ATTORNEYS FOR PETITIONER:              ATTORNEYS FOR RESPONDENT:
FRANCINA A. DLOUHY                     GREGORY F. ZOELLER
DANIEL R. ROY                          ATTORNEY GENERAL OF INDIANA
JON B. LARAMORE                        ANDREW W. SWAIN
FAEGRE BAKER DANIELS, LLP              CHIEF COUNSEL, TAX SECTION
Indianapolis, IN                       JESSICA E. REAGAN
                                       JOHN D. SNETHEN
                                       DEPUTY ATTORNEYS GENERAL
                                       Indianapolis, IN
_____________________________________________________________________

                              IN THE
                        INDIANA TAX COURT
_____________________________________________________________________
                                                      Sep 10 2015, 10:29 am

RENT-A-CENTER EAST, INC.,             )
                                      )
     Petitioner,                      )
                                      )
                 v.                   ) Cause No. 49T10-0612-TA-00106
                                      )
INDIANA DEPARTMENT OF STATE           )
REVENUE,                              )
                                      )
     Respondent.                      )
_____________________________________________________________________

       ORDER ON PARTIES’ CROSS-MOTIONS FOR SUMMARY JUDGMENT

                                 FOR PUBLICATION
                                 September 10, 2015

WENTWORTH, J.

      Rent-A-Center East, Inc. (RAC East) challenges the Indiana Department of State

Revenue’s assessment of adjusted gross income tax (AGIT) for the 2003 tax year. The

matter is currently before the Court on the parties’ cross-motions for summary

judgment. The dispositive issue is whether the Department properly determined that

RAC East must file a combined income tax return with two of its corporate affiliates for
the 2003 tax year.1      The Court finds that the Department’s determination was not

proper.

                          FACTS AND PROCEDURAL HISTORY

       The following facts are not in dispute. Renter’s Choice, Inc. (n/k/a RAC East)

was formed in 1986 to operate retail stores offering home electronics, appliances,

computers, furniture, and accessories to customers under flexible rent-to-own

agreements. (See Resp’t Des’g Evid., Ex. N ¶ 2, Ex. A at 4.) In 1998, Renter’s Choice

acquired its largest rent-to-own competitor with the trademarks and trade names

associated with the “Rent-A-Center” brand (RAC Marks), changed its name to Rent-A-

Center, Inc. (RAC Inc.), and transferred the RAC Marks to its new affiliate, Advantage

Companies, Inc. (Advantage). (See Resp’t Des’g Evid., Ex. N ¶ 5, Ex. A at 4.)

       RAC Inc. and its affiliates subsequently reorganized their corporate structure

whereby RAC Inc. assumed the name RAC East and Advantage changed its name to

Rent-A-Center West, Inc. (RAC West). (See Resp’t Des’g Evid., Ex. N ¶¶ 5-6.) In

addition, two new entities were formed, Rent-A-Center Holdings, Inc. (RAC Holdings)

and Rent-A-Center Texas, LP (RAC Texas). (See Resp’t Des’g Evid., Ex. N ¶ 6.) As

part of the reorganization, RAC East (f/k/a RAC Inc.) engaged 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

(the Intercompany Transactions). (See Resp’t Des’g Evid., Ex. N ¶¶ 16-21, Ex. A at 1,

3.)

1
  Given its resolution of this issue, the Court will not address whether the Department erred in
imposing negligence penalties or whether requiring RAC East to file a combined income tax
return violated the Commerce Clause of the United States Constitution. (See Pet’r Br. Supp.
Mot. Summ. J. & Resp. Resp’t Mot. Summ. J. at 31-32.)


                                               2
      During 2003, RAC East had 11,359 employees and operated 1,932 rent-to-own

stores in the Midwest and eastern United States, including 106 stores in Indiana. (See

Resp’t Des’g Evid., Ex. N ¶¶ 3, 7.) RAC West owned and licensed the RAC Marks,

operated 437 rent-to-own stores in the western United States, and employed 2,537

individuals. (See Resp’t Des’g Evid., Ex. N ¶¶ 11-13.) RAC Texas operated 278 rent-

to-own stores in Texas and employed 1,994 individuals, including the executive

management team.2 (See Resp’t Des’g Evid., Ex. N ¶¶14-15.) 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 of their capital, plant, or other property in Indiana.

