At the end of 2012, the New York Division of Tax Appeals decided yet another combination case involving New York’s “distortion requirement.” In the case, the Department argue that related corporations should not be permitted to file on a combined basis because they did not meet the “presumption of distortion” (in existence prior to the enactment of the mandatory combined reporting rules).
Notwithstanding that the presumption was not met, the taxpayer successfully demonstrated that distortion existed and combination was required by showing that the related corporations were not conducting intercompany activities on an arm’s length basis. Specifically, the Administrative Law Judge determined that the existence of a centralized cash management system without arm’s length pricing, unreimbursed loans, centralization of management and the provision of administrative services without adequate compensation created distortion.
Although the case was decided under the law in effect prior to the enactment of the current mandatory combination rules, it is important because the Department of Taxation and Finance has been aggressively pursuing de-combination in cases where taxpayers do not meet the pre-2007 presumption of distortion test or the substantial intercompany transactions tests under the mandatory combination rules. This case confirms that under both prior and current law, the lack of “substantial inter-corporate transactions” does not prevent a taxpayer from filing on a combined basis if combination is otherwise necessary to properly reflect income.
This case may be used to show that distortion may be demonstrated through the lack of arm’s length pricing, and confirms that intercompany financing and cash management without arm’s length pricing is evidence of distortion which should result in an improper reflection of income.