State Insecurity

Faced with alarming budget shortfalls, states are pursuing corporate tax dollars in new and aggressive ways.

Of special interest to state tax officials are out-of-state online retailers. Employing such notions as “click-through nexus,” New York, North Carolina, Colorado, and Rhode Island have already enacted laws that incorporate the theory of economic nexus to enable them to tax companies like Amazon, requiring them to collect sales taxes from online shoppers. Says Walter Nagel, a partner at law firm Reed Smith in Washington D.C.: “More and more of the economy is online and electronic, and so the states are trying to tax as much of that revenue as possible.”

Here Comes the Audit

Much of the quest for corporate tax payments, however, centers on good old-fashioned investigations and audits. But there are some new wrinkles there as well. In the District of Columbia, for instance, the revenue department has outsourced transfer-pricing audits on a contingency-fee basis to ACS, a Dallas-based provider of information-technology and business-process-outsourcing services. Since 2008, Chainbridge Software, an ACS subcontractor, has been using statistical analysis to dig up companies that seem likely to have been avoiding taxes in D.C. by shifting income among commonly controlled corporations.

In its work for the District, Chainbridge calculates a particular company’s expected range of profit by comparing it with the estimated profit of comparable companies, according to Stephen M. Cordi, deputy CFO in D.C.’s Office of Tax and Revenue. If the income tax paid by the company is lower than Chainbridge’s analysis indicates it should be, the firm does what it calls a “transfer-pricing analysis” to see what further taxation is needed to bring the company within the acceptable range, Cordi says.

For such reports, ACS collects a contingency fee of 16% of the tax revenue the District recovers as a result of its work, up to $30 million, and 14% of the revenue recovered in excess of $30 million. There is an overall cap of $9 million on ACS’s fees.

Although D.C. has “collected nothing” as a result of the audits to date, it has a $3 million case in litigation and a number of cases to follow, says Cordi. If the District ends up collecting all the potential revenue identified by the audits to date, “you’re talking $50 million and up,” he adds.

For his part, Stephen Kranz, a lawyer with Sutherland, Asbill & Brennan who is representing the corporation currently in litigation with D.C., objects strenuously to at least one aspect of the District’s approach. “The contingency-fee aspect of it is particularly offensive to many in the tax world,” he says. “And we think that it very well may be developing into a trend.” The presence of a contingency fee “creates an unnatural bias for the auditor to inflate the assessment,” Kranz contends. “If the auditor gets paid on the size of the dollar figure they’re going to deliver, they’re going to be biased toward producing a larger number.”

Room to Negotiate

With state and local governments pursuing corporate taxpayers so aggressively, what’s a CFO to do? “I don’t think there’s a great deal you can do to plan for this,” says Willens, reasoning that a corporation doing decent business in a state won’t pull up stakes merely for tax reasons.

Still, there may be a faint silver lining in the fact that states are so anxious for revenue. Such eagerness offers corporate taxpayers an opportunity to settle for a fixed-dollar amount rather than pursuing the uncertainty of long-term litigation, according to Reed Smith’s Nagel. In their current dire economic straits, states would rather get their money now than later.

David M. Katz is New York bureau chief and senior editor for accounting at CFO.

Methodology

This biannual survey, conducted since 1996 with the help of KPMG LLP, the audit, tax, and advisory firm, aims to capture tax executives’ impressions about differing tax environments in each state in which they do business. The results presented here represent those opinions, rather than quantitative assessments of actual policies, tax rates, or other criteria.

2011 CFO State Tax Survey Results

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