September 15, 2009, is the deadline for applying to North Carolina’s Resolution Initiative (Initiative) to settle certain corporate income and franchise tax issues. With a backlog of audits and combination challenges mounting within the North Carolina Department of Revenue (the Department), the Initiative is targeted to entice corporate taxpayers to settle audits and subsequent tax return filings that contain targeted issues. Further, the Department is taking the position that in most cases it is unable to waive penalties outside of the Initiative.
I. Are You Eligible?
Unlike other state amnesty or settlement programs which apply to a wide variety of taxes and issues, North Carolina’s Initiative is limited. The Initiative applies to certain targeted issues that the Department has asserted under audit, including: (1) forced combination; (2) economic nexus, including out-of-state credit card companies; and (3) specified franchise tax issues relating to (a) billings in excess of cost for taxpayers in the construction industry, (b) incorrect calculation of amortization deductions, and (c) improper deductions related to reserves for pensions.
To participate in the Initiative, taxpayers must file an Election to Participate in Resolution Initiative application by September 15, 2009—and taxpayers (or the Department) may revoke the application at any time prior to entering into a settlement agreement. The application must be received by the Department by September 15.
Sutherland Observation: The Initiative is coming on the heels of the decision of the North Carolina Court of Appeals in Wal-Mart Stores East, Inc. v. Hinton on May 19, 2009. In Wal-Mart, the North Carolina Court of Appeals held that the Department was permitted to require a corporate taxpayer and two of its subsidiaries to file a combined income tax return on the basis that the separate company filings by the taxpayer did not disclose the “true earnings” of the corporations’ North Carolina activities. In addition, the Court upheld imposition of an understatement penalty (even though North Carolina statutorily requires separate reporting).
The Department has continued to assess the penalty in audits where they attempt to force combination on taxpayers. The Department has indicated that the imposition of penalties is mandatory and not discretionary.
II. No Down Side—Opportunity and Benefits of Program
The Department has promoted the Initiative as an opportunity to settle open audits with a waiver of all applicable penalties. In addition, it appears that the Department may be willing to negotiate and compromise tax issues. Significantly, the Initiative requires that the compromise must apply to: all issues; all related taxpayers; and all open and future tax years.
Sutherland Observation: There are several benefits to participating in the Initiative. Because the Initiative is non-binding, taxpayers may withdraw at any time before signing a Resolution Agreement. In addition, taxpayers will have the opportunity to settle filing positions on targeted issues for future years which may lead to additional certainty for taxpayers that have experienced regular audits in North Carolina on issues such as forced combination. Finally, the Department may waive all rights to assess additional tax against taxpayers for years that are successfully settled under the Initiative (except for adjustments related to federal corrections). This could result in a reduction of some taxpayers’ financial statement reserves.
The drawback to participating in the Initiative is that all open years for all related taxpayers must be settled and the agreement will apply prospectively. Thus, taxpayers must waive the right to seek refund claims for any years or amounts settled under the Initiative except for those claims related to federal corrections. And, taxpayers will be forced to handicap whether they want to “lock in” future years’ treatment (absent a significant law change or change in facts).
III. Tight Timeline for Settlement
Taxpayers participating in the Initiative will have approximately 2 months to reach an agreement with the Department and must be willing to submit state and federal tax returns, consolidated working papers, and any other records requested by the Department during the course of settlement discussions. The time period for settlement runs from September 16, 2009, to November 15, 2009. November 16, 2009, is the deadline for signing a Resolution Agreement. By December 15, 2009, all taxpayers who sign a Resolution Agreement must pay any tax and interest owed under the Agreement. Any Resolution Agreement entered into will represent a final and binding resolution for the underlying tax periods.
Sutherland Observation: It is unclear at this time how willing the Department will be to settle any proposed tax assessments or asserted filing positions. While the Initiative guidelines only expressly indicate that the Department will agree to waive all penalties, the Initiative has been promoted as a “settlement” of targeted issues. Because the Department has a short window (2 months) to attempt to settle targeted issues of taxpayers participating in the Initiative, we expect the Department to work quickly toward resolutions, which may mean that the Department will create standardized settlement criteria.