TEI Minnesota Chapter
State & Local Committee Meeting
Handling Tax Controversy To Win
October 28, 2014
Stephen Kranz
Partner
McDermott Will & Emery, LLP
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Agenda
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Agree on a Definition of Winning
Bringing a Gun to a Knife Fight
§ 482 Case Study
Friends Play Chess to Win
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Agree on a Definition of Winning
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Getting to the right number
Getting to a tolerable number
Getting to zero
Financial statement drivers
Principles to live by
Standing up for taxpayers
Cost-benefit analysis
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Be Ready Before Audit Notice
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Be Ready Before Audit Notice
• Who will be involved?
• Issues for financial accounting group?
• Preserve documents and witnesses
• If you are always audited by a state or have
a big transaction – consider pre-audit
discussions with state.
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Bringing a Gun to a Knife Fight
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The defensive tools to use
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Controlling disclosure of information
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Privilege
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Limiting scope
Overwhelm with documents
Give them nothing
Identify “hot documents” at the outset
SOL strategy
Posturing the law up front
Develop an audit strategy
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Bringing a Gun to a Knife Fight
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Identify Areas of Exposure
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Review files from prior audits.
Review tax returns for the years under examination.
Review tax journals and reach out to peers and determine “hot”
audit issues.
Identify Relevant Non-Tax Business People
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CEO, CFO, COO, General Counsel
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Bringing a Gun to a Knife Fight
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Develop an Audit Strategy
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Determine if any identified issues have significant dollar value.
Determine the impact of the identified issues on future years.
Determine relevance to other states.
Gather facts and conduct legal research to establish the
company’s position with respect to each identified issue.
Work with tax policy team to evaluate landscape.
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Bringing a Gun to a Knife Fight
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Establish Procedures for IDRs
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Establish written procedures, hierarchy and protocol for all audit
responses.
Insist on written requests.
Consider requiring compulsory subpoenas.
Insist on specificity and detail.
Consider benefit and risks of limited or no response to nonmaterial or out-of-scope requests.
Object to:
• 50 state inquiries;
• Providing returns from other states.
Object to creating new documents.
Options for protecting documents from disclosure to other states.
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Bringing a Gun to a Knife Fight
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Negotiate Scope of Requests
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Try to narrow scope of unreasonably burdensome requests.
Suggest use of samples.
Negotiate for extension of response deadlines if necessary.
Evaluate company position on SOL extensions.
Highlight potential misconceptions.
• Qui tam
You are under investigation!
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Bringing a Gun to a Knife Fight
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The offensive tools to use
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FOIA
Policy friends
Political friends
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Press friends
Question authority and breach of confidentiality
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External policy team
MTC and other § 482 contract auditors
Litigation and discovery
Build a Coalition
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Check the Caliber of your Weapon
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History with the state
Tax climate (administrative and legislative)
Economic development
Budget considerations
National landscape
Customer relationships
Press worthy?
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When is audit “over”
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Scope of closing agreement
RARs and other adjustments
NOLs
Prospective agreements and change in law or
circumstances
Effect on audits by other states
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482 Magic 8-Ball Bounty Hunters
A Case Study
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States currently employing contract auditors
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District of Columbia (contingency fee) – Renewed!
New Jersey (contingency fee) – Terminated!
Kentucky (contingency fee) – Terminated!
Alabama (behind the curtain, possible new firm)
Louisiana (behind the curtain)
Connecticut (behind the curtain; training)
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Bounty Hunters
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States frequently prohibit expert witnesses from being paid
based on outcome of litigation.
New Jersey transfer pricing compliance program
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Hired Chainbridge to prepare transfer pricing reports.
• 15 reports per year.
• New Commissioner may deemphasize the use of contract
auditors.
Contract Terminated September 2011
• According to NJ Department of Treasury, “[w]e terminated that
contract with Chainbridge earlier this year and then wound down
all of the outstanding cases." See 2011 STT 216-12.
New Jersey subsequently instigated and provided seed money for the
formation of the MTC’s Arm's-Length Adjustment Service (ALAS).
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Bounty Hunters (cont’d)
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District of Columbia
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Hired ACS State & Local Solutions, Inc. / Fast
Enterprises
“…to do economic analysis of potential candidates for
audit based on domestic transfer pricing issues.”
Estimated payment (based on contingency fee) of $9
million per original DC contract.
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D.C. Approach
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D.C. Code § 47-1810.03. Distribution,
apportionment, or allocation of income or
deductions between or among organizations,
trades, or businesses.
