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First of all, what is “transfer pricing?” This is, simply put, the amount one part of a business charges another part of that same business for goods or services. This applies to associated businesses, affiliated businesses, subsidiaries, etc. For the IRS  these fees for goods and services have to be the same as if they were dealing with an outside company. You cannot charge “your” company more than you would an unconnected company.

Transfer pricing often comes into play with multinational companies but it also happens in U.S. Companies that operate between states, as noted above, often sell goods and services to other parts of the company or affiliated businesses. State tax departments are  set to take a closer look at these multistate transactions.

Bloombergtax.com recently detailed three states poised to begin a cycle of audits “over manipulation of the substance, or transfer pricing, of the deals.” They also note that state audit teams are now better trained and being aided by outside consultants. They also have incentive given foreboding about a decline in future state tax revenues (to say nothing of the actual decline in recent years).

The scrutiny is mostly confined to “separate reporting” states. There are 17 of these and they tend to be in the Southeast. Separate reporting states allow tax returns for each business in a group of businesses to be considered separately. Income can be shifted between them. The other states do not allow this, viewing the associated businesses as a single entity.

The separate reporting states offer opportunity but there are also pitfalls. It may be fairly simple when one branch of a corporate entity sells “widgets” to another. But what about when it comes to more intangible things like services, patents or even trademarks it gets more complex. The states also have a similar view to the IRS regarding charges being the same between associated companies and unrelated companies. They have to match.

The Bloomberg Tax piece referenced above mentioned  Alabama, Florida, Georgia, Indiana, Mississippi, South Carolina, North Carolina, Louisiana and New Jersey as states “flexing their muscles” with regard to transfer pricing audits. Notice that while most of these states are in the Southeast a couple are not.

States have recently lost court cases related to transfer pricing audits but it is not wise to, therefore, write off state’s ability to press their claims. They are adjusting their tactics and their aims. If your company takes advantage of states that use separate reporting as a standard be aware of how the law applies to your business and how the law is being applied.

As always Hito is ready to help your business deal with any transfer pricing issues. Please feel free to schedule a time to talk with one of our tax professionals.