News Analysis: States Aggressively Contracting With Transfer Pricing Experts

News Analysis: States
Aggressively Contracting With
Transfer Pricing Experts
Records show that state revenue departments are aggressively
contracting with consultants — including high-profile former Treasury
and IRS officials — for transfer pricing expertise to assist agencies in
audits, litigation, and training on section 482.

While not comprehensive, information obtained through Freedom of
Information Act requests and searches of publicly available data shows
a sharp uptick over the past decade, and the past five years in
particular, in state revenue departments taking steps to enhance their
ability to detect profit shifting through intercompany transactions and
to build transfer pricing cases. At least 23 state revenue departments
and the District of Columbia have recently done one or more of the
following:

    contracted with outside experts for transfer pricing services;

    executed special transfer pricing information exchange
    agreements, which enable revenue officials from multiple states
    to share taxpayer documents and engage in case discussions; or

    sent revenue staff to national two-day training exclusively focused
    on instruction on section 482 and transfer pricing.

Those jurisdictions are Alabama, Arkansas, Connecticut, Delaware, the
District of Columbia, Florida, Georgia, Indiana, Iowa, Kansas, Kentucky,
Louisiana, Maryland, Massachusetts, Mississippi, Missouri, New

Jersey, North Carolina, Oregon, Pennsylvania, Rhode Island, Utah,
West Virginia, and Wisconsin.

The Massachusetts Department of Revenue, for example, has retained
Washington-based lawyers and economists to provide transfer pricing
expert witness or consultant services to its Litigation Bureau.
Documents obtained through records requests show that lawyers
available from Caplin & Drysdale Chtd. during state transfer pricing
litigation include former Treasury International Tax Counsel H. David
Rosenbloom and former IRS Deputy Chief Counsel Richard W.
Skillman. On tap from the economic consulting firm Horst Frisch Inc.
are founder Thomas Horst, a former director of the international tax
staff at the Treasury Office of Tax Analysis, and T. Scott Newlon, a
former senior Treasury economist who was a principal author of the
section 482 transfer pricing regulations.

Big names also popped up in a failed bid for a transfer-pricing-related
contract with the Connecticut Department of Revenue Services,
which, like many states, specified in its request for proposals that the
contract would be awarded based on the lowest quote meeting the
state’s specifications. Former Treasury International Tax Counsel Philip
R. West and Michael Durst, the former longtime director of the IRS’s
advance pricing agreement program, prepared Steptoe & Johnson
LLP‘s bid to provide specialized training to Connecticut from late 2013
through mid-2015 on transfer pricing methods and on section 482’s
application for state income tax purposes. The state’s contract award
template — also obtained through a records request — said the
training could also cover taxpayer planning techniques, economic
analysis of APAs, and pre- and post-audit planning.

Steptoe’s quoted prices likely took the firm out of the running —

Connecticut wound up spending about $60,000 in total for the training
— but the document provides a glimpse at the caliber of options
available to the states. In the bid, West and Durst proposed a menu of
transfer pricing services with costs starting at $850 per hour of on-
call advice and topping out at $100,000 to draft “a practical and
comprehensive manual to walk auditors through each step of a typical
transfer pricing audit.” Additional choices on Steptoe’s a la carte menu
included:

    an in-depth assessment of Connecticut’s current audit
    techniques and procedures, along with identification of areas
    most in need of improvement ($30,000–$50,000);

    classroom training, including a review of examination techniques
    like accessing records, reviewing workpapers, and drafting
    information document requests ($40,000–$60,000);

    half-day sessions in which Steptoe experts would meet with
    Connecticut audit teams to review the department’s largest
    transfer pricing cases, address problems specific to each case,
    and develop strategies for bringing the cases to conclusion
    ($10,000 per half-day session per case); and

    targeted audit selection, including Steptoe instruction on how to
    identify “the most fruitful transfer pricing audit targets” and
    assistance “in the actual selection process” on an annual basis
    ($10,000 a day for a Steptoe senior adviser).

Connecticut ultimately awarded separate contracts for the specialized
training to two consulting groups. State Economic Analysis LLC, a firm
that also goes by the name Economic Analysis Group (EAG) LLP,

provided the first round of transfer pricing training through mid-2014,
while Chainbridge Software LLC provided the second round of training
through mid-2015.

