By Jonathan Maddison and Timothy Gustafson

The Indiana Department of Revenue determined that forced combination of an Indiana taxpayer, its wholly owned disregarded entity and its out-of-state parent company was appropriate where the disregarded entity generated 92% of the federal consolidated group’s sales but only 0.14% of the consolidated taxable income for the taxpayer. The taxpayer was a member of a federal consolidated group of companies in the business of manufacturing, distributing and selling consumer goods, and owned a single-member disregarded entity responsible for distributing the consolidated group’s products to third-party customers. At audit, the Department found that the disregarded entity accounted for 92% of the consolidated group’s sales but reported its “Cost of Sales” at nearly three times the “Cost of Sales” reported by the entire consolidated group because the parent company increased the costs of goods sold for intercompany sales to the disregarded entity by 80%. The Department also found the income of the taxpayer was a meager 0.14% of the consolidated taxable income despite the fact that the average taxable income of the consolidated group was generally in the billions. In response, the taxpayer produced a transfer pricing study to justify its reporting position. The Department, however, determined that “transfer pricing studies are not Indiana-approved vehicles for justifying tax expenses through controlled party profits,” and noted the “arms-length” prices in the study had not been revised in over 30 years. The Department did use the study to further justify its decision to force combined reporting, though: “the audit noted that the [transfer pricing] study demonstrated that the Parent Company exerted significant control over its affiliates, including Taxpayer and Risk-Free Distributor and concluded that the entities were unitary and should file on a combined basis.” Ind. Dep’t of State Revenue, Letter of Findings No. 02-20130641 (posted Feb. 25, 2015).