The elements of the bill are as follows:
- Repeal the existing forced combination section 105-130.6 and the parts of 105-130.16 that contain broad, if vague, authority in the Secretary to do other things to find “true income.”
- Put all such, and other, powers in new section 105-130.5A.
- Create a new special discovery power in the Secretary as to intercompany transactions, with a 90 day response time.
- Based on information provided (not clear what happens if Secretary acts on information obtained elsewhere), Secretary can act upon (1) intercompany transactions that either (2) lack “economic substance” or (3) are not at arms length. See definition of economic substance below.
- If Secretary finds those two facts, he can redetermine income of “the corporation.”
- The redetermination can perform something like section 482 adjustments to “accurately” compute income.
- Alternately the Secretary can require combined returns for all unitary affiliates.
- The Secretary’s determinations shall be made year by year. This may mean that a multi year transaction can be found to lack economic substance because it loses money in early years.
- The Secretary must consider the taxpayer’s proposed method of combination.
- The Secretary cannot combine less than all of the unitary group, but the taxpayer and Secretary can agree to combine less than all of the unitary group. This is a constitutional fault in the bills because it will create discriminatory treatment of similarly situated taxpayers: those whom the Secretary allows to file on a non unitary basis, and those to whom the Secretary denies that privilege.
- The definition of economic substance is generally similar to the definition of the economic substance doctrine test in IRC section 7701(o), with these exceptions: (1) material business activity in an entity can evidence economic effects, (2) an intent by the General Assembly to allow a non economic tax benefit will be honored, and (3) centralized cash management is not evidence of lack of economic substance.
- The bill also allows the DOR to impose a fee up to $5,000 for a letter ruling.
Observations:
- The bill continues the basic regime that now exists: a bifurcated search for either (1) non arms length charges between related parties, or (2) something else the DOR does not like.
- The bill still fails define “true income” or “income properly attributable” and instead assumes that lack of business purpose or economic effects justifies forced combination. So in effect the bill creates a North Carolina version of IRC section 7701(o), and does not explain how they both will apply together.
- The main difference between the bill and a universal mandatory unitary combination is that the DOR will possess an undefined and uncontrolled ability to make deals with taxpayers to (1) not require combination, or (2) adjust the filing group and the method of combination. It is likely that the vast majority of large multistate groups will participate in this regime, if they have not already been forced to do so. That is why the regime would be de facto universal combination, with the Secretary possessing a wild card power to exempt or change.
- It remains to be seen whether the bill, if enacted, will lead to years of disputes and appeals over forced combination, or whether the corporate community will acquiesce to the secret law approach to corporate tax filing. The latter is likely, because current legal attacks on forced combination are quite sparse. That also makes it unlikely that any taxpayer will attack the results of the Secretary’s new powers, assuming the Secretary does not proceed as aggressively as in the recent past.
The good news for taxpayers is that they may be able to avoid forced combination by avoiding the use of “inactive” affiliates. That is, if the taxpayer wishes to use an intellectual property holding company, it should make sure it has an office and real employees and actually looks after the marks. After all, when the DOR went after The Limited, it did not claim the Delaware Holding Company did not have economic substance in Delaware, but rather that it did business in the state. A & F Trademark v. Tolson, 167 N.C. App. 150 (
