Earlier this year the General Assembly made significant changes in the statutes authorizing forced combinations of multistate corporate groups for income tax filing. The DOR has been scrambling to figure out how to enforce the old law and the new law, as reflected in three notices it has issued, discussed below, as well as a revised voluntary disclosure program discussed below. The changes offer significant promise for corporate taxpayers.

Undated 2011 Notice: The first notice stated that (a) the old forced combination statue, GS 105-130.6, would be applied in assessments proposed before New Year’s Day 2012; (b) the new statute, GS 105-130.5A, will be applied in assessments proposed after New Year’s Eve 2011, for future year; and (c) with respect to years up to 2011 for which assessments are proposed after 2011, the DOR said it can use all sorts of non-statutory remedies, even though it thought the old statute was no longer applicable (despite the fact that the old statute was in existence during the years under audit).

First Oct. 12, 2011 Notice: The DOR announced the amendment of the repeal bill, which amendment allows the old statute to apply to years before 2012, whether the DOR proposes assessment before 2012 or not.

Second Oct. 12, 2011 Notice: This notice addresses the effect of the revised statutory changes on the over 100 secret settlement agreements effected between corporate taxpayers and the DOR to require combined reporting, both for the past and future. In those agreements it is thought that the DOR allowed a variety of combination approaches, some of which included the unitary group, some of which did not, and which varied in other particulars of computation. The terms of those agreements are unknown because the DOR required taxpayers and their advisors to swear to secrecy. The notice states that “in many cases [those agreements] authorized a corporation to file a combined return.” Evidently this means that less than all of the agreements involved future combined filing; however it is thought that the majority required combined filing, since that is what the DOR generally sought.

Evidently the numerous major multistate corporations with whom the DOR had made these deals are concerned that the change in statutory standards for forced combinations might place their deals in jeopardy; that the DOR might re-audit them and impose different combinations. To address those concerns the new notice establishes these rules:

  1. The existing agreements are safe unless and until the DOR audits (which may be triggered by being informed by the taxpayer of material changes, which the taxpayers are required to do), and determines that “a corporation’s State net income is not accurately reported on a separate return.” In such cases the DOR will try to “agree” with the taxpayers about how to change the settlement, and if no agreement can be reached the settlement will be void, presumably prospectively only. This part of the Notice is curious because it only addresses that minority group of the settlements that DID NOT require future combined returns. Possibly this is not what the DOR meant and a third notice will be forthcoming.
  2. Those taxpayers currently under audit without settlement agreements can ask the DOR to negotiate a future filing methodology as well as determine past tax liability.
  3. Those taxpayers who are not under audit and who have no settlement agreement can initiate a Managed Audit and reach a settlement agreement thereunder. The Managed Audit Agreement form is the same one used for voluntary compliance programs that produced the 100+ settlement agreements for combined returns. Thus, in effect, the DOR is running a continuous settlement program for forced combinations.
  4. Those taxpayers who have not filed any returns, even single entity returns, can seek a private letter ruling as to past and future filing liabilities and methods.

Voluntary disclosure program change: On 10/31/2011 the DOR revised its voluntary disclosure program to limit a nonfiler’s liability for past year’s taxes to three years, with no penalties, as opposed to six years and penalties if the non filer is discovered by the DOR. The primary change is a reduction of the voluntary compliance lookback period from four to three years. Different rules apply to sales tax.

The Oct. 12, 2011 notices do not reference the VDP, even as to those nonfilers who enter into a managed audit. As to past years’ liability the notice only says the taxpayer and the DOR will agree as to any such liability. Apparently this means that in the area of forced combinations, the requirement to pay three years back taxes may not apply.

Voluntary Combination. The October 12 Notice appears to be a not too subtle invitation to those few multistate corporations that have not already done so to seek voluntary combination by secret contract with the DOR. No one else will know who has obtained voluntary combination and no one else will know the terms on which the particular taxpayer is filing combined, because there is no officially adopted combination procedure.

Conclusion. It appears that North Carolina has achieved the best of all possible worlds, so far as corporate income tax filing is concerned, at least from the viewpoint of the DOR. It does not have to put up with the complications and confusion of general unitary combined filings; but it can imposed specialized combined filing when it wants to; and it has the power to run a voluntary combination program, the details and scope of which no one can ascertain, and entry into which is entirely within the DOR’s uncontrolled discretion.

Multistate corporations that have previously entered into forced combination agreements with the DOR should rest easy; it appears that the DOR will not be re-examining those agreements unless the taxpayer notifies the DOR that material changes have occurred. Those that have not should consider proposing to file combined on terms most favorable to that taxpayer, without paying any taxes for prior years under a combined approach, and without paying any penalties. The latter group has nothing to lose but the possibility of long and expensive litigation with the NCDOR.