WENTWORTH, J.
Rent-A-Center East, Inc. (RAC East) challenges the Indiana Department of State Revenue's assessment of adjusted gross income tax (AGIT) for the 2003 tax year. The matter is currently before the Court on the parties' cross-motions for summary judgment. The dispositive issue is whether the Department properly determined that RAC East must file a combined income tax return with two of its corporate affiliates for the 2003 tax year.
The following facts are not in dispute. Renter's Choice, Inc. (n/k/a RAC East) was formed in 1986 to operate retail stores offering home electronics, appliances, computers, furniture, and accessories to customers under flexible rent-to-own agreements. (See Resp't Des'g Evid., Ex. N ¶ 2, Ex. A at 4.) In 1998, Renter's Choice acquired its largest rent-to-own competitor with the trademarks and trade names associated with the "Rent-A-Center" brand (RAC Marks), changed its name to Rent-A-Center, Inc. (RAC Inc.), and transferred the RAC Marks to its new affiliate, Advantage Companies, Inc. (Advantage). (See Resp't Des'g Evid., Ex. N ¶ 5, Ex. A at 4.)
RAC Inc. and its affiliates subsequently reorganized their corporate structure whereby RAC Inc. assumed the name RAC East and Advantage changed its name to Rent-A-Center West, Inc. (RAC West). (See Resp't Des'g Evid., Ex. ¶¶ N 5-6.) In addition, two new entities were formed, Rent-A-Center Holdings, Inc. (RAC Holdings) and Rent-A-Center Texas, LP (RAC Texas). (See Resp't Des'g Evid., Ex. N ¶ 6.) As part of the reorganization, RAC East (f/k/a RAC Inc.) engaged an independent accounting firm to conduct a Transfer Pricing Study to determine arm's-length pricing for royalties it would pay to RAC West and management fees it would pay to RAC Texas (the Intercompany Transactions). (See Resp't Des'g Evid., Ex. N ¶¶ 16-21, Ex. A at 1, 3.)
During 2003, RAC East had 11,359 employees and operated 1,932 rent-to-own stores in the Midwest and eastern United States, including 106 stores in Indiana. (See Resp't Des'g Evid., Ex. N ¶¶ 3, 7.) RAC West owned and licensed the RAC Marks, operated 437 rent-to-own stores in the western United States, and employed 2,537 individuals. (See Resp't Des'g Evid., Ex. N ¶¶ 11-13.) RAC Texas operated
For the 2003 tax year, RAC East filed an Indiana corporate AGIT return on a separate company basis reporting that it owed no tax. (See Resp't Confd'l Des'g Evid., Ex. J at 1-4.) The Department audited RAC East for the 2001, 2002, and 2003 tax years, proposing an additional $513,272.60 in AGIT, penalties, and interest for the 2003 tax year based on its determination that RAC East should have filed a combined income tax return with RAC West and RAC Texas (the RAC Group). (See Resp't Des'g Evid., Ex. N ¶¶ 22-25, 28, 33.) RAC East protested, and after conducting a hearing, the Department issued its final determination upholding the audit results. (See Resp't Des'g Evid., Ex. N ¶¶ 29-31.)
On December 12, 2006, RAC East initiated an original tax appeal. On March 20, 2009, the Department filed its motion for summary judgment and designated, among other things, its proposed assessments as evidence. On June 3, 2009, RAC East filed a cross-motion for summary judgment. On May 27, 2011, after holding a hearing, the Court granted summary judgment to RAC East stating the Department had not designated facts sufficient to make a prima facie case. See Rent-A-Center East, Inc. v. Indiana Dep't of State Revenue (RAC I), 952 N.E.2d 387, 390-92 (Ind. Tax Ct.2011), rev'd, 963 N.E.2d 463 (Ind. 2012). The Department subsequently sought review with the Indiana Supreme Court. On March 9, 2012, the Indiana Supreme reversed this Court's decision in RAC I, explaining that "as a starter" the Department needs nothing more than its motion and "notice of proposed assessment [to] constitute a prima facie showing—sufficient to satisfy Trial Rule 56(C)—that there is no genuine issue of material fact with respect to the validity of the unpaid tax[.]" See Indiana Dep't of State Revenue v. Rent-A-Center East, Inc. (RAC II), 963 N.E.2d 463, 465-67 (Ind.2012). Consequently, the Supreme Court remanded the case for the Court to consider the parties' motions on their merits. Id. at 467. Additional facts will be supplied as necessary.