(See Resp’t Des’g Evid., Ex. N ¶¶ 8, 10.)

      For the 2003 tax year, RAC East filed an Indiana corporate AGIT return on a

separate company basis reporting that it owed no tax. (See Resp’t Confd’l Des’g Evid.,

Ex. J at 1-4.) The Department audited RAC East for the 2001, 2002, and 2003 tax

years, proposing an additional $513,272.60 in AGIT, penalties, and interest for the 2003

tax year based on its determination that RAC East should have filed a combined income

tax return with RAC West and RAC Texas (the RAC Group). (See Resp’t Des’g Evid.,

Ex. N ¶¶ 22-25, 28, 33.) RAC East protested, and after conducting a hearing, the

Department issued its final determination upholding the audit results. (See Resp’t Des’g

Evid., Ex. N ¶¶ 29-31.)

      On December 12, 2006, RAC East initiated an original tax appeal. On March 20,

2009, the Department filed its motion for summary judgment and designated, among


2
  The executive management team performed, among other things, accounting, advertising,
marketing, and employee training/evaluation services for both RAC East and RAC West. (See
Resp’t Des’g Evid., Ex. N at Ex. A at 9-13.)


                                            3
other things, its proposed assessments as evidence. On June 3, 2009, RAC East filed

a cross-motion for summary judgment. On May 27, 2011, after holding a hearing, the

Court granted summary judgment to RAC East stating the Department had not

designated facts sufficient to make a prima facie case. See Rent-A-Center East, Inc. v.

Indiana Dep’t of State Revenue (RAC I), 952 N.E.2d 387, 390-92 (Ind. Tax Ct. 2011),

rev’d, 963 N.E.2d 463 (Ind. 2012). The Department subsequently sought review with

the Indiana Supreme Court. On March 9, 2012, the Indiana Supreme reversed this

Court’s decision in RAC I, explaining that “as a starter” the Department needs nothing

more than its motion and “notice of proposed assessment [to] constitute a prima facie

showing – sufficient to satisfy Trial Rule 56(C) – that there is no genuine issue of

material fact with respect to the validity of the unpaid tax[.]” See Indiana Dep’t of State

Revenue v. Rent-A-Center East, Inc. (RAC II), 963 N.E.2d 463, 465-67 (Ind. 2012).

Consequently, the Supreme Court remanded the case for the Court to consider the

parties’ motions on their merits.    Id. at 467.    Additional facts will be supplied as

necessary.

                                STANDARD OF REVIEW

      Summary judgment is proper when the designated evidence demonstrates that

no genuine issues of material fact exist and the moving party is entitled to judgment as

a matter of law. Ind. Trial Rule 56(C).     When the Department moves for summary

judgment, it makes a prima facie case that there is no genuine issue of material fact

regarding the validity of an unpaid tax by properly designating its proposed

assessments as evidence. RAC II, 963 N.E.2d 466-67. “The burden then shifts to the

taxpayer to come forward with sufficient evidence demonstrating that there is, in



                                            4
actuality, a genuine issue of material fact with respect to the unpaid tax.” Id. at 467.

Cross-motions for summary judgment do not alter this standard. Horseshoe Hammond,

LLC v. Indiana Dep’t of State Revenue, 865 N.E.2d 725, 727 (Ind. Tax Ct. 2007), review

denied.

                                           LAW

      Indiana taxes the portion of a corporation’s adjusted gross income that is derived

from sources within Indiana. IND. CODE § 6-3-2-1(b) (2003) (amended 2004). Each

corporation with Indiana adjusted gross income must report its AGIT liability on a

separate company basis according to the applicable allocation and apportionment rules

set forth in Indiana Code § 6-3-2-2(a)-(k) (Standard Sourcing Rules). See RAC II, 963

N.E.2d at 465; RAC I, 952 N.E.2d at 389. While separate filing is the default filing

method in Indiana, in limited instances, the Department may grant prospectively or

require retroactively that a taxpayer determine its AGIT liability using an alternative

method to that provided by the Standard Sourcing Rules:

          If the allocation and apportionment provisions of this article do not
          fairly represent the taxpayer’s income derived from sources within
          the state of Indiana, the taxpayer may petition for or the department
          may require, in respect to all or any part of the taxpayer’s business
          activity, if reasonable:

                (1) separate accounting;

                (2) the exclusion of any one (1) or more factors;

                (3) the inclusion of one (1) or more additional factors
                which will fairly represent the taxpayer’s income
                derived from sources within the state of Indiana; or

                (4) the employment of any other method to effectuate
                an equitable allocation and apportionment of the
                taxpayer’s income.

