On July 28, the Arm’s Length Adjustment Services Advisory Group (Group) of the Multistate Tax Commission (MTC) met for the third time at the MTC Annual Conference in Albuquerque, New Mexico. The Group began this effort on June 2 and met again on June 25 in furtherance of a Summer 2015 deadline to implement its transfer pricing model.

The Group established the following projected milestones:

• November 2014 – Group will complete draft of Preliminary Design
• December 2014 – Present draft to Executive Committee
• March 2015 – Target for completion of the Final Design
• July / August 2015 – Target for implementation

Using External Economists

Consistent with the Group’s prior two meetings, the discussion focused primarily on increasing the ability of states and the MTC to analyze intercompany transactions. While taxpayers typically engage economists to ensure accurate intercompany pricing, states have not traditionally done the same when conducting audits. Dan Bucks, project facilitator, engaged several firms specializing in transfer pricing economics to determine how—and at what cost—the MTC could utilize these firms when conducting transfer pricing audits. As was predicted, the cost of hiring these firms is high—and perhaps prohibitively so.

The Group plans to meet in Atlanta on October 6 with up to seven firms to explore engaging them. Some firms have indicated that their expertise could be leveraged to eventually increase the capacity of states to conduct economic analysis without the assistance of outside firms. Others, however, have resisted that transference of expertise to the states and thus envision their role as full-service audit assistance.

The Group is continuing to consider the ability of the MTC to hire an internal economic expert to work in tandem with an outside firm. While there was no clear consensus about the appropriate level of involvement by an outside firm, there was a clear sense of anticipation among the Group’s members that these issues should be resolved at the October 6 meeting.

Developing In-House Skills

Beyond hiring an outside firm (or firms) to assist with the audit process, the Group discussed to what extent states can implement their own internal procedures to increase their ability to conduct transfer pricing audits. For instance, the Group considered training state auditors to request the proper documents from the taxpayer at the beginning of the audit process. At this point, the District of Columbia reiterated its purported success in preemptively identifying taxpayers for transfer pricing audits. An additional component of increasing the states’ ability to conduct transfer pricing audits is establishing a robust information sharing program. One recommendation was to hire an MTC employee to coordinate the sharing of taxpayer-provided information among the states. The Group conceded that this is likely a sensitive issue for taxpayers.

The MTC also envisions providing comprehensive training for state employees. Similar to its “nexus school,” the MTC proposes to provide detailed transfer pricing training to state auditors. Because transfer pricing is a recent focus of the MTC, the training classes would likely begin at a fairly rudimentary level, with the hope of increased sophistication over time. The MTC would provide additional training for litigating transfer pricing issues.

Incorporating Transfer Pricing Audits into Existing MTC Audit Structure?

The Group again broached the controversial issue of how the MTC may incorporate transfer pricing into its audit process. The topic was discussed at both prior meetings, with little consensus being reached. Bucks indicated that there are three options for conducting transfer pricing audits: (1) joint audits solely for transfer pricing issues; (2) a comprehensive audit program that incorporates transfer pricing issues operating parallel to the current MTC audit program; or (3) incorporating transfer pricing into the existing MTC audit program. Not only is there disagreement about the need for an MTC-directed audit for transfer pricing issues (Florida, for example, has repeatedly indicated it would not participate in a joint audit), but there is also disagreement over how the audit process would work. Five states indicated that the audit service would potentially be utilized, and four indicated that such a service is not a priority. Bucks indicated that his preference is to incorporate the transfer pricing audits into the existing MTC audit program. The continued debate over the audit process makes it the controversial component of the Group’s mission.

Next Steps     

With the self-imposed November deadline to complete its preliminary draft, the Group has set the following meetings for the coming months:

• August / September 2014 – Bucks will conduct interviews with states involved in the project
• Week of September 22, 2014 – Meeting via teleconference
• October 6, 2014 – Meeting with economics consulting firms in Atlanta
• October 7, 2014 – Meeting to discuss meeting with firms in Atlanta

All meetings are open to the public, and interested parties are encouraged to participate in the public comment portion of each meeting.