Summary judgment is proper when the designated evidence demonstrates that no genuine issues of material fact exist and the moving party is entitled to judgment as a matter of law. Ind. Trial Rule 56(C). When the Department moves for summary judgment, it makes a prima facie case that there is no genuine issue of material fact regarding the validity of an unpaid tax by properly designating its proposed assessments as evidence. RAC II, 963 N.E.2d at 466-67. "The burden then shifts to the taxpayer to come forward with sufficient evidence demonstrating that there is, in actuality, a genuine issue of material fact with respect to the unpaid tax." Id. at 467. Cross-motions for summary judgment do not alter this standard. Horseshoe Hammond, LLC v. Indiana Dep't of State Revenue, 865 N.E.2d 725, 727 (Ind. Tax Ct.2007), review denied.
Indiana taxes the portion of a corporation's adjusted gross income that is
IND.CODE § 6-3-2-2(l) (2003) (amended 2006) (emphasis added). This alternative apportionment method, sometimes referred to as the equitable apportionment method, applies only when the use of the Standard Sourcing Rules "`works a hardship or injustice upon the taxpayer, results in an arbitrary division of income, or in other respects does not fairly attribute income to this state or other states.'" RAC II, 963 N.E.2d at 467, n. 3 (quoting 45 IND. ADMIN. CODE 3.1-1-62 (2003)). The Department's authority to require an alternative apportionment method is further limited if it chooses a combined income tax return
In response to the Department's prima facie case that its assessments are correct, RAC East contends that the Department could not force it to file a combined income tax return because its 2003 separate return fairly reflected its Indiana source income. (See, e.g., Pet'r Br. Supp. Mot. Summ. J. & Resp. Resp't Mot. Summ. J. ("Pet'r Br.") at 21-28). In support of this position, RAC East designated its Transfer Pricing Study as evidence that its Intercompany Transactions were conducted at arm's-length rates.
The Department, on the other hand, claims that RAC East's separate return did not fairly reflect its Indiana source income and, thus, it properly required RAC East to file a combined income tax return with its two affiliates. (See, e.g., Resp't Br. Supp. Mot. Summ. J. ("Resp't Br.") at 15.) The Department explains
The Department first claims that RAC East must file a combined income tax return with RAC West and RAC Texas because they operate together as a unitary business. (See Resp't Br. at 15-34.) More specifically, the Department reasons that because RAC East's separate return "cannot demonstrate the precise source of its net income[,]" only by filing a combined income tax return would RAC East capture "`the many subtle and largely unquantifiable transfers of value that take place among the components of a [unitary business].'"