Tax agencies from at least nine jurisdictions entered into
agreements this past decade for outside transfer pricing
expertise.

At a cost of $337,500, the Louisiana DOR recently extended through
fiscal 2022 its contract with Ednaldo Silva of RoyaltyStat LLC for
consulting services related to transfer pricing pre-audit and audit
issues, including assistance in conducting audits of specific taxpayers.
Silva is a former senior economic adviser with the IRS Office of Chief
Counsel who also was on the team that drafted the final section 482
regs. In his promotional materials, Silva highlights his role in
developing the comparable profits method, the best method rule, and
the concept of the comparable profit interval.

Silva‘s contract with Louisiana stated that his consulting services “may
include characterization of related party transactions, analysis of the
economic substance of such transactions, selection of comparables,
determination of an arm’s length range of results (royalty rates
covering intangibles or operating profit margins or markups covering
the transfer of tangible goods and the provision of services), and
preparation for the tax settlement negotiation.” Silva also agreed to
assist the DOR in tax controversies and in preparing rebuttal reports
and expert testimony.

Silva offers transfer pricing consulting services separate from and in
addition to annual subscriptions to RoyaltyStat’s two online proprietary
databases. Seven state revenue departments currently subscribe to

the firm’s royalty rates database, which auditors use to assess the
related-party transfer of intangibles, and to RoyaltyStat’s company
financials database, to assess the controlled provision of services,
distribution, and retail functions. Eighteen OECD nations subscribe to
the databases.

From 2016 through the end of the newly extended contract, Louisiana
agreed to pay Silva a maximum $675,000 for both his transfer pricing
consulting services and the database subscriptions. But that’s not all.
The Louisiana DOR also entered into a professional services contract
with David Brunori, then of Quarles & Brady LLP and now with RSM US
LLP, for “expertise and consultation in the field of transfer pricing and
all other tax issues relating thereto for matters in audit, audit review,
settlement discussions, litigation and/or in any other stage related
thereto.”

Brunori, whose varied career includes having served as deputy
publisher at Tax Analysts, started as an appellate trial attorney with the
Department of Justice Tax Division. He then joined the tax specialty
law firm Zapruder & Odell, where he represented multinational
corporations in international transfer pricing tax controversies.
Louisiana is paying Brunori $575 per hour, with the aggregate total not
to exceed $100,000 over a three-year contract, which started in July
2018 and terminates in May 2021.

The Contracts
Tax agencies from at least nine jurisdictions entered into agreements
this past decade for outside transfer pricing expertise. Alabama, the
District of Columbia, Mississippi, New Jersey, North Carolina, and
Rhode Island joined the above examples of arrangements in

Massachusetts, Connecticut, and Louisiana.

Anecdotal evidence from practitioners representing large multistate
corporations suggests the number of states with formal arrangements
is higher. Some agencies declined the Tax Notes records requests by
stating that the requester must be a resident of the state. Indiana’s
response suggested that the revenue department might well have
such a contract — the DOR in 2015 found itself on the losing end of a
headline-making state tax court decision involving the relevance of a
taxpayer’s transfer pricing study to determining whether intercompany
payments resulted in the clear reflection of income. In declining the
records request, the DOR said it “may not divulge the information
sought” and cited the following exemption to the state’s public records
law: “Records that are intra-agency or interagency advisory or
deliberative material, including material developed by a private
contractor under a contract with a public agency, that are expressions
of opinion or are of a speculative nature, and that are communicated
for the purpose of decision making.”

The contracts have been for services ranging from training on
transfer pricing methods to assistance in selecting taxpayers for
audit, preparation of economic reports that support a state’s
adjustments, and serving as expert witnesses during litigation.

EAG, Chainbridge, and RoyaltyStat are the firms that state revenue
departments have contracted with most frequently in the past five
years. The contracts have been for services ranging from training on
transfer pricing methods to assistance in selecting taxpayers for audit,
preparation of economic reports that support a state’s adjustments,
and serving as expert witnesses during litigation.

Contingency Fee Structures
The most controversial arrangements have involved states using a
contingency fee structure to pay contractors for assistance in
identifying multistate taxpayers for transfer pricing audits and in
calculating potential intercompany pricing adjustments. Lawyers
representing taxpayers in litigation have called such third-party
contractors bounty hunters, arguing that they have incentive to inflate
proposed income adjustments.

