Ohio Tax State Transfer Pricing Audits Effective Strategies to - PDF document

27th Annual Tuesday & Wednesday, January 23‐24, 2018 Hya� Regency Columbus, Columbus, Ohio Workshop Z Ohio Tax State Transfer Pricing Audits … Effective Strategies to Minimize Your Risk Tuesday, January 23, 2018 4:15 p.m. to 5:15 p.m.

Biographical Information Diann L. Smith, Counsel, McDermott Will & Emery 500 N. Capitol St. NW Washington, DC 20001 dlsmith@mwe.com 202.756.8241 Fax 202.756.8087 Diann Smith is counsel in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office. Diann focuses her practice on state and local taxation with an emphasis on tax challenges relating to compliance, controversy, planning and legislative activity. Diann has experience representing clients in nexus, tax base, business and non- business income classification, apportionment and FIN 48 compliance issues. She has also counseled clients on multi-state unclaimed property compliance and voluntary disclosure opportunities. Diann has represented clients from a broad range of industries, including retail, insurance and communications services. Diann has significant experience representing clients before the Multistate Tax Commission (MTC). Prior to joining McDermott, Diann was counsel at another international law firm, where she also focused on state and local taxation. She also previously served as general counsel for the Council On State Taxation (COST). While at COST, Diann worked on nearly every major state and local tax issue confronting multi-state businesses. From 1998 to 2005, Diann was an adjunct professor at Georgetown University Law Center for the LL.M. in taxation program. Diann received her J.D. from the Georgetown University Law Center, where she was an editor of the Georgetown Law Journal. She received her B.A. from Miami University. Diann served as a law clerk to the Honorable Alan E. Norris of the U.S. Court of Appeals for the Sixth Circuit in 1991 and 1992. Diann is admitted to practice in the District of Columbia, Ohio and New York. Ellen Bloch, CPA, Director, International Tax & Business Advisory Services GBQ Partners LLC, 230 West Street, Suite 700, Columbus, OH 43215 614.947.5278 Fax: 614.227.6999 ebloch@gbq.com Prior to joining GBQ in 2017, Ellen spent the past 12 years in Big 4, most recently with EY, where she primarily focused on supporting clients with international tax and transfer pricing matters. Ellen brings diverse tax experiences to clients across many industries including life sciences, consumer products, chemical and industrial products. She works with clients to develop, analyze, and prepare transfer pricing planning, documentation, and audit dispute resolutions, including working with the IRS and foreign tax authorities in audit settlements and advanced pricing agreements. Ellen has worked extensively with companies in understanding and adopting the new global tax and transfer pricing requirements under the OECD BEPS initiative and pending US tax reform. She strives to bring a practical perspective to help clients find reasonable and cost-efficient compliance approaches specific to their needs and priorities. Ellen is also experienced in domestic and international supply chain planning projects, working closely with business and finance teams to design and implement new operating models and related tax planning opportunities. Ellen is a graduate of the University of Akron with a B.S. in Accounting, with Honors. Ellen is a member of the Leadership Columbus Class of 2016.

27 th Annual Ohio Tax Conference State Transfer Pricing Audits Effective Strategies to Minimize Your Risk Ellen J. Bloch Diann L. Sm ith GBQ Partners LLC McDermott Will & Emery LLP Columbus, OH Washington, DC (614) 947-5278 (202) 756-8241 EBloch@gbq.com dlsmith@mwe.com

Agenda • Introduction • Overview of Federal Landscape ▫ What is Transfer Pricing? ▫ Statutory Authority ▫ Global Trends • Overview of State Landscape ▫ State Transfer Pricing Authority ▫ MTC SITAS ▫ Contract Auditors! Oh my… ▫ Recent Developments • Key Differences – State v. Federal • State Audit and Controversy Considerations

3 What is Transfer Pricing? • The method used to establish pricing of transactions between related parties for goods, intangible assets, services, and loans. ▫ Related party relationships suspend the normal laws of supply and demand. • Objective under IRC § 482 is determine an “arm’s length” transfer price and prevent related parties from artificially shifting income to achieve tax benefits. ▫ A tax evasion or avoidance motive is generally not a prerequisite for application of an IRC § 482 adjustment.