If an Indiana taxpayer is a member of a unitary group,
Regardless of a possibility of distortion, however, Indiana's AGIT statutory framework does not require a member of a unitary group to file a combined income tax return solely because there is a unitary relationship. See generally IND.CODE § 6-3-2-1 et seq. Indeed, it is well established that filing on a separate company basis is the default method for reporting an Indiana AGIT liability. See RAC II, 963 N.E.2d at 465. Moreover, Indiana Code § 6-3-2-2 expressly states that a taxpayer may report, or the Department may require, the filing of a combined income tax return in only limited instances. See I.C. § 6-3-2-2(p)-(q); accord 45 I.A.C. 3.1-1-62. Thus, to require a taxpayer to file a combined income tax return merely because
Next, the Department claims that RAC East must file a combined income tax return because its payment of royalties to RAC West and management fees to RAC Texas distorted (i.e., did not fairly reflect) its Indiana source income. (See Resp't Br. at 43.) In other words, the Department claims that much of the income earned by RAC East, some of which was attributable to Indiana according to Indiana's apportionment formula, was deducted as intercompany business expenses, reducing RAC East's Indiana taxable income to zero. See, e.g., BMC Software, Inc. v. C.I.R., 780 F.3d 669, 672 (5th Cir.2015) (explaining that a taxpayer may artificially deflate its taxable income by manipulating the prices charged for intercompany transactions with related entities). The Department explains that RAC East's Transfer Pricing Study is not relevant to the determination of whether RAC East's Indiana source income was fairly reflected on its separate return. (See Resp't Br. at 40-44; Hr'g Tr. at 12-13.) Moreover, the Department states that RAC East's 2003 separate return could not fairly reflect its Indiana source income because RAC East's payments of royalties to RAC West lacked a valid business purpose and economic substance, and RAC East's payments of management fees to RAC Texas violated the Uniform Partnership Act. (See Resp't Br. at 36-38.)
In 2002, when RAC East and its affiliates reorganized their corporate structure, RAC East hired an independent accounting firm to conduct a Transfer Pricing Study to determine arm's-length pricing for the royalties it would pay RAC West and the management fees it would pay RAC Texas. (See Resp't Des'g Evid., Ex N ¶¶ 17, 19.) Based on the Study, RAC East paid 3% of its revenues to RAC West for use of the RAC Marks, and RAC East paid RAC Texas a management fee consisting of all amounts that exceeded 4.5% of its total costs (i.e., product costs and operating expense), which guaranteed that RAC East earned a return of 4.5% of its total costs in 2003. (See Resp't Des'g Evid., Ex. N 17-21.) The Department has asked the Court to disregard the Transfer Pricing Study, explaining that it is not relevant because: 1) it concerns financial accounting, not tax, 2) it concerns federal, not Indiana law, 3) it has no binding effect on state tax authorities, 4) other jurisdictions have rejected similar studies, and 5) it is flawed. (See Resp't Br. at 40-43.)
The Department first explains that the Transfer Pricing Study is not relevant because it was "done for financial accounting purposes, not for tax accounting purposes[.]" (See Resp't Br. at 41; Hr'g Tr. at 12-13.) The Transfer Pricing Study, however, states that it was based on federal income tax law, expressly IRC § 482 and the related regulations. (See Resp't Des'g Evid., Ex. N at Ex. A at 1.) The Transfer Pricing Study states that IRC § 482 requires intercompany transactions
Next, the Department explains that RAC East has placed entirely too much weight on the Transfer Pricing Study because it uses the arm's-length standard, a method required under IRC § 482 for evaluating intercompany transactions under federal law, not Indiana law. (See Resp't Br. at 40-41; Hr'g Tr. at 11-13.) The Department further explains that IRC § 482 redresses wholly different circumstances (i.e., combating "off-shore tax evasion by multinational corporations whose taxable income is subject to multiple international treaties") than those that concern Indiana's AGIT scheme (i.e., "fairly representing [a multi-state taxpayer's] in-state business activities within the bounds of the Commerce Clause"). (See Resp't Br. at 41.) Moreover, the Department points out that Indiana has neither adopted nor incorporated by reference IRC § 482 or any other similar statutory provision. (See Resp't Br. at 41.) These arguments are not persuasive, however, for at least two reasons.
First, IRC § 482 does not solely address federal tax evasion. Indeed, the U.S. Court of Claims has explained that IRC § 482 serves two distinct purposes because it may be applied to prevent tax evasion or to clearly reflect the income of related organizations. See Eli Lilly & Co. v. U.S., 178 Ct.Cl. 666, 372 F.2d 990, 999 (1967). Both of these purposes are also important to the administration of Indiana's AGIT scheme. For example, the Legislature gave the Department the extraordinary power to change a taxpayer's adjusted gross income, even though the taxpayer calculated its tax liability in complete conformance with the Standard Sourcing Rules, if the reported income does "not fairly represent the taxpayer's income derived from sources within the state of Indiana[.]" I.C. § 6-3-2-2(l).