Mississippi. This is the most recent example of a state revenue
agency entering into this type of arrangement. In 2017 the Legislature
gave the DOR authority to use a contingency fee payment structure to
contract for intercompany pricing analysis services. In its solicitation,
the DOR sought a contractor to provide it with audit leads ranking
multistate corporations from highest to lowest, based on
recommended section 482 adjustments; summary reports providing
the initial legal basis for the potential adjustments; transfer pricing
analysis reports that would include an expert’s summary of the
proposed adjustments to be submitted as evidence in administrative
hearings or at trial; and training and audit and litigation support. These
are now typical of the types of services state revenue departments
secure when they contract for third-party transfer pricing audit
assistance.

The Mississippi DOR was willing to pay up to $1 million in capped
contingency fees for at least 12 transfer pricing reports per contract
term, although the RFP contained three more options from which the
contractor could choose: at least nine transfer pricing reports per
contract term for a maximum $750,000, six reports for $500,000, or

three reports for $250,000.

EAG won the contract. “The audit lead list will be generated from a
known list of taxpayers audited in another state that will more likely
than not produce an assessment due to an addback of royalty
expenses from an embedded royalty,” the firm said in its bid.
“Generally, taxpayers use a comparable profits method study that
does not identify the intangible charge. Instead, the study describes
the income that must be earned by the tested party, the Mississippi
taxpayer.” EAG then highlighted its ability to uncover and unwind
buried royalties.

EAG chose the option of producing three transfer pricing reports per
contract term, with Mississippi agreeing to pay the firm a contingency
fee equal to 10 percent of the total amount of tax, penalties, and
interest recovered associated with the section 482 adjustments, up to
a capped $250,000 per contract term. The DOR renewed the
agreement once, through June 30, 2019, meaning Mississippi agreed
to pay EAG a maximum $500,000 over the combined initial and
renewed contract terms.

But for almost two decades, Chainbridge has dominated in providing
transfer pricing audit assistance to the states. Founder Eric Cook — an
economist who was with the Joint Committee on Taxation during the
1986 federal tax reform effort and later worked for two Big Four
accounting firms — started Chainbridge in 2000, where he developed
microsimulation revenue estimating and tax policy modeling systems
used by industry and state governments. Cook also developed section
482 applications, initially to assist accounting firms in minimizing a
company’s state and federal taxes. In 2003 the Alabama DOR became
the first state client to use Chainbridge’s transfer pricing audit

selection services. Before the end of the decade, Kentucky, the
District of Columbia, Louisiana, and New Jersey had followed.

The most controversial arrangements have involved states using
a contingency fee structure to pay contractors for assistance in
identifying multistate taxpayers for transfer pricing audits and in
calculating potential intercompany pricing adjustments.

Chainbridge works as either a direct contractor with a state or as a
subcontractor to a vendor that has been awarded a broader main
contract — for example, to implement a state’s tax systems
modernization project. Often, the vendor awarded the main contract is
paid on a contingency fee basis, but compensation agreements
between a main vendor and a subcontractor are generally not part of
the government’s records.

“We are not bounty hunters,” Cook said in a 2014 letter to the editor.
“We are not auditors, and we do not, have not, and will not operate on
a contingency-fee basis in providing our products and services to our
clients. All of our work is performed on either a fixed-price or hourly
basis.” (Prior analysis: State Tax Notes, Apr. 21, 2014, p. 177.)

New Jersey. Subcontractor arrangements present more challenges in
tracking how many and which revenue departments are using outside
transfer pricing consultants, and how much states are paying for them.
For example, it was public knowledge that the New Jersey Division of
Taxation used Chainbridge’s transfer pricing audit selection services
from 2005 through 2011 when the firm was a subcontractor to ACS
State and Local Solutions Inc. And yet, the division initially said it had
no documents responsive to the Tax Notes records request.

When asked to check again, the custodian of records determined that
the services subject to Tax Notes’ records request “may have
occurred under the scope of solicitation 05-X-36861 — Taxation Data
Warehouse, Partnership Development.” New Jersey had awarded the
contract for developing that tax data warehouse not to ACS State and
Local Solutions but to the Teradata Division of NCR Government
Systems LLC. “However, ACS was a subcontractor of NCR for this
contract,” said the manager of the state treasury’s government
records access unit. “We have no documents stating if any of NCR’s
subcontractors subcontracted.”

