NOTICE: IC § 6-8.1-3-3.5 and IC § 4-22-7-7 require the publication of this document in the Indiana Register. This document provides the general public with information about the Department's official position concerning a specific set of facts and issues. This document is effective on its date of publication and remains in effect until the date it is superseded or deleted by the publication of another document in the Indiana Register. The "Holding" section of this document is provided for the convenience of the reader and is not part of the analysis contained in this Letter of Findings.

The Department agreed with Paper Manufacturer that its intra-company sales and cancelled sales should be removed from both the numerator and the denominator of the sales factor in order to conform with the Department's multi-factor calculation of Paper Manufacturer's corporate income tax.

I. Indiana Corporate Income Tax - Intercompany Transactions and Sales Factor Adjustments.

Authority: IC § 6-3-2-2; IC § 6-8.1-5-1; Dept. of State Revenue v. Caterpillar, Inc., 15 N.E.3d 579 (Ind. 2014); Indiana Dept. of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463 (Ind. 2012); State Bd. of Tax Comm'rs v. Jewell Grain Co., 556 N.E.2d 920 (Ind. 1990); Lafayette Square Amoco, Inc. v. Indiana Dept. of State Revenue, 867 N.E.2d 289 (Ind. Tax Ct. 2007); Mynsberge v. Indiana Dep't of State Revenue, 716 N.E.2d 629 (Ind. Tax Ct. 1999); Tri-States Double Cola Bottling Co. v. Department of State Revenue, 706 N.E.2d 282 (Ind. Tax Ct. 1999); 45 IAC 3.1-1-38; Income Tax Information Bulletin 12 (February 2020); Income Tax Information Bulletin 12 (October 2015); FASB ASC 845-10-30-3.

Taxpayer argues that the Department erred in adjusting its federal taxable income.

Taxpayer is a company, headquartered outside Indiana, in the business of manufacturing and selling paper products. Taxpayer's business operations are organized as two "divisions." The first division consists of Taxpayer's cardboard manufacturing mills. The second division consists of the manufacturing facilities which produce cardboard boxes, paper boxes, and displays.

In addition, Taxpayer manufactures white duplicator paper, protective packaging, specialized commodity paper, and a variety of other specialized paper products.

Taxpayer operates three Indiana manufacturing facilities.

For the years 2017 and 2018, Taxpayer filed a federal consolidated income tax return. For the years 2017 and 2018, Taxpayer filed an Indiana income tax return (Form IT-20) on a separate basis. Those Indiana returns included five "disregarded entities" whose income was reported on Taxpayer's returns.

One of the five disregarded entities was acquired in 2013 but not fully merged with Taxpayer until July 2017.

The Indiana Department of Revenue ("Department") conducted an audit review of Taxpayer's 2017 and 2018 tax returns and business records. That audit resulted in an assessment of additional Indiana corporate income tax. Taxpayer disagreed with the audit "adjustments" which led to the additional proposed assessment and submitted a protest to that effect. An administrative hearing was conducted by video conference during which Taxpayer's representatives explained the basis for its protest. This Letter of Findings results.

I. Indiana Corporate Income Tax - Intercompany Transactions and Sales Factor Adjustments.

The issue is whether Taxpayer has met its burden of proof necessary to establish that the Department's adjustment of its reported Indiana income was wrong, inconsistent, and/or incomplete. In particular, Taxpayer challenges the Department's decision increasing Taxpayer's reported taxable income resulting in an additional total assessment of approximately $275,000.

Pursuant to IC § 6-3-2-2(a)(2), Taxpayer's income from doing business in Indiana was subject to Indiana corporate income. 45 IAC 3.1-1-38 explains:

Indiana imposes a tax on each corporation's adjusted gross income derived from "sources within Indiana." IC § 6-3-2-2(a). The statute provides in relevant part:

Where a corporation receives income from both Indiana and out-of-state sources, the amount of tax is determined by a single-factor sales apportionment calculation as defined in IC § 6-3-2-2(b).

The "sales factor" consists of a fraction, "[T]he numerator of which is the total sales of the taxpayer in [Indiana] during the taxable year, and the denominator of which is the total sales of the taxpayer everywhere during the taxable year." IC § 6-3-2-2(e).

Income Tax Information Bulletin 12 (October 2015), 20151125 Ind. Reg. 045150409NRA, summarizes:

The most current version of Income Tax Information Bulletin 12 (February 2020), 20200226 Ind. Reg. 045200064NRA, summarizes:

Taxpayer falls squarely within the category of businesses which are required to calculate their income tax liability utilizing Indiana's apportionment regime. In this case, the Department made a series of sales factor adjustments to conform with those requirements. However, it is those adjustments to which - in one manner or another - Taxpayer objects.

