Reprinted from Tax Notes State, April 22, 2024
It’s hard to believe it’s been over five years since the Maryland Court of Special Appeals held in Staples Inc. that an out-of-state parent could be subject to tax in the state by virtue of royalty payments made by in-state related entities despite all intercompany transactions being at arm’s length. That case is one in a line of Maryland cases that purport to permit separate reporting in the state only when related entities have “economic substance as business entities separate from” other members of a unitary group despite being a separate reporting state. I think most would agree that this exception has swallowed the rule in Maryland, and even out-of-state entities with property, payroll, and third-party sales have fallen prey to the requirement that they be discrete business enterprises. But since at least 2006, Maryland has proposed bill after bill studying the fiscal impact that combined reporting might have, coupled with attempts to adopt various iterations of combined reporting. Proposed this February, Maryland H.B. 1007 would require a unitary business to file a combined return on its worldwide taxable income. No such bills have passed thus far.
I’m no fiscal policy expert, so I’m inclined to believe the consensus from those advocating for combined reporting that it typically has the effect of raising revenue in states, although that impact often appears minimal. Only one data point, but the first report of that study mandated by Maryland in 2006 suggested that the state would have collected an additional $109 million to $170 million had it adopted combined reporting. Nonetheless, many state policymakers reasonably prefer separate reporting for its simplicity, not to mention avoiding the technical and constitutional complexities that arise in combined reporting regimes, such as how to apportion disparate streams of income.
Maryland is hardly alone in this struggle between having a legislature stalwartly support a separate reporting framework and the taxing authority aggressively attempting to undermine that statutory framework. As recently as March 11, the governor of South Carolina signed into law S.B. 298, which limits the extent to which the Department of Revenue can force combination among unitary business affiliates. That legislation came after nine years of the DOR asserting that separate reporting is inherently distortive when a unitary business earns income outside South Carolina and that combined reporting would be required in those situations. After the department’s recent win in Tractor Supply, the General Assembly reinforced the requirement that the department look to whether intercompany transactions are at arm’s length, and it imposed numerous conditions that the state must meet in imposing alternative apportionment and requiring combined returns.
