South Carolina administrative court upholds forced combination

Taxpayer's transfer pricing study rejected

Aug 21, 2023
Income & franchise tax Business tax State & local tax

Executive summary

Taxpayer’s transfer pricing study failed to overcome tax authority’s burden

A South Carolina administrative law judge (ALJ) recently upheld the South Carolina Department of Revenue’s requirement that a multistate taxpayer use combined reporting. (Tractor Supply Company v. South Carolina Department of Revenue, Docket No. 19-ALJ-17-0416-CC, Aug. 8, 2023). While South Carolina is a separate-reporting state, the department (or the taxpayer) may require an alternative apportionment methodology if it believes the standard formula fails to fairly represent the taxpayer’s business activity in the state. The party advocating for alternative apportionment has the burden to prove by a preponderance of evidence the statutory formula does not represent the taxpayer’s in-state activity and that the alternative methodology is reasonable. Here, the taxpayer’s own transfer pricing study was determined to be flawed by both of the parties’ experts.  

Request for forced combination

The taxpayer is headquartered in Tennessee and had two subsidiaries located in Michigan and Texas. The Texas subsidiary operated retail stores, a distribution center, and owned the intellectual property for the parent company. The Texas subsidiary performed procurement functions for the group, including inventory management and product development. The Michigan subsidiary owned and operated retail stores. The Michigan business leased all its employees from the parent for cost plus 10% markup under a shared services agreement.

For the years at issue, the taxpayer commissioned a transfer pricing study that was used as the basis for intercompany transactions during the audit period. Specifically, the study noted that the Texas entity waived its right to compensation for the licensing of trademarks for the 2014 year and that it was determined that using the markup of 9.7% in the study would allow it to provide the Michigan subsidiary and the taxpayer-parent with procurement services.


The taxpayer filed its South Carolina corporate income tax returns for the 2014 through 2016 tax period on a separate entity basis, as was statutorily required. The department subsequently determined that combined reporting, including the income of the taxpayer’s entire group, was a more reasonable representation of the taxpayer’s activities in the state after conducting an audit. The department concluded that the statutory separate-entity reporting was distortive because it allowed the taxpayer to minimize its South Carolina tax exposure by shifting income from its retail sales to Texas through the 9.7% markup on inventory. The result was an artificial reduction of the taxpayer’s South Carolina net income. On appeal, the ALJ found that the department had the authority to mandate combined reporting if it more accurately reflected the group’s income. The taxpayer was unable to overcome that finding because the transfer pricing study was determined to be flawed. As a result, the taxpayer was assessed additional tax of about $1.38 million.

Whether the tax department had the authority to require the taxpayer to use combined reporting was a central issue in the case since South Carolina statute calls for separate-reporting to be the default method. However, previous case law in the state had established that both the tax agency and businesses may use combined reporting in certain instances.


The South Carolina courts have upheld the department’s authority to require combined reporting as an alternative apportionment method. This case rested in part on the Texas subsidiary inflated prices to the taxpayer and the Michigan affiliate which shifted income to Texas. The ALJ found the pricing study to be flawed, primarily because both parties’ experts found the study flawed.  

The ALJ also emphasized that this case was very fact specific and that it should not be interpreted too broadly. Still, there are several cases pending in South Carolina in which the department is requiring combined reporting.  Moreover, it is unusual for a taxpayer’s transfer pricing study to be rejected by a court. A transfer pricing study will often protect against successful allegations of distortion. Taxpayers with questions about transfer pricing studies and how to use them effectively should speak to their state and local tax advisers. More information on state transfer pricing is available in our articles, State transfer pricing series: Be prepared for audits ramping up and State transfer pricing series: Audit past and future – be informed.

Finally, as a general rule, states that have an alternative apportionment provision allow the tax administrator to require, or a taxpayer to request, the use of separate or combined accounting, exclusion of one or more factors, inclusion of an additional factor, or the use of any other more equitable apportionment formula when the application of the standard apportionment formula results in distortion. For example, when a state’s standard apportionment formula requires the use of the cost-of-performance method to source receipts from sales of services for sales factor purposes, possible alternatives that could be required or requested include population sourcing, market sourcing, or a variation on income-producing activity sourcing (e.g., time spent) depending on the facts and circumstances involved. Although a state’s use of alternative apportionment typically occurs as the result of an audit, a taxpayer must separately navigate each state’s laws to determine when and how it can request to use an alternative method. Alternative apportionment may result in a more fair representation of a taxpayer’s activity in a jurisdiction, but taxpayers should carefully weigh the risks of such a request and be prepared to submit evidence justifying an alternative methodology. 

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