Taxpayer provided the Department a download of its "sales data" which "represented [all] total sales made by [Taxpayer]." However, that data represented only Taxpayer's sales and not the disregarded entities' sales. The Department found fault with Taxpayer's method of accounting for "broken items." The audit explains what "broken items" means.

The audit explained how Taxpayer accounted for all these credits, discounts, and rebates.

As pointed out above, the Department reviewed Taxpayer's Indiana return and adjusted the sales factor utilized in that return. It made those adjustments because the Department concluded that the credits, rebates, and discounts should not have been included in the sales factor.

The Department's audit again found fault in the manner in which Taxpayer calculated its sales factor and, again, the Department cited to Taxpayer's initial "download" of Taxpayer's sales data. The audit report explained the Department's objections.

The Taxpayer's initial sales "download" included sales by one Taxpayer location to another Taxpayer location. The audit report provided a specific example:

The Department's audit concluded that these intra-company sales to disregarded entities should not be included in Taxpayer's sales factor.

In each of three adjustments listed above, the audit concluded that pursuant to Accounting Standards Codification ("ASC") 845 of the United States Generally Accepted Accounting Principles ("GAAP"), these transactions are not revenue and do not represent sales. As the audit report explains;

As to each of the three categories listed above (1, 2, 3), Taxpayer agrees; the audit correctly removed "broken sales" and intra-company sales from the sales factor. Taxpayer essentially maintains that the audit did not go far enough in implementing those adjustments. As to the category of "broken sales," Taxpayer argues that all broken sales - and not simply one facility's broken sales - should also have been removed from sales factor.

As to the audit's treatment of intra-company sales, Taxpayer again agrees that intra-company sales should be eliminated from the sales factor because intra-company sales "lack commercial substance." However, Taxpayer points to two instances in which the Department missed the mark. In particular, Taxpayer maintains that intra-company sales between one of its separate entities with one of its disregarded entities should also be eliminated from the sales factor.

Taxpayer argues that its audited financial statements and the information it provided to the SEC all tie to its original federal income tax return and that the adjustments made during the audit should be implemented consistently across all the reporting entities.

It is the Taxpayer's responsibility to establish that the corporate tax assessments are incorrect because the audit's calculations were incomplete. As stated in IC § 6-8.1-5-1(c), "The notice of proposed assessment is prima facie evidence that the department's claim for the unpaid tax is valid. The burden of proving that the proposed assessment is wrong rests with the person against whom the proposed assessment is made." Indiana Dept. of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463, 466 (Ind. 2012); Lafayette Square Amoco, Inc. v. Indiana Dept. of State Revenue, 867 N.E.2d 289, 292 (Ind. Tax Ct. 2007).

With that threshold burden in mind, a taxpayer is required to provide documentation explaining and supporting his or her challenge that the Department's position is wrong. Further, "[w]hen [courts] examine a statute that an agency is 'charged with enforcing . . . [courts] defer to the agency's reasonable interpretation of [the] statute even over an equally reasonable interpretation by another party.'" Dept. of State Revenue v. Caterpillar, Inc., 15 N.E.3d 579, 583 (Ind. 2014). Thus, interpretations of Indiana tax law contained within this decision, as well as the preceding audit, shall be entitled to deference.

Nevertheless, in determining whether a taxpayer has met that burden of proof, the Department bears in mind its own responsibility. [A] tax imposition statutory provision . . . is to be strictly construed against the imposition of tax. See State Bd. of Tax Comm'rs v. Jewell Grain Co., 556 N.E.2d 920, 921 (Ind. 1990); Tri-States Double Cola Bottling Co. v. Department of State Revenue, 706 N.E.2d 282, 285 n.9 (Ind. Tax Ct. 1999). However, the policy of strict construction will not override the plain language of a tax imposition provision. Mynsberge v. Indiana Dep't of State Revenue, 716 N.E.2d 629, 632-33 (Ind. Tax Ct. 1999).

Taxpayer agrees with the principles underlying the Department's adjustments to its sales factor but argues that the adjustments were either wrongly applied or simply incomplete. A "plain reading" of the facts and law leads the Department to agree and, to the extent specified in this Letter of Findings, the Department concludes that the results of the original audit should be reviewed by the audit division in a manner consistent with accepted principles of calculating Indiana sales factor.

As specified in this Letter of Findings, Taxpayer's protest is sustained, and the Department's audit division is requested to review the original calculation of Taxpayer's 2017 and 2018 corporate income tax and to make any adjustments consistent with the findings listed above.

April 27, 2022