South Carolina Legislature Severely Limits Department’s Ability to Force Companies to File Combined Returns
Since the South Carolina Supreme Court held in Media General Communications, Inc. v. South Carolina Department of Revenue, 694 S.E.2d 525 (S.C. 2010), that the Department of Revenue (“Department”) had the authority to allow companies to file a combined unitary return (in that case the companies wanted to file on a combined basis), the Department has been attempting to forcibly combine taxpayers with their affiliates and usually with all of the companies included in the federal consolidated return. Fortunately, the Legislature has now severely limited the Department’s ability to force combined returns.
The legislation (S298), which was modeled on similar legislation in North Carolina, was unanimously passed by both the Senate and House and signed into law by the Governor on March 11, 2024. It provides that the Department may only force a corporate taxpayer to file a combined unitary return if (1) the Department finds that the taxpayer’s intercompany transactions either (a) lack economic substance or (b) are not at fair market value and (2) the Department is unable to properly determine the taxpayer’s income attributable to the State through adding back, eliminating, or otherwise adjusting the intercompany transactions.
A transaction has economic substance if the transaction (1) has one or more reasonable business purposes other than the creation of state income tax benefits and (2) has economic effect beyond the creation of state income tax benefits. An affiliated group’s having centralized cash management specifically does not constitute evidence of an absence of economic substance.
In determining whether transactions between affiliates are not at fair market value, the Department is required to apply the standards contained in the regulations adopted under Internal Revenue Code Section 482. This will likely increase the use of transfer pricing studies in South Carolina.
Significantly, the legislation applies to all open periods except for assessments under review by the Administrative Law Court, the Court of Appeals, or the Supreme Court as of the date of the Governor’s approval. This should be helpful to many taxpayers.
The cynical among us had often wondered whether the reason the Department stipulated in Media General that the standard method of apportionment did not fairly represent the taxpayer’s income in South Carolina, and that a combined return did fairly represent the taxpayer’s income in the State, was to obtain the right to force other taxpayers to file combined returns. The recent legislation will now prevent (or at least severely limit) such actions in the future.
This update is one in a series of updates written for the April 2024 edition of The BR State + Local Tax Spotlight.