IND. CODE § 6-3-2-2(l) (2003) (amended 2006) (emphasis added).            This alternative

                                            5
apportionment method, sometimes referred to as the equitable apportionment method,

applies only when the use of the Standard Sourcing Rules “‘works a hardship or

injustice upon the taxpayer, results in an arbitrary division of income, or in other

respects does not fairly attribute income to this state or other states.’”            RAC II, 963

N.E.2d at 467, n.3 (quoting 45 IND. ADMIN. CODE 3.1-1-62 (2003)). The Department’s

authority to require an alternative apportionment method is further limited if it chooses a

combined income tax return3 as that method. See I.C. § 6-3-2-2(p).

                                           ANALYSIS

       In response to the Department’s prima facie case that its assessments are

correct, RAC East contends that the Department could not force it to file a combined

income tax return because its 2003 separate return fairly reflected its Indiana source

income. (See, e.g., Pet’r Br. Supp. Mot. Summ. J. & Resp. Resp’t Mot. Summ. J. (“Pet’r

Br.”) at 21-28). In support of this position, RAC East designated its Transfer Pricing

Study as evidence that its Intercompany Transactions were conducted at arm’s-length

rates.4 (See Pet’r Des’g Evid., Ex. A.)

       The Department, on the other hand, claims that RAC East’s separate return did

not fairly reflect its Indiana source income and, thus, it properly required RAC East to

file a combined income tax return with its two affiliates. (See, e.g., Resp’t Br. Supp.

Mot. Summ. J. (“Resp’t Br.”) at 15.) The Department explains that three interrelated

3
  A “combined income tax return” is “any income tax return on which one (1) or more taxpayers
report income, deductions, and credits on a combined basis with one (1) or more other entities.”
IND. CODE § 6-3-1-28 (2003).
4
  A transfer pricing study, done in accordance with IRC § 482 and its associated regulations,
determines whether the intercompany transactions between related entities are conducted at
the same cost as similar transactions with third parties, i.e., at arm’s length. See generally, e.g.,
26 C.F.R. § 1.482-3 (2015).


                                                 6
factors support its determination: 1) RAC East operates as a unitary business; 2) RAC

East’s Intercompany Transactions with RAC West and RAC Texas distorted its Indiana

source income; and 3) RAC East earned substantial profits in 2003 that were not taxed

by Indiana. (See, e.g., Resp’t Br. at 15-47; Resp’t Reply to [Pet’r Br.] (“Resp’t Reply

Br.”) at 9-19, 24-34.)

                                    I.   Unitary Business

       The Department first claims that RAC East must file a combined income tax

return with RAC West and RAC Texas because they operate together as a unitary

business. (See Resp’t Br. at 15-34.) More specifically, the Department reasons that

because RAC East’s separate return “cannot demonstrate the precise source of its net

income[,]” only by filing a combined income tax return would RAC East capture “‘the

many subtle and largely unquantifiable transfers of value that take place among the

components of a [unitary business].’”5 (See Resp’t Br. at 39-40 (citation omitted); Resp’t

Reply Br. at 8, 13-16.)

