Tennessee Sales Tax Update: Transactions With Affiliates Receive Additional Scrutiny From Tennessee Tax Department

Transactions between related entities are sometimes overlooked from a sales tax perspective, which can result in tax liability that might have been avoided. Using a pending Tennessee case and a recent statutory change, this article highlights different scenarios in which these issues often come into play, and provides tips on how to avoid exposure in this area and maximize the benefits available under statutes exempting certain affiliate transactions.

The focus of sales and use tax compliance departments is often on making sure that sales tax is being properly applied to transactions with third-parties, that exemptions are properly documented, and that use tax is being assessed and remitted when appropriate. Transactions that can often be overlooked, however, are those that involve the interaction between the taxpayer and its affiliates.

In Tennessee, the Department of Revenue has begun focusing on these affiliated-party transactions during audits, asserting that sales tax is due depending on the nature of the transaction between affiliates.

In one case now pending before the Davidson County Chancery Court in Tennessee, a taxpayer served as the central purchasing agent for its various affiliates. Purchases of tangible personal property were made by the parent, and sales tax was paid on those purchases. The purchased goods were then transferred to the various affiliates, and the costs were shared pursuant to an Intercompany Cost Allocation Agreement. Significantly, the Agreement also provided for the allocation of costs for a variety of administrative and management services, which included (1) personnel services, (2) financial, legal and accounting services, (3) other administrative services, and (4) investment management services. The taxpayer also provided information technology services, including the development of certain software projects that, once developed, allowed the taxpayer's affiliates to access software maintained by the taxpayer at its centralized servers. The Department issued an assessment based on the provision of all these services to the taxpayer's affiliates.

Tennessee has a long history of targeting affiliated-party transactions dating back to Standard Advertising v. Jackson, 735 S.W.2d 441 (Tenn. 1987), in which the Department successfully asserted that charges between Service Merchandise and its affiliated advertising entity were subject to sales and use tax. More recently, Tennessee has attempted to disregard...