By Ted Friedman and Andrew Appleby

The Indiana Department of Revenue determined that an audit correctly required a distribution and manufacturing subsidiary of a tobacco company to file a combined return with its corporate affiliates. The Audit Division concluded that the subsidiary’s income, as reported, did not fairly reflect its Indiana source income because of the financial effects of a $700 million inter‑divisional loan between the tobacco company and the tobacco company’s U.S. affiliates. The subsidiary paid 100% of all interest costs on the loan, but certain loan proceeds flowed to other subsidiaries that were not required to repay any portion of the loan. The Department determined that the Audit Division was justified in requiring the subsidiary and its corporate affiliates to file a combined return because of the distortive effects of the loan. On audit, the subsidiary did not present an alternative to combination. The subsidiary did, however, subsequently present an alternative methodology to the Department. The Department acknowledged its statutory responsibility to fully explore reporting alternatives before requiring a combined return and requested the Audit Division to review the subsidiary’s alternative methodology to determine whether it fully addressed the Audit Division’s original concerns. Ind. Dep’t of Revenue, Letter of Findings No. 02-20130427 (Apr. 30, 2014).