United States: Indiana Tax Court Holds Taxpayer Not Required To File Combined Return

On September 10, 2015, the Indiana Tax Court granted a taxpayer's motion for summary judgment and held that the Indiana Department of Revenue could not require the taxpayer to file a combined return with non-resident affiliates.1 The Court held that the taxpayer's separate return properly reflected the taxpayer's income derived from Indiana. In rejecting the Department's arguments, the Court determined that a taxpayer cannot be required to file a combined return solely because it operates as a member of a unitary business. There was no evidence that the taxpayer engaged in any improper tax avoidance measures. The taxpayer's intercompany transactions were conducted at arm's-length rates as established in a transfer pricing study. The fact that the taxpayer had zero tax liability even though the affiliated group had greater profits than the preceding year largely could be explained by statutory amendments changing the tax basis during the relevant tax years.


Rent-A-Center East, Inc. (RAC East) and its affiliates operate retail stores that offer home electronics, appliances and furniture to customers under flexible rent-to-own agreements. In 2002, RAC East and its affiliates reorganized their corporate structure. During the 2003 tax year at issue, RAC East operated over 1,900 rent-to-own stores in the midwestern and eastern United States, including 106 stores in Indiana. Rent-A-Center West, Inc. (RAC West) owned and licensed trademarks and trade names associated with the Rent-A-Center brand, and operated over 400 rent-to-own stores in the western U.S. Rent-A-Center Texas, LP (RAC Texas) operated nearly 300 rent-to-own stores in Texas and employed the executive management team. As part of the reorganization, RAC East hired an independent accounting firm to conduct a transfer pricing study to determine arm's-length pricing for royalties it would pay to RAC West and management fees it would pay to RAC Texas. 2 RAC West and RAC Texas were not qualified to do business in Indiana, did not have any employees in Indiana, and did not own or use any property in Indiana. RAC East filed its 2003 Indiana corporate adjusted gross income tax (AGIT) return on a separate company basis and reported that it owed no tax. Following an audit, the Department proposed additional tax, penalties and interest for the 2003 tax year based on a determination that RAC East should have filed a combined return with RAC West and RAC Texas. The Department contended that RAC East's separate return did not fairly reflect its Indiana source income. In response to RAC East's protest of the assessment, the Department conducted a hearing and issued a final determination upholding the audit results. RAC East initiated an original tax appeal and the Department filed a motion for summary judgment. After conducting a hearing, the Indiana Tax Court granted RAC East's cross-motion for summary judgment because the Department had not designated facts sufficient to make a prima facie case. 3 The Department appealed this decision to the Indiana Supreme Court.

In reversing the Tax Court, the Indiana Supreme Court held that the Department only needed its motion and notice of proposed assessment to constitute a prima facie showing there is no genuine issue of material fact concerning the validity of the unpaid tax. 4 Since the Department met this standard, the burden shifted to the taxpayer to produce evidence showing that there was a genuine issue of material fact with respect to the unpaid tax. The Supreme Court remanded the case to the Tax Court to consider the parties' motions for summary judgment on their merits.

Department's Authority to Require Combined Reporting

Indiana taxes the portion of a corporation's adjusted gross income derived from sources within Indiana. 5 Each corporation with Indiana adjusted gross income generally reports its tax liability on a separate company basis using statutory apportionment rules. 6 Separate filing is the default method, but if the standard apportionment provisions do not fairly represent the taxpayer's income from sources within Indiana, the taxpayer may petition for or the Department may require an alternative apportionment method. 7 In the case of organizations, trades or businesses owned by the same interests, the Department will distribute, apportion or allocate the income derived from sources within Indiana between and among the organizations, trades or businesses to fairly reflect the income derived within Indiana by the various taxpayers. 8 The Department may not require that income, deductions and credits attributable to a taxpayer and another entity be reported in a combined return unless the Department is unable to fairly reflect the taxpayer's adjusted gross income through the use of the powers described above. 9

Taxpayer's Separate Return Fairly Reflected Indiana Source Income

In granting RAC East's motion for summary judgment, the Tax Court held that RAC East was not required to file a combined income tax return with RAC West and RAC Texas. RAC East successfully argued that the Department could not force it to file a combined return because its 2003 separate return fairly reflected its Indiana source income. To support its argument, RAC East offered its transfer pricing study as evidence that its intercompany transactions were conducted at arm's-length rates. The Department argued that it properly required RAC East to file a combined return with its two affiliates because its separate return did not fairly reflect its Indiana source income. According to the Department, three interrelated factors supported this position: (i) RAC East operated as a unitary business; (ii) RAC East's intercompany transactions with its affiliates distorted its Indiana source income; and (iii) RAC East earned substantial profits in 2003 that were not taxed by Indiana.