On request, New Jersey provided a compact disc containing
thousands of pages of documents related to the larger tax data
warehouse project. The tax division’s RFP said it wished to enter into a
“novel business partnership” with a contractor to develop, implement,
and operate the tax data warehouse; as described, the warehouse was
to be a platform that collects, stores, integrates, and analyzes
compliance-related tax and fee data from a variety of internal and
external sources. The project was to be a self-funded initiative under
which the contractor would be paid “exclusively from the increased
revenue to the State” generated through collections from tax cases
identified solely through the warehouse platform. Prospective
contractors were to estimate the increase in state revenue expected
from implementation of each defined application. “Failure to meet the
estimate may result in a reduction of compensation. Revenue
collections in excess of the estimate may result in a payment of a
premium to the Business Partner,” the solicitation said.

The final proposal submitted by NCR/Teradata included an optional
transfer pricing compliance component. While the New Jersey

documents did not name Chainbridge, they described the firm’s
history and method.

Generally, Chainbridge uses a patented software program to identify
potential section 482 audit candidates, producing an initial audit lead
set ranking from highest to lowest the potential tax adjustments of
taxpayers falling below the interquartile range of independently
operated comparable companies in similar production. After the
revenue agency selects taxpayers for more in-depth review,
Chainbridge prepares an executive summary report for each taxpayer
covering the tax years at issue; the firm generates an information
document request package that includes a questionnaire with about
50 functional analysis questions to be answered by the taxpayer. It
then produces a final report for the tax agency that includes the
proposed income and tax adjustment, the basis for the calculations,
and section 482-compliant documentation for the adjustment. All
correspondence, which the contracts sometimes explicitly say is
meant to drive voluntary compliance without the need for formal
section 482 audits, is conducted by the revenue agency.

New Jersey was estimated to gain an additional $12.5 million per
contract year for every 20 transfer pricing reports created if the tax
division purchased this optional compliance application, the
NCR/Teradata proposal said, adding that section 482 analysis also can
be used effectively “to justify the complete or partial disallowance of
certain deductions such as royalties, interest expense, and dividends
received deductions.” New Jersey’s initial contract term and one-year
renewal through 2011 would have required Chainbridge to produce at
least 100 single-year transfer pricing reports.

Washington, D.C. The District of Columbia’s Office of Tax and

Revenue (OTR) similarly used Chainbridge’s transfer pricing audit
services through April 2018. Starting in 2008, the OTR did so through
ACS State and Local Solutions, which was working on a contingency-
fee basis and subcontracted with Chainbridge for the work. When ACS
left the transfer pricing audit market in 2011 because of conflicts of
interest with its corporate clientele, the OTR issued an RFP to continue
the audit services of parent/subsidiary and brother/sister corporations.
In 2012 it entered into an agreement with Fast Enterprises LLC, which
also operated on a contingency-fee basis and subcontracted the
continuation of the transfer pricing work to Chainbridge.

The Fast Enterprises contract shows that — in theory, at least — the
District was willing to pay almost $50 million for third-party transfer
pricing audit services from 2012 through April 2018 alone. The District
categorized the Fast Enterprises contract type as “contingency fee
with firm fixed percentage rates.” The OTR capped the total amount
payable to Fast Enterprises for the transfer pricing audit services at
$45 million over the initial five-year term and $4.5 million for a six-
month extension — in other words, the District placed a $9 million
ceiling on the total amount of contingency fees it would pay per
contract year. The contract laid out a contingency values fee structure
as the District hit various revenue collection targets as a result of the
transfer pricing services. The main contractor would receive a fee
equal to 16 percent of the first $30 million collected as a result of the
transfer pricing work; the fee would decline to 14 percent for all
additional collections, with the total possible payment to the
contractor capped at $9 million annually.

Chainbridge would have been required to produce at least 96 reports
for the District from 2012 to 2018. In the contract with Fast

Enterprises, the OTR said it was interested “in participating in this
exercise” to “generate audit deficiency reports for those entities
‘pushing the envelope.’”

