In Loper Bright Enterprises v. Raimondo, the US Supreme Court overturned the 40-year-old Chevron doctrine, which instructed courts to defer to any reasonable agency interpretation of an ambiguous law. This move has led many in the state and local tax community to consider the potential impact on state agencies authorized with administering revenue statutes.
Although Loper Bright‘s exact impact on deference to state tax authorities is unclear, taxpayers will point to the case in their challenges against state actions. We’re already seeing this at the federal level with a taxpayer appeal in US Tax Court regarding the IRS’s enforcement of Section 482 of the tax code.
Regardless of the outcome in that federal case, transfer pricing is a particularly important topic when considering judicial deference to administrative actions at the state level. Loper Bright resurrected Skidmore deference, under which the weight afforded to agency determinations depends on the thoroughness of the agency’s consideration, the validity of the agency’s reasoning, and the determination’s consistency with earlier and later pronouncements from the agency.
State courts aren’t bound by Loper Bright or the now-resurrected Skidmore standard. But under the Skidmore standard, most state transfer pricing determinations that we have seen shouldn’t be afforded any deference.
Most separate reporting states have adopted a statute that tracks the language in Section 482, yet certain tax departments haven’t adopted regulations interpreting the statute or otherwise evidenced any “thoughtful consideration” of their approaches to transfer pricing.
State tax departments tend to be inconsistent with their enforcement of transfer pricing provisions. Compounding that concern, most states also appear to acknowledge they lack robust transfer pricing capabilities. This can lead states to rely on forced combination, addback statutes, or results-driven transfer pricing analysis that, in most cases, deserves little deference under the Skidmore standard or any other rational standard.
Due to lack of capabilities within tax departments, multiple states have hired outside consultants to aide in transfer pricing audits. New Jersey raised eyebrows last month when it requested bids for an outside transfer pricing consultant five years after it adopted combined reporting. (However, after the request was publicized, Division leadership eased taxpayer concerns and stated that the Division doesn’t have an interest in challenging federal transfer pricing reports concerning cross-border transactions, especially those that have been scrutinized by the IRS. The request for bids was intended to allow the Division to wrap up its pre-combination audits.) It raises the question of whether tax departments should be afforded deference at all when a private party, rather than the agency, is the transfer pricing “expert.”
Loper Bright may have addressed the federal Administrative Procedure Act, but the case is simply the biggest development in a trend away from providing too much discretion to state tax agencies. Many states have already rejected Chevron-style deference legislatively, but other state agencies have seen their regulatory discretion constrained by courts.
It might be fair to ask, for instance, whether the Arkansas Department of Finance and Administration won a battle but lost a war in American Honda Motor v. Walther. The DFA prevailed regarding the characterization of income earned on the sale of credits as business income, but the Arkansas Supreme Court also ruled the DFA’s interpretation of the state’s Tax Procedure Act is de novo and that even the presumption of correctness doesn’t attach to a final assessment or determination of the secretary in a trial de novo or an appeal.
We suspect other state “interpretations” of their statutes will be similarly disregarded as taxpayers capably defend their transfer pricing studies in courts where states lack competing studies or evidentiary support for their disregard of taxpayers’ documentation.
Transfer pricing may be ripe for the next iteration of challenging state authority and holding state actions accountable in courts. The Loper Bright court overruled deference to reasonable federal agency regulations. State courts can devise their own deference standards, but one would think agency actions that undermine the standard statutory method of calculating income should face an uphill battle when it comes to deference.
The case is Loper Bright Enterprises v. Raimondo, U.S., No. 22-451, decided 6/28/24.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Reproduced with permission. Published August 20, 2024. Copyright 2024 Bloomberg Industry Group 800-372-1033.
