The New Jersey Division of Taxation recently announced a voluntary corporate income tax transfer pricing resolution initiative. The initiative began on June 15, 2022, and will continue through March 2, 2023. Generally, the initiative is intended to expedite the resolution of corporate intercompany pricing issues for all open years as requested by the taxpayer. The initiative applies to all filed corporate income tax returns within the statute of limitations that have intercompany transactions that would be subject to adjustment under the applicable laws. To participate in this initiative, taxpayers must complete an “Election to Participate in Transfer Pricing Initiative” form by Sept. 15, 2022, and submit all required transfer pricing, tax, and financial information and documentation by Oct. 31, 2022.
New Jersey transfer pricing initiative
This is a welcome initiative as it will provide certainty and uniformity to taxpayers and will reduce the overall time disputes take to resolve. The FAQ issued by the New Jersey tax division provides further clarification.
Taxpayers often focus primarily on cross-border transfer pricing rather than domestic transfer pricing. However, this new initiative in New Jersey is a signal of a renewed focus on transfer pricing by the state. New Jersey can raise significant revenue from transfer pricing adjustments because its top statutory corporate tax rate of 11.5% is the highest across the nation.
Appropriate intercompany pricing under New Jersey law
According to the announcement, “Certain New Jersey corporate taxpayers may engage in transactions between members of an affiliated group (intercompany transactions). Intercompany transactions that lack economic substance or are not at fair market value can cause a taxpayer to inaccurately report net income attributable to New Jersey.” However, the announcement does not provide specific transfer pricing methods and dispute resolution. Generally, states use the arm’s-length standard under IRC Section 482 and the related U.S. Department of the Treasury regulations. The arm’s-length standard is highly dependent on facts and circumstances. Therefore, it is prudent for taxpayers based in New Jersey that likely will be subject to an arm’s-length standard to understand the economics surrounding their intercompany transactions and prepare support that can be used if audited by the state.
Under the arm’s-length standard, demonstrating that a company’s transfer pricing is supported by economic substance is key to favorable resolution of a transfer pricing dispute. In recent years, many taxpayers have been successful in demonstrating economic substance by providing the IRS and foreign taxing authorities with a key entrepreneurial risk-taking analysis, a significant people function analysis, or both. While these analyses are based on international tax principles, aspects of them can be used to resolve a state intercompany pricing dispute. For instance, portions of these analyses can be used for a New Jersey intercompany pricing analysis by focusing on the functions performed, assets employed, and risks borne by the New Jersey taxpayer and its related party, as well as pricing support within the market.
Transfer pricing documentation
Because of the New Jersey tax division’s focus on transfer pricing, all New Jersey-based taxpayers, even those who are not planning to participate in the initiative, should prepare a transfer pricing analysis that:
- Demonstrates a good understanding of the intercompany transaction flow involving the New Jersey taxpayer, focusing on the substance of the transaction
- Includes a robust analysis of the intercompany pricing methodology to demonstrate that the methodology is consistent with arm’s-length standards or market pricing
In addition, the New Jersey initiative could provide an example for other states. Although New Jersey has the highest state corporate tax rate, other states with high corporate tax rates, such as Pennsylvania (at 9.99%), Iowa and Minnesota (both at 9.8%), and Alaska and Illinois (both at 9%), might follow New Jersey’s lead. Therefore, taxpayers operating in these states should also be prepared for a review of their intercompany transactions in light of the New Jersey tax division’s initiative.