A purchase order shows that the OTR also paid RoyaltyStat’s Silva
almost $100,000 to serve as an expert witness in 2017 in litigation
arising from business challenges to the transfer pricing assessments.

Businesses spent most of the decade arguing that the OTR’s
assessments were based on a flawed transfer pricing analysis under
which Chainbridge relied solely on the comparable profits method, and
that the OTR had not performed independent audits of taxpayers’
books and records. Counsel for the taxpayers also suggested that the
OTR used the Chainbridge approach to force taxpayers to settle.

The District argued that a detailed analysis of individual arm’s-length
transactions is neither necessary nor even appropriate under the CPM,
which is designed to analyze profits and not individual transactions. By
using the Chainbridge analyses, the OTR had determined that the
businesses bringing challenges had engaged in related-party
transactions at something other than arm’s-length pricing, resulting in
each taxpayer’s net income being understated by billions of dollars for
each tax year at issue.

The challenges took several detours but returned to the underlying
transfer pricing analyses in 2017, at which time the OTR’s chief counsel
and assistant general counsel said that transfer pricing is inherently
facts-and-circumstances-based and that no discovery had yet been
allowed in any of the D.C. transfer pricing cases. The OTR pressed for
an evidentiary hearing — but by early 2018 all of the remaining
companies in litigation had settled their cases. Those companies

included Exxon Mobil Corp., Shell Oil Co., Hess Corp., Eli Lilly and Co.,
AT&T Services Inc., Honeywell International Inc., Pfizer Inc., and Ahold
USA Holdings Inc. OTR payments to Fast Enterprises for transfer
pricing services that resulted in adjustments to these companies
presumably were based on the amounts the District collected through
the settlements, which are private.

More Contract Templates
Within the past five years, Rhode Island, Alabama, and North Carolina
also entered into contracts for transfer-pricing-related services, but
Massachusetts is working from a different template altogether.

Massachusetts. The DOR’s Litigation Bureau is in the midst of a 10-
year, $20 million project under which it retains specialists from a
variety of fields to provide it with expert witness or consulting
services. “The areas in which the Department is soliciting services by
Expert Witnesses include, but are not limited to, transfer pricing,
accounting, finance, appraisal and valuation, statistics,
telecommunications, banking, transportation, intellectual property,
licensing, municipal finance, pharmaceuticals, and other industry-
specific areas of expertise, as needed,” the Litigation Bureau said in its
2013 request for responses.

The $20 million overall total is based on legislative authorization for
the DOR to spend up to $2 million each fiscal year on litigation
expenses. Generally, the Litigation Bureau enters into an initial five-
year contract with a firm or individual, with one option to renew that
arrangement for up to an additional five years. The point of the project
is to build a list of expert witnesses and litigation consultants and for
that list to evolve; the bureau periodically reopens the procurement

process — about every six months — to take new bids. The Litigation
Bureau does not guarantee that it will purchase services from any of
the expert witnesses, but contracts provide that any work entered into
before the end of the term can continue for the duration of the
litigation or project at issue.

The Massachusetts scenario provides an example of a revenue
agency seeking transfer-pricing-related services even though the
state long ago moved away from separate-entity filing —
Massachusetts enacted unitary combined reporting in 2009.

The Tax Notes records requests produced only documents showing
those consultants that Massachusetts retained for transfer-pricing-
related litigation; the state did not provide any resulting purchase
orders for such services. In addition to the experts from Caplin &
Drysdale and Horst Frisch, the bureau retained CRA International Inc.,
a global consulting firm based in Boston specializing in transfer
pricing, valuation, and economics, and Nevium Intellectual Property
Consultants, a firm based in La Mesa, California, specializing in
intellectual property valuation.

The Massachusetts scenario provides an example of a revenue agency
seeking transfer-pricing-related services even though the state long
ago moved away from separate-entity filing — Massachusetts enacted
unitary combined reporting in 2009. Richard L. Jones, a partner in the
Boston office of Sullivan & Worcester LLP, said that even though
Massachusetts has many tools to attack tax planning and related-
party transactions, transfer pricing issues can still arise in other
contexts, like transactions between one unitary combined group and
another. And scrutiny of federal transfer pricing and of international
transactions continues, he said.