Operation of Unitary Business Does Not Mandate Combined Reporting

The Tax Court rejected the Department's argument that RAC East was required to file a combined income tax return with its two affiliates solely because they operated as a unitary business. Distortion of income may be inherent when a member of a unitary group files a separate return, but Indiana's income tax statutory framework does not require a unitary group member to file a combined return solely because there is a unitary relationship. The Court noted that filing on a separate company basis is the established default method in the state, but an Indiana statute provides that a taxpayer may report, or the Department may require, the filing of a combined return in limited instances. 10 Requiring a taxpayer to file a combined return merely because it operates as a unitary business would render these fundamental tax aspects of Indiana's income tax system superfluous.

Intercompany Transactions

The Department unsuccessfully argued that RAC East must file a combined return because its payments of royalties to RAC West and management fees to RAC Texas distorted its Indiana source income. Under this argument, the Department claimed that much of RAC East's income was deducted as intercompany business expenses and as a result, such deductions reduced its taxable income to zero. Also, the Department argued that RAC East's payments of royalties to RAC West lacked a valid business purpose and economic substance. Finally, the Department contended that RAC East's payments of management fees to RAC Texas violated the Uniform Partnership Act (UPA).

RAC East and its affiliates' transfer pricing study was the basis for some of the Department's arguments. The Department asked the Court to disregard the transfer pricing study, arguing that the study was not relevant because: (i) it concerned financial accounting rather than tax; (ii) it concerned federal law rather than Indiana law; (iii) it had no binding effect on state tax authorities; (iv) other jurisdictions had rejected similar studies; and (v) it was flawed. In rejecting the first argument, the Court noted that the transfer pricing study was based on federal income tax law, expressly Internal Revenue Code (IRC) Section 482 and the related regulations. 11 Under the second argument, the Department contended that RAC East placed too much weight on the transfer pricing study because it used the arm's-length standard, a method required under IRC Section 482 for evaluating intercompany transactions under federal law, not Indiana law. The Court rejected this argument because IRC Section 482 does not solely address federal tax evasion and is very similar to the corresponding Indiana statute allowing the Department to fairly reflect income in the case of organizations, trades or businesses owned by the same interests. 12 In response to the third argument, the Court explained that the failure of the transfer pricing study to have binding effect on the tax authorities had no bearing on its relevance for purposes of summary judgment. The Court held that the Department's fourth argument that other jurisdictions have rejected similar transfer pricing studies was not supported by authority cited by the Department. 13 Finally, the Department failed to provide any specific evidence to support its assertion that the transfer pricing study was flawed.

The Court rejected the Department's argument that RAC East's royalty payments to RAC West were tax avoidance measures that lacked a valid business purpose or economic substance. Specifically, the Department contended that RAC East adopted a business structure that allowed it to shift its Indiana source income outside the state by deducting its royalty payments to RAC Texas. The Court noted that the parties had stipulated that the affiliates were formed for valid business purposes related to the operation of their businesses. The Department did not provide evidence or authority indicating that RAC Texas' management of the Rent-A-Center brand and RAC West's ownership of the RAC trademarks lacked economic substance. Also, the evidence did not indicate that RAC West returned the royalty payments to RAC East through intercompany loans or other "circular flow of funds" means.

The Department unsuccessfully argued that RAC East, the general partner of RAC Texas, improperly used its payment of management fees to RAC Texas to reduce its Indiana tax liability. To support its argument, the Department cited to a provision in the UPA14 that prohibits partners from receiving compensation for providing services to the partnership unless the parties agree otherwise. Because the portion of the limited partnership agreement between RAC East and RAC Texas that was submitted as evidence did not address the compensation of partners, it did not show whether the payment of management fees violated the UPA. Based on the Department's stipulation that RAC Texas was formed for valid business purposes and that the management fees were made at arm's-length rates, the Court could not conclude that RAC East used its payment of management fees to avoid its Indiana tax liability.

Taxpayer's Profits

The Court rejected the Department's argument that RAC East's separate return failed to fairly reflect its Indiana source income because RAC East reported an Indiana tax liability in the tax years before it restructured, but in 2003 it reported an Indiana AGIT liability of zero and requested a refund of nearly $500,000. The Department contended that 2003 was a "record-setting" year for RAC East and its affiliates, as total revenue increased by 10.9 percent, and RAC East contributed more than two-thirds of the increase. Also, RAC East and its affiliates' net earnings increased 22.6 percent between 2002 and 2003. The Department noted that RAC East and its affiliates' 2003 tax rate only decreased by 6.7 percent nationwide, but RAC East's 2003 Indiana tax rate decreased by 100 percent. The Court explained that although these facts did not facially support a taxpayer reporting a zero tax liability in any state where it does business, they did not trigger the Department's authority to combine non-resident affiliates in RAC East's Indiana return.

