This North Carolina corporate income tax alert discusses developments from the recently concluded short session of the General Assembly.
General Assembly passes new statute governing rule making under G.S. 105-130.5A.
The General Assembly has enacted a new statute, G.S. 105-262.1, that suspends the Department’s authority to redetermine the State net income of a corporation under G.S. 105-130.5A until the Department enacts a rule pursuant to an expedited rule-making procedure. New G.S. 105-262.1 also prohibits the Department from interpreting G.S. 105-130.5A in the form of a bulletin or directive under the authority of G.S. 105-264.
Background to the enactment of G.S. 105-262.1
G.S. 105-262.1 was enacted in response to three directives (CD-11-01, CD-12-01, and CD-12-02) that the Department issued in response to the passage of HB 619 (Session Law 2011-390, as amended). HB 619 comprehensively revised the statutory framework governing the Department’s authority to require the filing of combined returns or to otherwise adjust a corporation’s net income. Directive CD-11-01 was issued on November 16, 2011. Directives CD-12-01 and CD-12-02, published on April 17, 2012, largely, though not entirely, restate the content of Directive CD-11-01.
Directive CD-11-01 originated in efforts by the Department to address taxpayer complaints about the lack of guidance as to when the Department of Revenue would pursue forced combination of affiliated corporations. Responding to these complaints, in late 2010, David Hoyle, the new Secretary of Revenue, began the process of promulgating rules in compliance with the Administrative Procedure Act (“APA”) by drafting and then releasing for public comment a draft of proposed rules. Due in part to pending legislation concerning the forced combination remedy, which was subsequently enacted and signed into law by the Governor on June 30, 2011 (2011 N.C. Sess. Laws ch. 390), the proposed rules were never promulgated. However, the draft regulations, substantially changed and expanded to reflect the new legislation, were largely incorporated into Directive CD-11-01.
Directive CD-11-01 was published purportedly pursuant to G.S. 105-264, which makes it the duty of the Secretary of Revenue (“Secretary”) to interpret all laws administered under the Secretary’s authority. However, several groups representing taxpayers questioned whether the Secretary had the authority to publish Directive CD-11-01 without proceeding under the rule-making requirements of G.S. 105-262.
Directive CD-11-01 sets forth the Secretary’s interpretation of the Department’s discretionary authority to adjust corporate net income, including the authority to combine the returns of affiliated corporations, pursuant to G.S. 105-130.6, G.S. 105-130.15, and G.S. 105-130.16, as well as what the directive vaguely refers to as “other law,” for tax years beginning before January 1, 2012. For tax years beginning on and after January 1, 2012, the Directive explains the Department’s authority and the standards it will follow under new G.S. 105-130.5A, enacted by HB 619 in 2011, to adjust intercompany transactions or require a corporation to file a combined return.
In addition to being an apparent response to taxpayer complaints, Directive CD-11-01 also implicitly responded to criticism of the Department by the North Carolina Business Court in Delhaize America, LLC v. Lay, 2011 NCBC 2 (Jan. 12, 2011), for the failure to provide guidance in the area of forced combination.
There have been three major areas of concern with the directive raised by taxpayers and others:
- The Directive lacks clarity and predictability.
- The Directive erroneously interprets certain aspects of the legislation passed by the 2011 session of the General Assembly and by prior sessions of the General Assembly.
- Publication of the Directive without undergoing formal rule making may violate the APA.
Perhaps in response to these recent criticisms of Directive CD-11-01, the Department published two new corporate income tax directives on April 17, 2012. The first directive, CD-12-01, restates without substantive changes the discussion in Directive CD-11-01 that addresses the Department’s authority to require the filing of a combined return or adjust net income for tax years beginning before January 1, 2012.
The second directive, CD-12-02, addresses the Department’s authority under G.S. 105-130.5A (eff. for tax years beginning on or after Jan. 1, 2012). Directive CD-12-02 generally restates the discussion of G.S. 105-130.5A in Directive CD-11-01 but includes several changes from the earlier directive. These changes respond to some of the concerns that taxpayers raised about Directive CD-11-01.
However, most of the problems raised by taxpayers about Directive CD-11-01 remain. (See letter and memorandum jointly submitted by the Council on State Taxation, the North Carolina Retail Merchants Association, and the North Carolina Chamber of Commerce to the co-chairs of the Revenue Laws Study Committee on January 30, 2012, and available on the committee’s website.)
