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Agenda Agree on a Definition of Winning Bringing a Gun to a Knife Fight § 482 Case Study Friends Play Chess to Win 2

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Agree on a Definition of Winning 4 Getting to the right number Getting to a tolerable number Getting to zero Financial statement drivers Principles to live by Standing up for taxpayers Cost-benefit analysis

Be Ready Before Audit Notice 5

5 Who will be involved? Issues for financial accounting group? Preserve documents and witnesses If you are always audited by a state or have a big transaction – consider pre-audit discussions with state.

Bringing a Gun to a Knife Fight 5 The defensive tools to use Controlling disclosure of information Limiting scope Overwhelm with documents Give them nothing Privilege Identify “hot documents” at the outset SOL strategy Posturing the law up front Develop an audit strategy

Bringing a Gun to a Knife Fight 6 Identify Areas of Exposure Review files from prior audits. Review tax returns for the years under examination. Review tax journals and reach out to peers and determine “hot” audit issues. Identify Relevant Non-Tax Business People CEO, CFO, COO, General Counsel

Bringing a Gun to a Knife Fight 7 Develop an Audit Strategy Determine if any identified issues have significant dollar value. Determine the impact of the identified issues on future years. Determine relevance to other states. Gather facts and conduct legal research to establish the company’s position with respect to each identified issue. Work with tax policy team to evaluate landscape.

Bringing a Gun to a Knife Fight 8 Establish Procedures for IDRs Establish written procedures, hierarchy and protocol for all audit responses. Insist on written requests. Consider requiring compulsory subpoenas. Insist on specificity and detail. Consider benefit and risks of limited or no response to non- material or out-of-scope requests. Object to: 50 state inquiries; Providing returns from other states. Object to creating new documents. Options for protecting documents from disclosure to other states.

Bringing a Gun to a Knife Fight 9 Negotiate Scope of Requests Try to narrow scope of unreasonably burdensome requests. Suggest use of samples. Negotiate for extension of response deadlines if necessary. Evaluate company position on SOL extensions. Highlight potential misconceptions. Qui tam You are under investigation!

Bringing a Gun to a Knife Fight 10 The offensive tools to use FOIA Policy friends Political friends External policy team Press friends Question authority and breach of confidentiality MTC and other § 482 contract auditors Litigation and discovery Build a Coalition

Check the Caliber of your Weapon 11 History with the state Tax climate (administrative and legislative) Economic development Budget considerations National landscape Customer relationships Press worthy?

When is audit “over” 11 Scope of closing agreement RARs and other adjustments NOLs Prospective agreements and change in law or circumstances Effect on audits by other states

482 Magic 8-Ball Bounty Hunters A Case Study 12 States currently employing contract auditors District of Columbia (contingency fee) – Renewed! New Jersey (contingency fee) – Terminated! Kentucky (contingency fee) – Terminated! Alabama (behind the curtain, possible new firm) Louisiana (behind the curtain) Connecticut (behind the curtain; training)

Bounty Hunters 13 States frequently prohibit expert witnesses from being paid based on outcome of litigation. New Jersey transfer pricing compliance program Hired Chainbridge to prepare transfer pricing reports. 15 reports per year. New Commissioner may deemphasize the use of contract auditors. Contract Terminated September 2011 According to NJ Department of Treasury, “[w]e terminated that contract with Chainbridge earlier this year and then wound down all of the outstanding cases." See 2011 STT New Jersey subsequently instigated and provided seed money for the formation of the MTC’s Arm's-Length Adjustment Service (ALAS).

Bounty Hunters (cont’d) 14 District of Columbia Hired ACS State & Local Solutions, Inc. / Fast Enterprises “…to do economic analysis of potential candidates for audit based on domestic transfer pricing issues.” Estimated payment (based on contingency fee) of $9 million per original DC contract.

D.C. Approach 15 D.C. Code § Distribution, apportionment, or allocation of income or deductions between or among organizations, trades, or businesses. This parallels the statutory authority under § 482. In 2011, DC went from allowing separate returns to mandatory combined reporting.