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This parallels the statutory authority under § 482.
In 2011, DC went from allowing separate returns
to mandatory combined reporting.
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D.C. Approach (cont’d)
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Information Document Request (IDR)
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Gives appearance of audit
Requests volumes of taxpayer documents
How to respond:
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Challenge Authority
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Ignore
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Withhold potentially privileged or confidential information
Give them all of the documents
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Same result—so why give them anything?
Give them some of the documents
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Keep detailed records and document the process
Information overload
Contact the revenue department
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Supply the voice of reason—attempt to limit scope
Make strategic concessions
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Confidentiality Issues
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Extensive federal protection for federal return information (IRS
Pub. 1075).
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Federal and state crime to improperly disclose.
Most RFPs have disclosure and confidentiality rules.
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State disclosure of federal information.
Violation may jeopardize state/federal information sharing
agreements (memorandum of understanding).
Limited number of people with access.
Specific rules on physical security of tax data.
Problems with contract auditors.
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Not clear that they are following requirements of confidentiality
agreements.
Questions regarding ability to use disclosure by one state in
contract for another.
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Preventing the Spread
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Broad general authorization attempted - KILLED
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Indiana
California
Nebraska
Massachusetts
Specific transfer pricing contingent fee authorization
attempted - KILLED
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Minnesota
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MTC’s Arm’s-Length Adjustment Service (ALAS)
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Goals:
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(1) Enhance the ability of participating states to correct cases of taxpayer
underreporting associated with related party transactions.
(2) Increase audit coverage of related party transactions for states electing to
participate in the MTC Audit Program for corporate income taxes.
(3) Provide opportunities for satisfactory resolution of disputes involving related
party transactions and transfer pricing issues.
(4) Inform and advise states of emerging developments concerning related party
transactions and transfer pricing issues.
Timeline:
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March 6, 2014- Project Facilitator and former MT DOR Director Dan Bucks
releases an initial project plan.
October 7, 2014- ALAS Advisory Group meets and releases draft design.
July 2015- anticipated draft submission and Commission approval.
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Transfer pricing audits begin?
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MTC’s Arm’s-Length Adjustment Service (ALAS)
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States Providing Seed Money:
• Alabama, DC, Florida, Georgia, Hawaii, Iowa, Kentucky,
New Jersey, and North Carolina
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Contract Auditors Involved:
• Chainbridge Software LLC
• Economic Analysis Group LLP
• Economists Inc.
• NERA Economic Consulting
• Peters Advisors LLC
• RoyalStat LLC
• WTP Advisors
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Resolution of National Conference
of State Legislatures (NCSL)
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NCSL has adopted a resolution calling upon states to end the use
of contingent fee arrangements in tax audits and appeals.
The resolution opposes the use of contingent fee arrangements
because such arrangements:
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Provide an incentive for third-party auditors to arbitrarily inflate a
taxpayer’s liability;
Encourage auditors to be overly aggressive, to interpret State laws to
their own pecuniary advantage, and to “cherry pick” taxpayers as audit
targets and to ignore taxpayer errors that would result in lower
assessments;
May serve as a disincentive to enter into settlement discussions with
taxpayers; and
Creates a perception of unfairness that undermines taxpayers’
relationships with tax administrators.
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Recent and Pending D.C. 482
Cases
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Siemens- D.C. OTR settled for $0 tax liability.
BP- Settled. OTR refunded $140,895 plus interest.
Shell - Filed in OAH – MSJ pending.
Exxon- Filed in OAH – MSJ pending.
Hess- Filed in OAH – MSJ pending.
Pfizer- Filed in OAH – MSJ pending.
Ahold- Filed in OAH – hearing pending.
AT&T- Filed in OAH – hearing pending.
Eli Lilly- Filed in OAH – hearing pending.
Exxon II- Filed in OAH – hearing pending.
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Rules to Win By
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Audit = Investigation.
The best defense is a great offense.
Understand the politics of tax.
State house or court house – you fund them both.
It’s your money – keep it.
Voluntary Disclosures are voluntary.
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Friends Play Chess to Win
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Relationships matter.
Reputations matter.
Handling a case to win should not cost either.
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Contact Info
Stephen P. Kranz
Partner
McDermott Will & Emery LLP
Washington, DC
skranz@mwe.com
(202) 756-8180
Join our blog at: www.insidesalt.com
Find me on LinkedIn at: www.linkedin.com/pub/stephen-kranz/a/8a6/167
or www.linkedin.com/groups?home=&gid=3862215&trk=anet_ug_hm
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Questions?
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