The Utah Supreme Court recently heard arguments in Utah State Tax Comm’n v. See’s Candies Inc., Utah, No. 20160910-SC, which is an important case for whether Utah will respect arm’s-length transfer pricing. During the hearing, the Utah State Tax Commission (“Commission”) argued that Internal Revenue Code (“IRC”) § 482 should not limit its discretionary authority to reallocate income between related companies. The taxpayer, on the other hand, claimed the intercompany transactions at issue were at arm’s length and therefore deductible. For background, the taxpayer paid a royalty to a related company for use of its intellectual property in Utah. The taxpayer then took a deduction on its Utah corporate income tax return for said royalties, which were supported by an independent, third-party transfer pricing report. The licensing company did not have a presence in Utah, nor did it file returns there. In audit, the Commission viewed the intercompany transactions as a mechanism for removing income from Utah and denied the royalty deductions under Utah Code § 59-7-113.
Utah Code § 59-7-113 allows the Commission to allocate, distribute, or apportion income or deductions between related corporations to prevent tax evasion or to properly reflect income in Utah. The language of this provision resembles the language in IRC § 482 , which provides similar powers to the Internal Revenue Service. But unlike its federal counterpart, the Commission provided little guidance on the application of the provision.
The dearth of state guidance on the application of Utah Code § 59-7-113 moved the lower court to side with the taxpayer. Specifically, the lower court held that the state’s provision allowing it to reallocate income, which, according to the court, is “virtually identical” to IRC § 482, should be interpreted with reference to IRC § 482 and the accompanying federal regulations. The lower court found that by denying the taxpayer’s deductions without reviewing them under the federal regulations, the Commission had abused its discretion. For additional background on the case and the lower court ruling, see our previous blog post on the topic “Keeping the State at Arm’s Length: State Transfer Pricing Recent Developments”.
The court’s pending decision in this case may have a broad impact. There are many states that have discretionary authority provisions that mirror IRC § 482, but lack much additional guidance (e.g., the District of Columbia and Missouri). D.C. has been particularly active in the transfer pricing space, hiring private contractors to audit taxpayers on a contingency basis “Summary Judgment Denied (Again) in District of Columbia Transfer Pricing Cases”. Thus, Utah’s decision on whether to look to the federal guidelines may be persuasive for certain other states, especially given the recent uptick in interest for transfer pricing issues in many states as a measure to close budget gaps.
While it is not clear how the Utah Supreme Court will decide this case, one of the justices may have provided a hint. When discussing the adoption dates of Utah Code § 59-7-113 and the federal regulations for IRC § 482, with the former coming 4 years before the latter, the justice commented on whether the Utah legislature was “clairvoyant enough” to have foreseen the federal regulations being used to interpret the state law.