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March 11, 2022

SALT Transfer Pricing Enforcement Is Increasing – Defend Your Transfer Pricing

Mandy Li, Transfer Pricing Managing Director at MGO and Nolan Shutler, SALT Director at MGO

Transfer pricing was once primarily an international tax issue, but it’s become increasingly important at the state and local tax (SALT) level. States are experiencing financial pressures from multiple sources—including the COVID-19 pandemic, and if your business is a multistate taxpayer with significant domestic intercompany transactions, you should expect increased state tax authority scrutiny and audit activities. Even if you haven’t needed to consider transfer pricing in the past, you should proactively plan for these audits and seek out additional opportunities.

State and local enforcement is increasing, and states are hiring

It’s important for you to know that the number of state transfer pricing audits has significantly increased in the past few years, and state tax authorities are adding transfer pricing resources, including auditors and outside consultants. Indiana, North Carolina, and Louisiana are among the states that are leading the efforts in state transfer pricing dispute resolutions with various programs. Note that other state tax authorities are expected to develop similar programs in the future to boost their tax revenues.

As a result of the potential for increased revenue, there has been renewed interest in collaboration among state tax authorities on transfer pricing. The State Intercompany Transactions Advisory Service (SITAS) of Multistate Tax Commission (MTC) was established to unite those states interested in transfer pricing, encourage information sharing among them, and train groups for transfer pricing audits.

What the states and local tax authorities are looking at

At the federal level, transfer pricing is governed by the regulations promulgated under Internal Revenue Code (IRC) section 482 based on the rules of the arm’s length standard. State and local tax authorities are not bound solely to the arm’s length standard and are free to assert their own transfer pricing requirements. Intercompany transactions are often scrutinized at the SALT level in accordance with concepts like economic substance and business purpose, and in key focus areas such as royalties, debt, management or franchise fees, insurance, expense deductions, and allocations.

The tools available to the state tax authorities to tackle transfer pricing issues include adopting the section 482 rules, forced combination, alternative apportionment, related party expense addback, and asserting nexus with the out-of-state entities.

How we can help

This area is complicated and filled with potential pitfalls. We are here to guide you, whether it means reviewing your intercompany transactions and determining arm’s length pricing, helping to establish your transfer pricing policy, or representing you in an IRS audit. MGO’s SALT and transfer pricing teams are highly experienced and can guide you through best practices in these various areas. Reach out to our team of professionals to help protect your business.

For more details on the best practices to defend your transactions, please see our full article here.