Second, a comparison of the text of Indiana Code § 6-3-2-2(m) with the text of IRC § 482 inescapably demonstrates their similarities. Specifically, Indiana Code § 6-3-2-2(m) provides:
I.C. § 6-3-2-2(m) (2003). In turn, IRC § 482 provides:
I.R.C. § 482 (2003). Accordingly, the Transfer Pricing Study does not lack relevance on this basis.
The Department also explains that the Transfer Pricing Study is not relevant because it states that it "is not binding upon the IRS, any other tax authority[,] or any court[.]" (See Resp't Br. at 42 (citing Resp't Des'g Evid., Ex. N at Ex. A at 33).) The binding effect of the Transfer Pricing Study, however, has no bearing on its relevance for purposes of summary judgment. In this summary judgment context, the Transfer Pricing Study has been designated as evidence, and its relevance depends on whether it tends to prove or disprove that RAC East's use of a separate return fairly reflected its Indiana source income in 2003. See Ind. Evidence Rule 401 (explaining that evidence is relevant if it has any tendency to make a fact of consequence in determining the action more or less probable than it would be without the evidence). In other words, a transfer pricing study is relevant because it can serve as an objective evidentiary method for evaluating state tax issues that may arise in cross-border transactions between related organizations. Consequently, the Department's position that the Transfer Pricing Study lacks relevance because it has no binding effect is not persuasive.
The Department also discounts the Transfer Pricing Study's relevance on the basis that other jurisdictions have rejected these types of studies. More specifically, the Department explains that other courts have found arm's-length pricing irrelevant in determining whether the income of a taxpayer that operates as a unitary business and engages in intercompany transactions with its affiliates is fairly reflected on a separate return. (See Resp't Br. at 43-44.) The Department relies on the decisions in Eli Lilly & Company v. United States, 178 Ct.Cl. 666, 372 F.2d 990 (1967) and In re The Petition of The Talbots, Inc., DTA No. 820168, 2008 WL 4294963 (N.Y. Tax. App. Trib. Mar. 22, 2007) as support for its position. (See Resp't Br. at 43-44; Resp't Notice of Additional Auth.) Neither of these cases supports the Department's position.
In Eli Lilly, the court held that a taxing official's reallocation of a taxpayer's income under IRC § 482 was reasonable, even though the taxpayer developed an intercompany pricing policy for valid business purposes, because the taxpayer failed to prove that its sales to a related subsidiary were made at arm's-length rates. See Eli Lilly, 372 F.2d at 992-99. The court explained that the arm's-length standard under IRC § 482 was the proper benchmark to apply when examining whether reported income fairly reflected "true taxable income." See id. at 995-96. Contrary to the Department's claim, therefore, the Eli Lilly case indicates that evidence regarding the arm's-length standard of IRC § 482 is relevant when determining whether a taxpayer's return clearly reflects income. See id. at 995-96, 999-1000. Furthermore, the holding in Eli Lilly indicates that the taxpayer did not present a transfer pricing study to establish that its intercompany pricing policy was based on arm's-length rates. See id. at 994-95 (stating that the taxpayer's management team formulated the pricing policy), 997-98 (explaining that the taxpayer presented evidence of sales between itself and certain unrelated bulk purchasers).
Finally, the Department explains that the Transfer Pricing Study is not relevant because it used properties that were not comparable to the RAC Group in formulating the arm's-length rates for the Intercompany Transactions. (See Resp't Br. at 42; Hr'g Tr. at 43.) The Department, however, has not provided any further explanation, factual basis, or precedential or persuasive legal authority to support this claim. (See, e.g., Hr'g Tr. at 43; Resp't Des'g Evid., Ex. N ¶¶ 26-27 (both indicating that the Department never attempted to examine the Transfer Pricing Study).) Accordingly, the Department has not shown that the Transfer Pricing Study is not relevant because it is flawed.