       If an Indiana taxpayer is a member of a unitary group,6 a combined return would

include all of the property, income, or receipts attributable to the group’s out-of-state


5
   In making this claim, the Department uses the terms “separate accounting” and “separate
reporting” as if they are interchangeable, but they are not. (See, e.g., Resp’t Br. Supp. Mot.
Summ. J. (“Resp’t Br.”) at 18-19, 38-39; Resp’t Reply to [Pet’r Br.] at 15; Hr’g Tr. at 8-10.)
Indeed, separate accounting is a method for determining the geographic source of a taxpayer’s
income. See, e.g., Mobil Oil Corp. v. Comm’r of Taxes of Vermont, 445 U.S. 425, 438 (1980)
(stating that separate geographical accounting purports to isolate the portions of income
received in various states). In contrast, separate reporting refers to a type of tax return in which
the taxpayer reports its income tax liability alone. See, e.g., Kohl’s Dep’t Stores, Inc. v. Indiana
Dep’t of State Revenue, 822 N.E.2d 297, 299 (Ind. Tax Ct. 2005) (discussing separate and
combined income tax returns). In this case, RAC East reported its Indiana AGIT liability on a
separate return and did not use separate accounting.
6
  The three indicia of a unitary business are functional integration, centralized management,
and economies of scale. Allied-Signal, Inc. v. Dir., Div. of Taxation, 504 U.S. 768, 781 (1992).


                                                 7
and in-state activities in the taxpayer’s apportionable tax base. See Hunt Corp. v. Dep’t

of State Revenue, 709 N.E.2d 766, 770 (Ind. Tax Ct. 1999). This Court has explained

that combined reporting for unitary businesses is based on the premise that “‘in order to

avoid distortion of income, the income and apportionment factors of all the components

of the unitary business must be taken into account.’” Hunt, 709 N.E.2d at 777 n.27

(emphasis and citation omitted). Thus, distortion of income, whether purposeful or not,

may be inherent when a taxpayer in a unitary group files a separate rather than a

combined income tax return.

      Regardless of a possibility of distortion, however, Indiana’s AGIT statutory

framework does not require a member of a unitary group to file a combined income tax

return solely because there is a unitary relationship. See generally IND. CODE § 6-3-2-1

et seq. Indeed, it is well established that filing on a separate company basis is the

default method for reporting an Indiana AGIT liability. See RAC II, 963 N.E.2d at 465.

Moreover, Indiana Code § 6-3-2-2 expressly states that a taxpayer may report, or the

Department may require, the filing of a combined income tax return in only limited

instances. See I.C. § 6-3-2-2(p)-(q); accord 45 I.A.C. 3.1-1-62. Thus, to require a

taxpayer to file a combined income tax return merely because it operates as a unitary

business would effectively render these two fundamental aspects of Indiana’s AGIT

scheme superfluous or nullities.    See Chrysler Fin. Co. v. Indiana Dep’t of State

Revenue, 761 N.E.2d 909, 916 (Ind. Tax Ct. 2002) (stating that the Court will not

presume that the legislature intended to enact a statutory provision that is superfluous,

meaningless, or a nullity), review denied. Accordingly, the Court finds the Department’s

claim that RAC East must file a combined income tax return with its two affiliates solely



                                           8
because it operates as a unitary business with them unpersuasive.

                       II.   The Intercompany Transactions

      Next, the Department claims that RAC East must file a combined income tax

return because its payment of royalties to RAC West and management fees to RAC

Texas distorted (i.e., did not fairly reflect) its Indiana source income. (See Resp’t Br. at

43.) In other words, the Department claims that much of the income earned by RAC

East, some of which was attributable to Indiana according to Indiana’s apportionment

formula, was deducted as intercompany business expenses, reducing RAC East’s

Indiana taxable income to zero. See, e.g., BMC Software, Inc. v. C.I.R., 780 F.3d 669,

672 (5th Cir. 2015) (explaining that a taxpayer may artificially deflate its taxable income

by manipulating the prices charged for intercompany transactions with related entities).

The Department explains that RAC East’s Transfer Pricing Study is not relevant to the

determination of whether RAC East’s Indiana source income was fairly reflected on its

separate return.    (See Resp’t Br. at 40-44; Hr’g Tr. at 12-13.)           Moreover, the

Department states that RAC East’s 2003 separate return could not fairly reflect its

Indiana source income because RAC East’s payments of royalties to RAC West lacked

a valid business purpose and economic substance, and RAC East’s payments of

management fees to RAC Texas violated the Uniform Partnership Act. (See Resp’t Br.

at 36-38.)

                     A. Relevance of the Transfer Pricing Study

      In 2002, when RAC East and its affiliates reorganized their corporate structure,

RAC East hired an independent accounting firm to conduct a Transfer Pricing Study to

determine arm’s-length pricing for the royalties it would pay RAC West and the



                                            9
management fees it would pay RAC Texas. (See Resp’t Des’g Evid., Ex N ¶¶ 17, 19.)