D.C. Approach (cont’d) 16 Information Document Request (IDR) Gives appearance of audit Requests volumes of taxpayer documents How to respond: Challenge Authority Keep detailed records and document the process Ignore Same result—so why give them anything? Give them some of the documents Withhold potentially privileged or confidential information Give them all of the documents Information overload Contact the revenue department Supply the voice of reason—attempt to limit scope Make strategic concessions

Confidentiality Issues 17 Extensive federal protection for federal return information (IRS Pub. 1075). State disclosure of federal information. Violation may jeopardize state/federal information sharing agreements (memorandum of understanding). Federal and state crime to improperly disclose. Most RFPs have disclosure and confidentiality rules. Limited number of people with access. Specific rules on physical security of tax data. Problems with contract auditors. Not clear that they are following requirements of confidentiality agreements. Questions regarding ability to use disclosure by one state in contract for another.

Preventing the Spread 18 Broad general authorization attempted - KILLED Indiana California Nebraska Massachusetts Specific transfer pricing contingent fee authorization attempted - KILLED Minnesota

MTC’s Arm’s-Length Adjustment Service (ALAS) 19 Goals: (1) Enhance the ability of participating states to correct cases of taxpayer underreporting associated with related party transactions. (2) Increase audit coverage of related party transactions for states electing to participate in the MTC Audit Program for corporate income taxes. (3) Provide opportunities for satisfactory resolution of disputes involving related party transactions and transfer pricing issues. (4) Inform and advise states of emerging developments concerning related party transactions and transfer pricing issues. Timeline: March 6, Project Facilitator and former MT DOR Director Dan Bucks releases an initial project plan. October 7, ALAS Advisory Group meets and releases draft design. July anticipated draft submission and Commission approval. Transfer pricing audits begin?

MTC’s Arm’s-Length Adjustment Service (ALAS) 20 States Providing Seed Money : Alabama, DC, Florida, Georgia, Hawaii, Iowa, Kentucky, New Jersey, and North Carolina Contract Auditors Involved : Chainbridge Software LLC Economic Analysis Group LLP Economists Inc. NERA Economic Consulting Peters Advisors LLC RoyalStat LLC WTP Advisors

Resolution of National Conference of State Legislatures (NCSL) 21 NCSL has adopted a resolution calling upon states to end the use of contingent fee arrangements in tax audits and appeals. The resolution opposes the use of contingent fee arrangements because such arrangements: Provide an incentive for third-party auditors to arbitrarily inflate a taxpayer’s liability; Encourage auditors to be overly aggressive, to interpret State laws to their own pecuniary advantage, and to “cherry pick” taxpayers as audit targets and to ignore taxpayer errors that would result in lower assessments; May serve as a disincentive to enter into settlement discussions with taxpayers; and Creates a perception of unfairness that undermines taxpayers’ relationships with tax administrators.

Recent and Pending D.C. 482 Cases 22 Siemens- D.C. OTR settled for $0 tax liability. BP- Settled. OTR refunded $140,895 plus interest. Shell - Filed in OAH – MSJ pending. Exxon- Filed in OAH – MSJ pending. Hess- Filed in OAH – MSJ pending. Pfizer- Filed in OAH – MSJ pending. Ahold- Filed in OAH – hearing pending. AT&T- Filed in OAH – hearing pending. Eli Lilly- Filed in OAH – hearing pending. Exxon II- Filed in OAH – hearing pending.

Rules to Win By 23 Audit = Investigation. The best defense is a great offense. Understand the politics of tax. State house or court house – you fund them both. It’s your money – keep it. Voluntary Disclosures are voluntary.

Friends Play Chess to Win 24 Relationships matter. Reputations matter. Handling a case to win should not cost either.

Contact Info 25 Stephen P. Kranz Partner McDermott Will & Emery LLP Washington, DC (202) Find me on LinkedIn at: or Join our blog at:

26 Questions ?