Utah: High court favors taxpayers on transfer pricing

The Supreme Court of Utah gave taxpayers a sweet victory recently in Utah State Tax Commission v. See’s Candies.  In See’s Candies, the Utah State Tax Commission challenged an arrangement between two wholly owned subsidiaries of Berkshire Hathaway that provided Utah corporate franchise tax benefits. The Utah Supreme Court, however, ultimately ruled in favor of the taxpayer, See’s Candies.

FRANCHISE TAX CONTROVERSY

See’s Candies sold its intellectual property, including trademarks, to an affiliate commonly owned by Berkshire Hathaway, namely Columbia Insurance Company. In return, Columbia leased the trademarks back to See’s and See’s paid a royalty to Columbia for the use of the trademarks. See’s deducted the royalty expense from their income for Utah corporate franchise tax purposes, but Columbia did not report the corresponding income because they did not file Utah corporate franchise tax returns. As the Tax Commission found, the effect of the arrangement was to reduce See’s Utah franchise tax liability by 75% for the audited years.

The Tax Commission disallowed the royalty expense to See’s under a provision of Utah tax law, “Section 113, that allowed the Commission to disallow deduction if “necessary to prevent evasion of taxes.”  However, the Tax Commission did not make any findings as to whether the royalty payments were “arm’s length.” The taxpayer, See’s, brought suit alleging that the arrangement was a legitimate, arm’s length transaction that should be respected. The Utah district court ruled in favor of See’s and the Utah Tax Commission appealed.

SUPREME COURT RULING

The Utah Supreme Court determined that the related-party arrangement was a legitimate one that should be respected for Utah franchise tax purposes. According to the Court, the arm’s length concept of Internal Revenue Code § 482 is implicit in Utah law, namely Section 113, as well. The Court found did not have to address a key factual finding, because the Tax Commission did not contest that the arrangement was arm’s length and instead focused on legal issues.

The See’s Candies case could be important moving forward to the extent that state taxing authorities assert their discretionary authority to “reallocate” income for net income tax purposes under their state law. In other words, the case could be used for interpretive guidance in other state to adopt IRC § 482 as applicable to state net income tax laws.