New procedure for adopting rules under G.S. 105-130.5A
In response to taxpayer concerns, the Revenue Laws Study Committee adopted a report on May 2 recommending that the General Assembly require the Department to undergo an expedited procedure in order to adopt rules pertaining to G.S. 105-130.5A. Based on this report, the General Assembly passed Senate Bill 824 (codifying G.S. 105-262.1), which requires the Department to follow an expedited rule-making procedure in promulgating interpretations of G.S. 105-130.5A.
The expedited procedure in G.S. 105-262.1 is based on the procedure for adopting a temporary rule under the APA. G.S. 105-262.1(d). The Department is required to provide electronic notification of the adoption of the rule and accept written comments according to the timetable provided for the adoption of temporary rules in G.S. 150B-21.1(a3). If the Department receives a written comment objecting to the proposed rule and requesting review by the Rules Review Commission, the proposed rule must proceed through the rules review process provided in G.S. 105-262.1(e) through (j).
SB 824 also “supersedes” Corporate Directive CD-12-02. 2012 N.C. Sess. Laws ch. 43 § 5.
Private Letter Rulings fee schedule and guidance
The Department of Revenue has published guidance on requesting private letter rulings under G.S. 105-264(b).
The fee structure for requests mailed on or after February 1, 2012 is $500 per tax type, per tax issue for a non-expedited private letter ruling; $5,000 per tax type, per tax issue for an expedited ruling; and $5,000 for a “redetermination private letter ruling.” A “redetermination private letter ruling” is written advice “regarding whether a redetermination of a corporation’s State net income or a combined return would be required by the Secretary” pursuant to G.S. 105-130.5A.
The Department does not accept requests for expedited redetermination private letter rulings.
A private letter ruling is distinguishable from a “Letter of General Applicability,” which is “general information about a tax issue of general applicability.” Letters of General Applicability may be requested by a tax professional or association of taxpayers in addition to a taxpayer. The Department does not charge a fee for issuance of a Letter of General Applicability, but, unlike private letter rulings, Letters of General Applicability are not binding on the Department.
The guidance on letter rulings is available on the Department’s website at http://www.dornc.com/practitioner/plr_policy.pdf.
General Assembly passes legislation prohibiting the use of contingent fee auditors.
The General Assembly has enacted legislation that prohibits the use of contingent fee auditors by the State Treasurer and by counties and cities for the purpose of determining tax liability. The broadly worded prohibition applicable to the Department prohibits the use of any “agent who is compensated in whole or in part by the State for services rendered on a contingent basis or any other basis related to the amount of tax, interest, or penalty assessed against or collected from the person.” 2012 N.C. Sess. Laws ch. 152 § 1 (adding new G.S. 105-243.1(a1)).
The legislation prohibits the State Treasurer from contracting with an auditor to perform an unclaimed property audit “on a contingent fee basis or any other similar method that may impair an auditor’s independence or the perception of the auditor’s independence by the public.” 2012 N.C. Sess. Laws ch. 152 § 3 (amending G.S. 116B-8). There is a limited exception allowing the State Treasurer to conduct audits of life insurance companies for the purpose of identifying unclaimed death benefits or for audits of holders of unredeemed bond funds on a contingent fee basis.
The legislation contains similar prohibitions applicable to the hiring of auditors by counties and cities for property tax and other local tax purposes. 2012 N.C. Sess. Laws ch. 152 § 2 (amending G.S. 105-299); 2012 N.C. Sess. Laws ch. 152 § 4 (amending G.S. 153A-146); 2012 N.C. Sess. Laws ch. 152 § 5 (amending G.S. 160A-206).
Per a revision to the effective date provision in Senate Bill 847, the Technical Corrections bill, the provisions in the act that prohibit contingent fee audits by the Department and the Treasurer are effective on October 1, 2012. The provisions that prohibit contingent fee audits by counties and cities are effective on July 1, 2013 and expire on July 1, 2015.
For the period in which new legislation is in effect, counties and cities are prohibited not only from entering into new contingent fee contracts, but also from renewing contingency fee-based contracts for services covered by the legislation. These governmental entities are also prohibited from assigning further audits on a contingency fee basis to an auditing firm under a contract that (i) would have been prohibited by the act had the contract been entered into after the relevant effective dates, and (ii) allows the assignment of audits on a discretionary basis. Senate Bill 847 § 61.5(b).