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A number of states, concerned about profit shifting, have been closely scrutinizing intercompany transactions on audit, or have hired third-party auditors to conduct transfer pricing specific audits, even among domestic domiciliaries.1 Last issue's edition of this column reported on the efforts of the Multistate Tax Commission-an intergovernmental state tax agency-to provide various transfer pricing services to concerned states. This month, I discuss the state income tax consequences of a sustained federal Section 4822 adjustment.
Almost all states that impose a corporate income tax rely upon federal taxable income to begin the computation of state taxable income. A sustained Section 482 adjustment to federal taxable income can cause a change to the state tax base, apportionment, and nexus determination; and may require the taxpayer to file amended state returns. Taxpayers can be proactive, rather than reactive, when it comes to state transfer-pricing issues and audits. This article identifies some, though by no means all, of the state substantive and procedural issues a taxpayer should consider after a federal Section 482 adjustment.
For purposes of discussion, I assume a U.S. Subsidiary purchases shoes from a U.K. Subsidiary, a wholly-owned subsidiary of a U.S. Parent, for $100. To illustrate particular state tax consequences, I will introduce variations to this basic scenario, such as the country making the adjustment (the U.K. makes a $20 adjustment rather than the Internal Revenue Service (IRS)) or whether the adjustment is positive or negative.3
State reporting requirements. Given that federal taxable income is generally the starting point in computing state taxable income, states usually require taxpayers to report adjustments resulting from an IRS final determination. Although the definition of "final determination" varies among the states, an IRS initiated transfer-pricing audit, resulting in a primary adjustment accepted by a taxpayer, may qualify as a final determination for state tax purposes.4
In addition to reporting corrections or changes to federal taxable income, certain states require a taxpayer to file an amended state return any time the taxpayer files an amended federal return.5 In other states, an amended state return may be required only if state taxable-income changes as a result of the adjustment, or the adjustment affects certain state tax attributes. 6 Under either approach, a taxpayer will need to work through the effects...