Rhode Island. In 2016 the Division of Taxation entered into a contract
with Revenue Solutions Inc. for implementation of a broad tax
compliance project. The parties added an initial two-year transfer
pricing audit component a few months later, which Revenue Solutions
subcontracted to Chainbridge through 2018.

The tax division redacted the payments Chainbridge was to receive
from late 2016 through 2018. However, the documents contain more
than a dozen deliverables for each year, including a redacted fixed
price for each deliverable. Each year also contains a redacted line-item
“holdback” payment that Chainbridge was scheduled to receive when
the division’s cumulative benefits from the transfer pricing services
reached $6.9 million in the first year and $5.9 million in the second.

Rhode Island had already moved away from separate-entity reporting,
having enacted combined reporting in 2014. The division indicated in
the documents that it was interested in pursuing tax avoidance that
had occurred under the separate company reporting regime.

Alabama. The DOR paid $475,000 for intercompany transaction audit
and litigation support services from 2015 to 2018, according to
contract review reports produced in response to the records request.
“No merit system employee possesses the resources, knowledge, and
expertise to perform this service,” the department’s 2014 RFP said.
The DOR’s minimum requirements included experience handling IRS
APAs and working with state corporate income tax intangible expense
disallowance statutes.

Alabama paid EAG $300,000 — $100,000 for an initial one-year
contract, which was renewed for two more years — for up to 156
hours of audit and litigation support per term for enforcement of

intercompany transaction antiabuse provisions and for two-day
training sessions for legal and audit staff. The DOR also paid $157,500
to Silva through 2018 for expert economic advisory services on
transfer pricing issues arising in Alabama income tax audits and
litigation, “collaboration with other states,” and the department’s
subscriptions to RoyaltyStat’s databases.

North Carolina. The DOR paid $200,000 to RoyaltyStat’s Silva from
late 2016 through 2018 for up to 100 hours of economic advice and
analysis on three active tax cases initially, but it indicated that its
needs “are an ongoing process that will be realized with completion of
several projects.” RoyaltyStat agreed to assist the DOR in determining
the economic substance of identifiable affiliate transactions, verifying
each taxpayer’s selection of comparables and profit indicator, and
determining the arm’s-length range of the selected profit indicator. In
addition to requiring RoyaltyStat to prepare written economist reports,
the DOR sought 50 hours of training on how to build a transfer pricing
case and pre-audit and audit techniques.

Earlier in the decade, Silva served as an expert witness for North
Carolina in the forced combination case Delhaize America Inc. v. Lay.
The North Carolina Superior Court held in the 2011 decision that the
DOR was authorized to require Delhaize and a wholly owned
subsidiary to file a combined return to properly reflect Delhaize’s true
net earnings in the state, but that the DOR abused its discretion by
assessing a 25 percent penalty without having adopted permanent
rules describing the facts and circumstances in which a taxpayer must
file a combined return.

How We Got Here

Some states started scrutinizing domestic intercompany transfer
pricing at the beginning of the 2000s, and the Great Recession
accelerated the trend later in the decade. Chainbridge early in the
decade had already started providing its transfer pricing audit
selection services to its first state revenue department clients. Silva,
meanwhile, had served as an expert witness for New York, including in
a case involving forced combination when a trademark license
agreement between the parent and subsidiary lacked economic
substance and a business purpose.

But it was former New Jersey Division of Taxation Director Michael
Bryan, now with Deloitte Tax LLP, who set off a chain reaction of state
activity in 2013 — although not quite in the way he expected. At that
time, New Jersey had wound down its contract for third-party transfer
pricing audit assistance. Bryan went to the Multistate Tax Commission
and asked the organization’s leaders to create a dedicated transfer
pricing services function. His idea was for states to pool resources to
jointly hire top-notch economic consultants and transfer pricing audit
assistance.

“States clearly haven’t lost interest in the issue,” Bryan said for this
article. “The way we look at it is the issue hasn’t gone away and it’s not
going to go away anytime soon. At the same time, the notion of
coordinating an effort really hasn’t gotten any more traction since
2013.”

Some states started scrutinizing domestic intercompany transfer
pricing at the beginning of the 2000s, and the Great Recession
accelerated the trend later in the decade.

