On October 6, the Multistate Tax Commission Arm’s-Length Adjustment Service Advisory Group (the “Group”) met in Atlanta, Georgia, to continue its foray into transfer pricing audits. The Group first met in June and has met several times to discuss how—and to what extent—the MTC can incorporate transfer pricing services in its range of services provided to member states. The Group seems to agree on the importance of using external economic firms, and the purpose of the presentations today was to allow the economic firms to inform the Group of the procedures the MTC should implement at the state level. Tomorrow’s discussion should address if and how the Group can effectively use these firms.

Economics Firms Presenting to the Group

The Group met with seven economic firms that could potentially provide transfer pricing services to the MTC. The firms were:

• Chainbridge Software LLC
• Economic Analysis Group LLP
• Peters Advisors LLC
• NERA
• RoyaltyStat
• Economists Incorporated
• WTP Advisors

Firms’ Advice to the Group

The Group provided each firm the same list of questions to facilitate the conversation. The questions presented were:

1. What are the greatest challenges that states might face in improving tax compliance related to intercompany transactions that distort the reporting of income to their states?
2. What are some of the best ways for states to meet those challenges?
3. What type of services is your firm prepared to provide states to assist with transfer pricing tax compliance and in what manner might those services be provided?
4. Given the fact-intensive nature of transfer pricing work, how might states best integrate expertise in economics and statistical analysis with their audit and legal staffs in the tax administrative process?
5. What objections will states face from taxpayers as they increase their compliance work? Which of those objections is a legitimate concern? How can states best respond to those criticisms?
6. What lessons can the project states learn from other taxing authorities with regard to transfer pricing enforcement?
7. What remedies are most effective in correcting income manipulation associated with intercompany transactions?

The presentations from the firms revolved around these questions.

Most firms discussed that the states’ greatest challenge in improving compliance was that the cost to do so was prohibitive. Peters Advisors LLC noted that taxpayers’ experience has been that certain states take unfair positions based on lack of information and misapplication of transfer pricing principles. Peters Advisors LLC also discussed that lack of information hampers both the state and the taxpayer. For instance, because intercompany transaction data is not readily available from state tax returns, and taxpayers are not required to prepare documentation prior to being audited, the state cannot identify good candidates for audit and taxpayers often are unprepared. NERA discussed the challenges of applying the arm’s-length standard to circumvent tax planning done by corporations. RoyaltyStat cited one of the challenges as the states adopting disparate approaches to transfer pricing adjustments.

The firms cited many ways for states to meet challenges: developing internal resources, such as implementing a training program, and identifying red flags, such as an in-state company that never makes money. This, the firms argued, will allow the state to identify good audit candidates. Several firms emphasized that a state can gain taxpayer information not only from tax returns but also from publicly available information. Other firms noted the importance of robust document requests from a taxpayer once the taxpayer is in the audit process. NERA discussed the importance of developing best practices for auditing transfer pricing as well as monitoring transfer pricing developments in the federal and international arenas. Economics Analysis Group LLP was the only firm that discussed how separate reporting states had different needs than those of the combined reporting states, but even then, every separate reporting state could have different provisions and tools in place. Other firms discussed the fact that all states had some form of Section 482 powers. Only a few of the firms, including RoyaltyStat, emphasized the importance of analyzing the underlying economic substance of the intercompany transactions. Interestingly, RoyaltyStat’s Ednaldo Silva was an expert for North Carolina in the Delhaize forced combination litigation.

The firms offer a wide range of services, ranging from audit identification to economic analysis. Peters Advisors LLC, for example, boasts that it can: create a standardized process for identifying taxpayers for review; train staff to perform reviews of identified taxpayers; develop questionnaires to gather information from taxpayers; conduct economic analysis; and support that analysis at the audit, negotiation, and litigation levels. NERA was one of several firms that stated it could offer expert witnesses support. Almost all the firms stated they could train the MTC or individual states. Because of budget constraints, Economists Incorporated stated that resources needed to be spent wisely and that states should “identify issues most likely to be productive.”

The firms were well aware of the negative perception by taxpayers of the services they provide. Chainbridge Software LLC preemptively addressed these concerns and attempted to rebut the public perception of their services. First, Chainbridge assured the Group that it “takes taxpayer information security seriously” and that risk of taxpayer information becoming public is nonexistent. Next, on the attack of “the Chainbridge method” by taxpayers, Chainbridge asserted that no such method existed—it simply follows the Section 482 method. Finally, Chainbridge rejected the critique that it acts as a “bounty hunter,” alleging that it “never got a dime from contingency payments.” Other firms noted that taxpayers would likely object to any additional compliance burden due brought about by additional disclosures that may be required.

Generally, the firms have substantial experience with federal and international transfer pricing issues. Some, including Peters Advisors LLC, suggested that the Group could leverage their experience at the international level to implement successful transfer pricing strategies used by other countries. For example, by involving transfer pricing experts throughout the entirety of the audit process—as is often the case at the international level—states would increase the likelihood of identifying and challenging what it might consider to be distortion of income. Moreover, the firms contended that involving experts throughout the process would have a chilling effect on tax planning. Economics Analysis Group LLP, for example, noted “settling 50% of cases with taxpayers will not deter tax planning.” Rather, only favorable and consistent resolutions for the state will address the issue.

Some firms emphasized that their services would increase the likelihood of the state deriving revenue from transfer pricing audits. The Economic Analysis Group, for example, said that its services “get money back in the hands of the states.” These services are necessary, it alleged, because the state “can’t afford to lose” if the audit proceeds to litigation. If the state loses, Economic Analysis Group asserted it “will embolden the taxpayers.” Some of the firms seemed to generally represent and assist states while others, such as Peters Advisors, more commonly represented taxpayers. Some presenters were economists, while others had their background in public accounting.

Conclusion

The Group meets again tomorrow to follow up from the presentations received today. The meeting is in Atlanta, and is open to the public.