The differences between RAC East's 2002 and 2003 tax liabilities were partially a result of Indiana's changing corporate tax structure in these tax years. Prior to 2003, Indiana corporations paid the greater of the gross income tax or the AGIT, plus the supplemental net income tax. 15 However, in 2003, Indiana corporations paid only the AGIT. 16 Because RAC East paid gross income tax and supplemental net income tax rather than the AGIT in 2002, the decrease in its Indiana income tax liability was not sufficient to demonstrate that the use of a separate return did not fairly reflect its Indiana source income. Also, Indiana's AGIT allows for a broader array of deductions than the gross income tax.

A comparison of RAC East's 2002 and 2003 deductions revealed that a one-time refinancing fee in 2003 increased its interest deduction for that year in comparison to 2002. Further, RAC East's 2003 expense deductions for royalties and management fees did not substantially increase the overall amount of its deductions. Finally, RAC East's refund request, based on an overpayment of estimated Indiana income taxes, did not have any bearing on whether its Indiana source income was fairly reflected on its separate return.


This is a favorable decision for taxpayers that want to file AGIT returns in Indiana on a separate basis. The Tax Court provides a detailed and thorough analysis of a variety of issues related to forced combinations. As explained by the Court, separate reporting is the default filing method in Indiana and the fact that a taxpayer is part of a unitary business does not give the Department unfettered authority to require combination. The Court also determined that the intercompany transactions did not distort the taxpayer's Indiana income. The taxpayer was able to rely on a transfer pricing study that provided arm'slength rates for the intercompany transactions. The implicit endorsement of the conclusions in the transfer pricing study, which was developed contemporaneously with the reorganization, is a good illustration of how such a study can protect a corporation from a state tax authority attempting to force a combination with its affiliates. The existence of the study also may have helped defeat the Department's argument that the transactions lacked a valid business purpose or economic substance. Finally, the Court held that the taxpayer's separate return accurately reflected its income derived from Indiana sources despite the fact that the taxpayer reported zero Indiana income during the same year that the RAC East and its affiliates had substantial profits. Thus, the decision includes several important conclusions that can be used by taxpayers with affiliates seeking to file a separate report.

This decision also is noteworthy because the taxpayer was successful despite an earlier loss before the Indiana Supreme Court. As mentioned above, the Supreme Court previously reversed a Tax Court decision that required the Department to consider alternative methods of apportionment before requiring a combined return. 17 According to the Supreme Court, the Department provided sufficient support to force combination, which required the taxpayer to provide evidence that combination was not appropriate. On remand to the Tax Court, the taxpayer persuaded the Court to grant summary judgment because there were no genuine factual issues to resolve. Thus, the taxpayer provided sufficient evidence to support a conclusion that forced combination was not warranted. However, given the history of this case and the direct limitation placed on the Department's discretionary authority to forcibly combine related taxpayers, an appeal by the Department to the Indiana Supreme Court is likely.


1 Rent-A-Center East, Inc. v. Indiana Department of State Revenue, Indiana Tax Court, No. 49T10-0612- TA-00106, Sept. 10, 2015.

2 Based on the study, RAC East paid 3 percent of its revenue to RAC West for use of the trademarks and a management fee to RAC Texas of all amounts over 4.5 percent of its total costs.

3 Rent-A-Center East, Inc. v. Indiana Department of State Revenue, 952 N.E.2d 387 (Ind. Tax Ct. 2011), rev'd, 963 N.E.2d 463 (Ind. 2012).

4 Indiana Department of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463 (Ind. 2012). For a discussion of this case, see GT SALT Alert: Indiana Supreme Court Reverses and Remands Forced Combination Decision on Procedural Grounds.

5 IND. CODE § 6-3-2-1(b).

6 IND. CODE § 6-3-2-2(a)-(k).

7 IND. CODE § 6-3-2-2(l).

8 IND. CODE § 6-3-2-2(m). As discussed below, this provision is similar to IRC § 482.

9 IND. CODE § 6-3-2-2(p).

10 See IND. CODE § 6-3-2-2(p)-(q); IND. ADMIN. CODE tit. 45, § 3.1-1-62.

11 Under IRC § 482, the Internal Revenue Service may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among organizations, trades or businesses that are owned or controlled by the same interests if it determines that such distribution,  apportionment, or allocation is necessary to prevent evasion of taxes or to clearly to reflect the income of the organizations, trades or businesses.

12 See IND. CODE § 6-3-2-2(m).

13 The Department cited Eli Lilly & Co. v. United States, 372 F.2d 990 (Ct. Cl. 1967) and In re The Petition of the Talbots, Inc., DTA No. 820168 (N.Y. Tax. App. Trib., Mar 22, 2007) in an effort to support its position.

14 IND. CODE § 23-4-1-18(f).

15 Former IND. CODE §§ 6-2.1-1-1 to 6-2.1-8-10; 6-3-8-1 to 6-3-8-6.

16 See P.L. 192 (H.B. 1001), Laws 2002, 1st Special Session.

17 Indiana Department of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463 (Ind. 2012).

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