The MTC formed an advisory committee that in 2015 released a

blueprint for the creation of a dedicated transfer pricing services
program. Charter states would be expected to invest about $200,000
per year during the project’s initial four-year rollout period, assuming
10 states committed to participate. Put another way, the project would
require $2 million annually over the four-year rollout period.
Fundamental at every stage of the design was the MTC‘s contracting
with consulting firms to provide advanced economic and technical
expertise to analyze transfer pricing studies submitted by taxpayers to
participating states and to support alternatives to taxpayer positions.
A second key component of the plan was to enhance the ability of
states to address income shifting on their own through training,
information exchanges, expanded audit coverage, and assistance in
developing and resolving cases and in defending that work in litigation.

It hasn’t happened. Only five states committed financially to becoming
charter members of such an MTC program.

Even so, by 2017 interaction among state revenue officials through the
MTC advisory committee had produced “a great deal of bilateral, ad
hoc state cooperation on transfer pricing audit issues,” Joe Garrett Jr.,
Alabama’s former deputy revenue commissioner, said at the time.
States by then had started contracting with consulting firms that had
presented overviews of their services at an October 2014 forum
hosted by the MTC advisory committee. So had the MTC, for that
matter: For its first round of transfer pricing training, the organization
contracted with Silva to provide the two days of instruction. Revenue
staff from the following 10 states — all of them separate-entity filing
states at the time — participated in that MTC training: Alabama,
Connecticut, Florida, Georgia, Iowa, Kentucky, Louisiana, New Jersey,
North Carolina, and Pennsylvania.

In 2016, after executing special information exchange agreements,
revenue staff from nine states participated in the first transfer pricing
case discussions organized by the MTC advisory committee. Those
states were Alabama, Indiana, Louisiana, Maryland, Massachusetts,
Mississippi, New Jersey, North Carolina, and Pennsylvania.

In addition to tax and information returns, information subject to
exchange includes nexus questionnaires, audit reports, contingent tax
liability and tax reserve workpapers, and proprietary taxpayer
information like transfer pricing reports, comparable profits, royalty
rates, responses to interrogatories, depositions, and any documents
regarding private letter ruling requests, protests, appeals, and criminal
tax matters. Even at the time, advisory committee members said the
states almost certainly already had the authority to share this same
information through preexisting information exchange agreements.
The advisory committee also developed a data sheet with options for
organizing taxpayer information, such as by high to low fiscal impact,
case urgency, degree of difficulty or complexity, or date the case
started or its status in the administrative process.

The MTC’s most recent two-day training on transfer pricing took place
in March 2019 and was attended by revenue staff from 16 states,
including staff from the following eight new participating jurisdictions:
Arkansas, Delaware, Kansas, Missouri, Oregon, Utah, West Virginia,
and Wisconsin. For this training, MTC staff provided most of the
instruction, although Silva provided an informational overview of his
firm’s services.

Bryan and Jones both recommended that states bring experts
into the process before the litigation stage.

“That’s helpful,” Bryan said. “But at the same time, you have folks at
the IRS with 25 to 30 years of experience and they’re still losing
cases.”

Bryan and Jones both said that transfer pricing is highly technical,
complicated subject matter requiring experts with PhDs in economics.

“Auditors can’t just be experts by studying up,” Jones said, and
advised states against trying to build internal expertise solely through
training. He added that some auditors who simply don’t have the
expertise are now making large transfer pricing adjustments. “A little
knowledge is a dangerous thing,” Jones said.

“Training is difficult,” Bryan agreed. “That’s why I went to the MTC.”
Bryan said his original goal was to see if states could collectively find
ways to build better cases with some outside support and through the
development of some in-house expertise. But not only is there a long
learning curve, the economics can be very complex even for career
state tax officials, he said. State revenue departments also have
difficulty recruiting economists like those who do this for the IRS
because states can’t compensate them — and even if they could,
those experts likely would be poached by law or accounting firms.

Bryan and Jones also both recommended that states bring experts
into the process before the litigation stage. Bryan said he wonders
what the work product will be like in those states that don’t bring
experts in during the field audit or administrative processes, and
whether such states are “developing a case essentially to defer to a
litigation process farther down the road.” Jones mentioned one case
involving the Massachusetts DOR in which an expert brought in during
the litigation stage tried her best but could not validate the auditor’s

adjustments, which he said can be difficult to do after the fact.