Next, the Department argues that RAC East has adopted a business structure that allowed it to shift its Indiana source income outside of the state by deducting its royalty payments to RAC Texas. (See Resp't Br. at 37-38.) More specifically, the Department explains that RAC East's payment of royalties to RAC West is an improper tax avoidance measure because RAC Texas rather than RAC West "`is responsible for developing advertising and marketing strategies to create, maintain and expand the brand name for the [RAC Group.]'" (See Resp't Br. at 37-38 (quoting Resp't Des'g Evid., Ex. N, Ex. A at 15).) In support, the Department cites a case in which a court required a taxpayer to file a combined income tax return with two related subsidiaries because the evidence showed that the taxpayer's trademark "assignment and license-back transaction[s with those subsidiaries] lacked a business purpose or economic substance apart from tax avoidance." (See Resp't Br. at 37-38 (citing In re Sherwin-Williams Co. v. Tax App. Trib. of the Dep't of Taxation & Fin. of N.Y., 12 A.D.3d 112, 115-16, 784 N.Y.S.2d 178 (2004) (indicating that both subsidiaries were run on a part-time basis by an employee inexperienced in trademark management, that the taxpayer actually managed the trademarks, and that the subsidiaries returned the royalties to the taxpayer as loans)).)
The Department also argues that because a portion of the Uniform Partnership Act, Indiana Code § 23-4-1-18(f), prohibits partners from receiving compensation for providing services to the partnership, RAC East, the general partner of RAC Texas, improperly used its payment of management fees to RAC Texas to reduce its Indiana AGIT liability. (See Resp't Br. at 36-37; Resp't Reply Br. at 9-10; Resp't Des'g Evid. Ex. A at 282.) Indiana Code § 23-4-1-18(f) states that "[t]he rights and duties of the partners in relation to the partnership shall be determined, subject to any agreement between them, by the following rule[ ]: . . . No partner is entitled to remuneration for acting in the partnership business, except that a surviving partner is entitled to reasonable compensation for his services in winding up the partnership affairs." IND. CODE § 23-4-1-18(f) (2003) (emphasis added). In other words, "a partner is not entitled to compensation for [the] services rendered to the partnership unless there is an agreement to the contrary." United Farm Bureau Mut. Ins. Co. v. Schult, 602 N.E.2d 173, 175 (Ind.Ct.App.1992) (emphasis added) (citations omitted).
The designated evidence reveals that RAC East and RAC Texas executed a limited partnership agreement, but the designated portion of that agreement does not address the compensation of partners. (See Resp't Des'g Evid. Ex. A at 280, 282.) Accordingly, the designated evidence does not show whether RAC East's payment of management fees to RAC Texas contravened Indiana Code § 23-4-1-18(f). Moreover, because the Department has stipulated that RAC Texas was formed for valid business purposes and that the management fee payments were made at arm's-length rates, the Court cannot conclude that RAC East used its payment of management fees to RAC Texas to avoid its Indiana AGIT liability. Thus, the Department has not shown that RAC East's payment of management fees to RAC Texas distorted its Indiana source income and necessitated the filing of a combined income tax return.
Finally, the Department claims that RAC East's use of a separate return did not fairly reflect its Indiana source income because RAC East reported an Indiana income tax liability in the tax years before it restructured, but in 2003, post-restructuring, it reported an Indiana
Initially, the difference between RAC East's 2002 and 2003 Indiana income tax liabilities may be explained because Indiana's 2002 and 2003 corporate income tax laws were amended. Specifically, prior to 2003, Indiana corporations paid the greater of the gross income tax or the AGIT, plus the supplemental net income tax. See Longmire v. Indiana Dep't of State Revenue, 638 N.E.2d 894, 896 (Ind. Tax Ct.1994); IND.CODE § 6-2.1-1-1 to -8-10 (2002) (regarding gross income taxes); IND.CODE § 6-3-8-1 to -6 (2002) (regarding supplemental net income taxes). In 2003, however, Indiana corporations paid the AGIT only. See P.L. § 192-2002(ss), § 191 (repealing, among other things, Indiana Code sections 6-2.1 and 6-3-8). The designated evidence in this case indicates that RAC East paid gross income tax and supplemental net income tax in 2002, not AGIT. (See Resp't Confd'l Des'g Evid., Ex. I at 1-2.) Consequently, the decrease between RAC East's 2002 and 2003 Indiana income tax liabilities is not by itself sufficient to demonstrate that its use of a separate return did not fairly reflect its Indiana source income.