Based on the Study, RAC East paid 3% of its revenues to RAC West for use of the RAC

Marks, and RAC East paid RAC Texas a management fee consisting of all amounts that

exceeded 4.5% of its total costs (i.e., product costs and operating expense), which

guaranteed that RAC East earned a return of 4.5% of its total costs in 2003. (See

Resp’t Des’g Evid., Ex. N ¶¶ 17-21.) The Department has asked the Court to disregard

the Transfer Pricing Study, explaining that it is not relevant because: 1) it concerns

financial accounting, not tax, 2) it concerns federal, not Indiana law, 3) it has no binding

effect on state tax authorities, 4) other jurisdictions have rejected similar studies, and 5)

it is flawed. (See Resp’t Br. at 40-43.)

                                1. Financial Accounting

       The Department first explains that the Transfer Pricing Study is not relevant

because it was “done for financial accounting purposes, not for tax accounting

purposes[.]” (See Resp’t Br. at 41; Hr’g Tr. at 12-13.) The Transfer Pricing Study,

however, states that it was based on federal income tax law, expressly IRC § 482 and

the related regulations. (See Resp’t Des’g Evid., Ex. N at Ex. A at 1.) The Transfer

Pricing Study states that IRC § 482 requires intercompany transactions between related

or “controlled” parties to be conducted at arm’s-length rates to mimic the economic

behavior that would take place if the parties were unrelated. (See Resp’t Des’g Evid.,

Ex. N, Ex. A at 18.) The Transfer Pricing Study further states that the “arm’s-length

standard is [one] way [that] taxing authorities endeavor to create market conditions

within a related group.” (Resp’t Des’g Evid., Ex. N at Ex. A at 18.) Accordingly, the

Department’s position that the Transfer Pricing Study is not relevant because it involves



                                             10
financial accounting rather than tax is unavailing.

                                     2. Federal Law

       Next, the Department explains that RAC East has placed entirely too much

weight on the Transfer Pricing Study because it uses the arm’s-length standard, a

method required under IRC § 482 for evaluating intercompany transactions under

federal law, not Indiana law.     (See Resp’t Br. at 40-41; Hr’g Tr. at 11-13.)       The

Department further explains that IRC § 482 redresses wholly different circumstances

(i.e., combating “off-shore tax evasion by multinational corporations whose taxable

income is subject to multiple international treaties”) than those that concern Indiana’s

AGIT scheme (i.e., “fairly representing [a multi-state taxpayer’s] in-state business

activities within the bounds of the Commerce Clause”).          (See Resp’t Br. at 41.)

Moreover, the Department points out that Indiana has neither adopted nor incorporated

by reference IRC § 482 or any other similar statutory provision. (See Resp’t Br. at 41.)

These arguments are not persuasive, however, for at least two reasons.

       First, IRC § 482 does not solely address federal tax evasion. Indeed, the U.S.

Court of Claims has explained that IRC § 482 serves two distinct purposes because it

may be applied to prevent tax evasion or to clearly reflect the income of related

organizations. See Eli Lilly & Co. v. U.S., 372 F.2d 990, 999 (Ct. Cl. 1967). Both of

these purposes are also important to the administration of Indiana’s AGIT scheme. For

example, the Legislature gave the Department the extraordinary power to change a

taxpayer’s adjusted gross income, even though the taxpayer calculated its tax liability in

complete conformance with the Standard Sourcing Rules, if the reported income does

“not fairly represent the taxpayer’s income derived from sources within the state of



                                            11
Indiana[.]” I.C. § 6-3-2-2(l).

       Second, a comparison of the text of Indiana Code § 6-3-2-2(m) with the text of

IRC § 482 inescapably demonstrates their similarities. Specifically, Indiana Code § 6-3-

2-2(m) provides:

           In the case of two (2) or more organizations, trades, or businesses
           owned or controlled directly or indirectly by the same interest, the
           department shall distribute, apportion, or allocate the income
           derived from sources within the state of Indiana between and
           among those organizations, trades, or businesses in order to fairly
           reflect and report the income derived from sources within the state
           of Indiana by various taxpayers.

