting only after first determining that other alternative apportionment methodologies would result in an equitable apportionment of the taxpayer’s income. AE Outfitters Retail Co. v. Ind. Dep’t of State Revenue (Ind. Tax Ct. Oct. 25, 2011).

The dispute in the case was whether the Department was required to first apply statutorily provided remedies to adjust a taxpayer’s income before applying combined reporting. Like many states, Indiana statutes provide alternative apportionment methods for re-determining income if the taxpayer’s income is not fairly represented, including separate accounting, the exclusion of factors, the inclusion of additional factors, or any other method to effectuate an equitable allocation and apportionment of the taxpayer’s income. Ind. Code § 6-3-2-2(l). Furthermore, in the case of commonly owned or controlled businesses, the statute allows the Department to “distribute, apportion or allocate the income derived from sources within the state of Indiana between and among those organizations, trades or businesses in order to fairly reflect and report the income derived from sources within the state of Indiana by various taxpayers.” Ind. Code § 6-3-2-2(m). The statute, however, limits the Department’s ability to use combined reporting in situations where it “is unable to fairly reflect the taxpayer’s adjusted gross income for the taxable year through use of other powers granted to the department by” those other statutory provisions.

The Department argued that it was permitted to apply combined reporting even if one of the other methods would fairly reflect a taxpayer’s income. Based on the plain meaning of the statute, the court rejected the Department’s position and held that the Department does not have the discretion to determine which of the methodologies it should apply prior to requiring a combined report. The Department must apply all of the other statutory methodologies first to determine whether application of each of them would result in an equitable allocation and apportionment of the taxpayer’s income. Only after making those determinations is the Department, under the law, allowed to require combined reporting.

Other states have similar limitations on Departmental ability to force combined reporting. For example, effective January 1, 2012, a new North Carolina statute allows the Secretary of Revenue to redetermine net income “properly attributable to [the corporation’s] business carried on in the state” by “adding back, eliminating, or otherwise adjusting intercompany transactions to accurately compute the corporation’s State net income.” N.C. Gen. Stat. § 105.130.5A(b). That law allows the North Carolina Department of Revenue to require a combined report “if such adjustments are not adequate under the circumstances to redetermine State net income . . . .” Id. Further, it requires that the state “consider and be authorized to use any reasonable method proposed by the corporation” for determining the taxpayer’s net income. Id. It remains to be seen whether North Carolina courts will interpret this limitation in a manner similar to the Indiana law.

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