Second, Indiana's AGIT scheme, unlike its gross income tax scheme, allows certain deductions related to the cost of doing business. See 20 Ind. Prac., Business Organizations § 51.13 (stating that "[d]eductions for cost of doing business, losses, or expenses are not allowed in computing [an] Indiana gross income tax liability"). The deductions, in turn, generally reduce the amount of taxable income. See IND.CODE § 6-3-1-3.5(b) (2003) (amended 2004) (defining "taxable income" for corporations); I.R.C. § 63 (2003). See also BLACK'S LAW DICTIONARY 475 (9th ed.) (providing that a "tax deduction" is "[a]n amount subtracted from gross income when calculating adjusted gross income, or from adjusted gross income when calculating taxable income"). The number of deductions that a taxpayer may take from year-to-year typically varies because deductions related to the operation of a business may be recurrent, like insurance, telephone, utility, or management fee expenses, while others are not, such as refinancing expenses. (Compare, e.g., Resp't Confd'l Des'g Evid., Ex. I at 15 (RAC East's 2002 deductions) with Ex. J at 13-14 (RAC East's 2003
Finally, the designated evidence does not indicate that RAC East's 2003 refund request has any bearing on whether its Indiana source income was fairly reflected on its separate return. Indeed, the designated evidence reveals that RAC East requested a refund because it had overpaid its Indiana income tax liability by making estimated tax payments in both 2002 and the first two quarters of 2003. (See Pet'r Reply [to Resp't Reply Br.] at 19 (citing Resp't Confd'l Des'g Evid., Exs. I at 1; J at 2).) In this case, therefore, the amount of RAC East's 2003 profits, the fact that its 2003 Indiana AGIT liability was zero, and its nearly half-million dollar refund request do not show that its separate return failed to fairly reflect its Indiana source income.
The Department has claimed that RAC East must file a combined income tax return with its affiliates because it "used Indiana's roadways to deliver . . . and offer its products to residents all over the state" and then it improperly avoided its Indiana AGIT liability by "siphon[ing] the money it earned in Indiana to [RAC West] and [RAC Texas]." (See Hr'g Tr. at 15, 20.) While the Court is aware that a taxpayer may use its business structure and transfer pricing policies to lower its state income tax liability, the evidence designated in this case simply does not indicate that RAC East has engaged in any improper tax avoidance measures. See, e.g., Carmax Auto Superstores W. Coast, Inc. v. S.C. Dep't of Revenue, 411 S.C. 79, 767 S.E.2d 195, 200-01 (2014) (holding that a taxing official's bald assertions and descriptions of how it recalculated a taxpayer's income tax liability failed to show that the statutory formula did not fairly represent the taxpayer's in-state business activities). Furthermore, it is undisputed that the Transfer Pricing Study established arm's-length rates for RAC East's Intercompany Transactions and that the royalty and management fee payments were consonant with the Transfer Pricing Study's rates. Moreover, the designated evidence as well as the parties' stipulations do not show that RAC East's Intercompany Transactions can be disregarded because they lacked a valid business purpose or economic substance. Consequently, RAC East's 2003 separate return fairly reflected its Indiana source income. The Court, therefore, GRANTS summary judgment in favor of RAC East and AGAINST the Department.
SO ORDERED.
