North Carolina Issues Further Guidance On Department Of Revenue's Income Adjustment And Forced Combination Procedures

Earlier this year, North Carolina enacted legislation that clarified the procedures the Secretary of the Department of Revenue must follow in order to adjust a corporation's tax return or require corporations to file on a combined basis.1 The Department of Revenue has issued a Directive that further explains the Secretary's authority to redetermine a corporation's net income by adjusting the corporation's intercompany transactions or requiring the corporation to file a combined income tax return.2

Background

The legislation enacted earlier this year repealed the Secretary's current statutory authority to adjust a corporation's net income or require a combined return and replaced it with new statutory authority effective for tax years beginning on or after January 1, 2012.3 The legislation also granted to the Secretary the authority to enter into a voluntary redetermination in which the Secretary and taxpayer mutually agree to an alternative filing methodology that accurately reports its North Carolina net income.4

The first part of the Directive explains the Secretary's practice under current law to require a corporation to file a combined income tax return with its parent, subsidiaries and affiliates for tax years beginning before January 1, 2012. The second part of the Directive explains the Secretary's authority under the new statute to redetermine a corporation's net income by readjusting the corporation's intercompany transactions or requiring the corporation to file a combined income tax return for tax years beginning on or after January 1, 2012. Also, the second part of the Directive describes when a voluntary redetermination is appropriate.

Tax Years Beginning Before January 1, 2012

The Secretary is authorized under current law to eliminate amounts paid by a corporation to an affiliate in excess of fair compensation.5 The Secretary also has the power to require a corporation doing business in North Carolina to file a combined corporate income tax return with some or all of its affiliated corporations if the separate entity income tax return does not disclose its true earnings in the state.6 Further, the Secretary may require a corporation to use a different method of accounting in order to clearly reflect its net income.7 When a corporation conducts its trade or business in a manner that distorts is true net income and the net income properly attributable to the state, the Secretary may correct the distortion through a variety of methods, including alternative apportionment and allocation.8 The application of these last two provisions may result in a combination or the disallowance or reduction of deductions for amounts paid by a corporation to an affiliated...