I.C. § 6-3-2-2(m) (2003). In turn, IRC § 482 provides:

           In any case of two or more organizations, trades, or businesses
           (whether or not incorporated, whether or not organized in the
           United States, and whether or not affiliated) owned or controlled
           directly or indirectly by the same interests, the Secretary may
           distribute, apportion, or allocate gross income, deductions, credits,
           or allowances between or among such organizations, trades, or
           businesses, if he determines that such distribution, apportionment,
           or allocation is necessary in order to prevent evasion of taxes or
           clearly to reflect the income of any of such organizations, trades, or
           businesses. In the case of any transfer (or license) of intangible
           property (within the meaning of section 936(h)(3)(B)), the income
           with respect to such transfer or license shall be commensurate with
           the income attributable to the intangible.

I.R.C. § 482 (2003).     Accordingly, the Transfer Pricing Study does not lack relevance

on this basis.

                                    3. Binding Effect

       The Department also explains that the Transfer Pricing Study is not relevant

because it states that it “is not binding upon the IRS, any other tax authority[,] or any

court[.]” (See Resp’t Br. at 42 (citing Resp’t Des’g Evid., Ex. N at Ex. A at 33).) The

binding effect of the Transfer Pricing Study, however, has no bearing on its relevance



                                            12
for purposes of summary judgment. In this summary judgment context, the Transfer

Pricing Study has been designated as evidence, and its relevance depends on whether

it tends to prove or disprove that RAC East’s use of a separate return fairly reflected its

Indiana source income in 2003. See Ind. Evidence Rule 401 (explaining that evidence

is relevant if it has any tendency to make a fact of consequence in determining the

action more or less probable than it would be without the evidence). In other words, a

transfer pricing study is relevant because it can serve as an objective evidentiary

method for evaluating state tax issues that may arise in cross-border transactions

between related organizations.      Consequently, the Department’s position that the

Transfer Pricing Study lacks relevance because it has no binding effect is not

persuasive.

                                 4. Other Jurisdictions

       The Department also discounts the Transfer Pricing Study’s relevance on the

basis that other jurisdictions have rejected these types of studies. More specifically, the

Department explains that other courts have found arm’s-length pricing irrelevant in

determining whether the income of a taxpayer that operates as a unitary business and

engages in intercompany transactions with its affiliates is fairly reflected on a separate

return. (See Resp’t Br. at 43-44.) The Department relies on the decisions in Eli Lilly &

Company v. United States, 372 F.2d 990 (Ct. Cl. 1967) and In re The Petition of The

Talbots, Inc., DTA No. 820168, 2008 WL 4294963 (N.Y. Tax. App. Trib. Mar. 22, 2007)

as support for its position. (See Resp’t Br. at 43-44; Resp’t Notice of Additional Auth.)

Neither of these cases supports the Department’s position.

       In Eli Lilly, the court held that a taxing official’s reallocation of a taxpayer’s



                                            13
income under IRC § 482 was reasonable, even though the taxpayer developed an

intercompany pricing policy for valid business purposes, because the taxpayer failed to

prove that its sales to a related subsidiary were made at arm’s-length rates. See Eli

Lilly, 372 N.E.2d at 992-99. The court explained that the arm’s-length standard under

IRC § 482 was the proper benchmark to apply when examining whether reported

income fairly reflected “true taxable income.”       See id. at 995-96.     Contrary to the

Department’s claim, therefore, the Eli Lilly case indicates that evidence regarding the

arm’s-length standard of IRC § 482 is relevant when determining whether a taxpayer’s

return clearly reflects income. See id. at 995-96, 999-1000. Furthermore, the holding in

Eli Lilly indicates that the taxpayer did not present a transfer pricing study to establish

that its intercompany pricing policy was based on arm’s-length rates. See id. at 994-95

(stating that the taxpayer’s management team formulated the pricing policy), 997-98

(explaining that the taxpayer presented evidence of sales between itself and certain

unrelated bulk purchasers).

