On October 28, 2021, the Louisiana Department of Revenue (the “Department”) publicly announced a transfer pricing managed audit program in Revenue Information Bulletin No. 21-029 (October 26, 2021). Louisiana’s program is similar to managed audit programs recently introduced in other states, such as Indiana and North Carolina. However, unlike some other states, Louisiana’s managed audit program offers the potential for a prospective agreement.
To be eligible to participate in the program, a taxpayer must have an established history of voluntary tax compliance with the Department, certify that the taxpayer has resources available to participate in the program, have suitable records concerning its intercompany transactions, and have a reasonable expectation of its ability to pay “an expected liability”. Interestingly, the Department did not refer in this section to the possibility that no liability would be determined, however, in a later section, they discuss collection “if” a liability is determined.
The tax periods eligible for resolution include the current tax period, any open tax periods that have not yet prescribed, and up to four future tax periods. In certain instances, a previously audited taxpayer may participate in the program. A previously audited taxpayer is eligible to participate if: (1) the taxpayer has already been audited and transfer pricing was at issue in the audit; (2) the audit is in a review or protest with the Audit Review and Appeals Division, or legal status with the Litigation Division; and (3) the taxpayer disagrees with the transfer pricing adjustments. If a previously audited taxpayer is accepted into the program, the taxpayer will have 30 days to offer comments to the previously made transfer pricing adjustments for the Department’s review.
If the eligibility requirements are met, the Department will authorize the taxpayer to conduct a managed audit with respect to its intercompany transactions under the supervision of a representative from the Field Audit Division. A taxpayer can appoint a representative, including a tax attorney, to assist with the managed audit.
If a taxpayer is accepted into the program, the taxpayer will be required to submit the following documentation within 30 days:
- Complete federal tax returns for the last three years;
- List of all intercompany transactions by type, amount, and entity, including journal entries;
- Transfer pricing studies, including comparable methods used and any agreements from the Internal Revenue Service;
- Organizational charts reflecting each subsidiary and its relationship to the parent company;
- Financial statements on a GAAP basis for each party to an intercompany transaction. (If these are not available, Department and the taxpayer will jointly determine operating income using the federal return (Form 1120) and its accompanying Schedule M-3 schedules); and
- Other invoices, checks, accounting records, or other documents or information, if requested by Department, to determine the correct amount of tax.
The Department will review this documentation and issue a written determination as to whether it agrees with the taxpayer’s transfer pricing studies and methods. The Department may use an external consultant to assist in its review. The taxpayer will have 30 days to accept the Department’s written determination or offer modifications or adjustments.
If additional tax is due, the Department will proceed with normal collection procedures. But no penalty will be assessed on any tax due related to the managed audit findings. In addition, interest that accrues during the managed audit tax period (i.e., the period of time from the date of Department’s notice of the taxpayer’s acceptance into the program through the date of Department’s notice of the correct amount of tax due) will be abated (not to exceed 180 days).
The program is scheduled to begin on November 1, 2021 and applications must be received by April 30, 2022. All managed audits must be closed by June 30, 2022.
Louisiana’s transfer pricing managed audit program is a major development that may be welcome to a taxpayer with significant intercompany transactions. In particular, an eligible taxpayer with a large volume of domestic intercompany transactions that could create state tax exposure but, necessarily, have not been subject to scrutiny by the Internal Revenue Service should consider participating in the program.
For the past several years, the Department has been very actively issuing transfer pricing adjustments resulting in typically large proposed tax assessments and many of those remain unresolved in various stages of audit review or litigation. As the Department developed its transfer pricing audit program over the last few years, it has not been unusual to find significant flaws in an auditor’s analysis, which was likely due to the extraordinary complexity of transfer pricing audits. In making a determination on whether to participate in this new program, a taxpayer that is currently attempting to resolve an existing transfer pricing audit should also consider the extent to which participating in the program could impact ongoing negotiations related to that audit. Due to the length of time it takes to resolve past audits, the possibility of prospective relief, and the potential for penalty and interest relief, an eligible taxpayer with an existing transfer pricing audit or a taxpayer desiring more certainty with respect to its Louisiana corporation income tax should discuss the possibly risks and benefits with their Louisiana tax counsel.
When considering whether to participate in the program, a taxpayer should also be aware of potential issues that could arise. If the Department does not agree with the taxpayer’s reasonable position as to the appropriate transfer pricing range, it appears that, with respect to the transfer pricing issue alone, statutory rights to contest any determination would apply, however, will the Department, as a policy matter limit itself to auditing only transfer pricing once it has all of the taxpayer’s information? The Department is not suggesting that these tax years will be closed as a result of this program so other issues remain ripe for audit. An eligible taxpayer should consider that while the managed audit program is limited to transfer pricing issues and the information provided to the Department could be used for purposes of other Louisiana audits, such as franchise tax or sales and use tax. It also is not clear whether the Department could take the position, after receiving all of the information required to participate in the program, that taxpayer has not provided all or sufficient data to continue in the program. At that point, the Department could potentially open a standard audit and there would be no penalty or interest protection for the taxpayer. For this reason, participation in the program may be more beneficial for a taxpayer that has already been audited or is in the process of being audited.
Another potential issue relates to confidentiality of information vis a vis other states. For example, many states have entered into transfer pricing information sharing programs so it is possible that any taxpayer documents and data provided in this context could be shared with other states as well as the Department’s third-party consultants. In many instances, transfer pricing documentation contains sensitive information, such as organizational charts or proprietary trade secrets. To minimize the risk of this information being shared with other states or the Internal Revenue Service, a taxpayer considering participating in the program should also consider entering into a confidentiality and nondisclosure agreement with the Department.
The volume of documentation required by the Department is substantial. A taxpayer will likely have to allocate a significant amount of time and resources to locate and prepare the required documentation for delivery to the Department, including, possibly, interstate transfer pricing analyses. Moreover, unless the taxpayer regularly reviews and updates its intercompany agreements (which we recommend), those agreements or other required information may be very old and difficult to obtain, particularly if employees with the required institutional knowledge have retired or are not longer employed by the taxpayer. Thus, a taxpayer considering applying to the program should ensure it has the ability to provide the required documentation in the time allotted before submitting its application.
A taxpayer considering participating in the managed audit program should carefully weigh the program’s benefits and risks. Depending on a taxpayer’s specific facts and circumstances, participating in the managed audit program may be beneficial. But participating could also result in confidential information being shared with other states, being used to generate audit leads by the Department’s consultants, or being used to generate additional assessments in other Louisiana audits, thereby increasing the risk of additional tax exposure. That said, Louisiana’s transfer pricing program will likely be a welcome development to many taxpayers because participation has the potential to both resolve time consuming and expensive audits and provide certainty in the future.