The controversial methodology relied upon by several states to assess corporate taxpayers for transfer pricing violations has been ruled invalid by a D.C. Administrative Law Judge (ALJ). Microsoft Corporation, Inc. v. Office of Tax and Revenue, D.C. Office of Administrative Hearings, Case No.: 2010-OTR-00012 (May 1, 2012). Specifically, the Judge found the methodology “useless” for purposes of determining whether the Taxpayer complied with the arm’s-length standard for the pricing of intercompany transactions embodied in IRC § 482. Several revenue authorities, including New Jersey, Alabama, Louisiana, Kentucky and the District of Columbia, have relied on this now invalidated transfer pricing audit methodology to assess corporate franchise and income tax. The favorable decision was reached on a motion for summary judgment argued by Sutherland SALT attorneys Stephen Kranz and Diann Smith.

Background

Chainbridge Software, LLC (Chainbridge), a subcontractor to contingent fee auditor ACS State and Local Solutions, Inc., performed what it claimed were transfer pricing analyses of District of Columbia taxpayers. In one such analysis, Chainbridge determined that Microsoft engaged in improper pricing of its domestic and international intercompany transactions. The District of Columbia, like many other states, has a statute modeled after Internal Revenue Code § 482. Under the federal code and regulations, taxpayers that engage in transactions with affiliates must price those transactions at arm’s length—meaning the result of the transaction must be “consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances.” Treas. Reg. § 1.482-1(b)(1).