4 S tatutory Authority • IRC § 482 states: ▫ In any case of two or more organizations, trades, or businesses . . . owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. . .

5 Overview of Federal Landscape • Due to the brevity of the statute, international transfer pricing by the IRS is governed almost exclusively by extensive regulations promulgated by the IRS. ▫ See 26 CFR 1.482-1 through -9. • The regulations outline specific methods to use in certain situations and specific rules/examples for tangible goods, intangibles and services.

6 Overview of Federal Landscape (cont.) • Regulations adopt the “arm’s-length” standard: ▫ An intercompany transaction is “arm’s-length” if the results are the same as results realized by uncontrolled taxpayers engaged in the same transaction under the same circumstances. ▫ Id entica l uncontrolled transactions are generally not available – so it is appropriate to consider com p a ra ble uncontrolled transactions. • Analysis of independent, uncontrolled comparable transactions is at the center of all transfer pricing analysis.

7 Overview of Federal Landscape (cont.) • Other key concepts in applying IRC § 482 include: ▫ Best Method Rule  Comparability  Quality of data and assumptions ▫ Arm’s Length Range (IQR) ▫ Burden of Proof—if an allocation is made, taxpayer bears the burden to prove that the IRS’s determinations are incorrect, either by establishing:  That the IRS’s determination was arbitrary, capricious, or unreasonable; and  That its prices were arm’s length under § 482

8 Global transfer pricing trends • Cross-border transfer pricing practices are high priority for many global tax authorities with increased focus on: ▫ Transparency into the global supply chain ▫ Economic substance ▫ Documentation standards • US multinational corporations are particularly under scrutiny globally

9 Global transfer pricing trends (cont.) • Transfer pricing regulations assume that expected returns are positively and causally related to the functions performed, assets owned and risks assumed by a given entity. ▫ More functions → higher expected return ▫ More complex functions → higher expected return ▫ More assets owned → higher expected return ▫ Intangible assets owned → higher expected return ▫ More risks assumed → higher expected return

10 S upply Chain Illustration Parent/ Sale of branded Strategic Sale of unbranded product product Management Routine Routine Sales Manufacturer Company Physical flow of product • Manufacturer is responsible for day-to-day production tasks and manufactures products under the direction of Parent. • Sales Company is responsible for customer relationships and execution of sales strategy established by Parent. • Parent provides strategic management and oversight to the supply chains, owns key intangibles, and bears critical risks.

11 S tate Transfer Pricing Authority • Many states have specific statutes that either adopt or are substantially similar to IRC 482. ▫ Nearly every state adopts some statutory regime to adjust transfer prices of intercompany transactions (with the exception of Delaware, New Mexico, and Pennsylvania). • Many states focus on IRC 482 language regarding their ability to make adjustments if the State “determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of State income taxes” in a manner “consistent with IRC 482 and the rulings, regulations issued thereunder”

12 S tate Transfer Pricing Authority (cont.) • State DOR’s generally exercise their State 482 authority to allocate and adjust income during an audit, and such adjustments often produce large assessments of liability for the taxpayer. • Jurisdictions actively assessing on 482 grounds: Alabama Indiana New York Connecticut Missouri New York City Georgia Mississippi North Carolina Florida New Jersey South Carolina

13 S tate Transfer Pricing Authority (cont.) • Some states explicitly adopt the IRC by cross-referencing the federal statute on a rolling basis or as of a certain date. ▫ E.g. , Alabama, Arkansas, Maryland. • Other states implicitly claim adoption of the IRC by adopting a state statute with the same/substantially similar language. ▫ E.g. , Connecticut, D.C., Kentucky. • Still others implicitly adopt the IRC by using federal taxable income before NOLs and special deductions as the starting point for calculating state corporate taxable income.