       In Talbots, a retailer paid royalties to its wholly-owned subsidiary for the right to

use the subsidiary’s trademarks. See In re Talbots, Inc., D.T.A. No. 820168, 2008 WL

4294963, at *11 ¶¶ 28-29 (N.Y. Tax. App. Trib. Mar. 22, 2007). Upon audit, the taxing

official required the retailer and its subsidiary to file a combined return, which resulted in

the assessment of additional tax, despite the fact that the retailer had presented a study

to show that its royalty payments were made at arm’s-length rates. See id., 2008 WL

4294963, at *11 ¶ 29, *13-27 ¶¶ 36-93, *30 ¶¶ 105-11.              The tribunal upheld the

assessment before even examining the taxpayer’s study because the evidence clearly

established that the transactions between the retailer and its subsidiary lacked any valid



                                             14
business purpose or economic substance. See id., 2008 WL 4294963, at *34-35. The

facts in this case, however, differ significantly from those in Talbots. Here, the parties

have stipulated that “RAC West and RAC Texas were formed for valid business

purposes related to the operations of their businesses[.]” (See Resp’t Des’g Evid., Ex.

N ¶ 9.)    Moreover, the Department did not claim that RAC East’s Intercompany

Transactions lacked economic substance. (See, e.g., Resp’t Br. at 43 (merely arguing

that “evidence of an arm’s-length fee is not automatically evidence that [RAC East’s

separate return] fairly represents its Indiana business activities”).)

                                       5. The Flaws

       Finally, the Department explains that the Transfer Pricing Study is not relevant

because it used properties that were not comparable to the RAC Group in formulating

the arm’s-length rates for the Intercompany Transactions. (See Resp’t Br. at 42; Hr’g

Tr. at 43.) The Department, however, has not provided any further explanation, factual

basis, or precedential or persuasive legal authority to support this claim. (See, e.g.,

Hr’g Tr. at 43; Resp’t Des’g Evid., Ex. N ¶¶ 26-27 (both indicating that the Department

never attempted to examine the Transfer Pricing Study).) Accordingly, the Department

has not shown that the Transfer Pricing Study is not relevant because it is flawed.

                                B. The Royalty Payments

       Next, the Department argues that RAC East has adopted a business structure

that allowed it to shift its Indiana source income outside of the state by deducting its

royalty payments to RAC Texas. (See Resp’t Br. at 37-38.) More specifically, the

Department explains that RAC East’s payment of royalties to RAC West is an improper

tax avoidance measure because RAC Texas rather than RAC West “‘is responsible for



                                             15
developing advertising and marketing strategies to create, maintain and expand the

brand name for the [RAC Group.]’” (See Resp’t Br. at 37-38 (quoting Resp’t Des’g

Evid., Ex. N, Ex. A at 15).) In support, the Department cites a case in which a court

required a taxpayer to file a combined income tax return with two related subsidiaries

because the evidence showed that the taxpayer’s trademark “assignment and license-

back transaction[s with those subsidiaries] lacked a business purpose or economic

substance apart from tax avoidance.” (See Resp’t Br. at 37-38 (citing In re Sherwin-

Williams Co. v. Tax App. Trib. of the Dep’t of Taxation & Fin. of N.Y., 12 A.D.3d 112,

115-16 (N.Y. App. 2004) (indicating that both subsidiaries were run on a part-time

basis by an employee inexperienced in trademark management, that the taxpayer

actually managed the trademarks, and that the subsidiaries returned the royalties to

the taxpayer as loans)).)

      As just mentioned, the parties in this case have stipulated that RAC West and

RAC Texas were formed for valid business purposes related to the operation of their

businesses.    See supra p.13.    Furthermore, the Department has not designated

evidence or offered any authority that would indicate that RAC Texas’ management of

the RAC brand and RAC West’s ownership of the RAC Marks lacked economic

substance. Moreover, the designated evidence in this case does not indicate that RAC

West returned the royalty payments to RAC East by using loans or some other method.

Indeed, the parties have stipulated that the Department did not study RAC East, its

affiliates, or their Intercompany Transactions during the audit, proposed assessment,

and administrative protest phases.     (See Resp’t Des’g Evid., Ex. N ¶¶ 26-27.)

Accordingly, the facts in this case, unlike those in Sherwin-Williams, simply do not



                                         16
demonstrate that RAC East’s payment of royalties to RAC West were tax avoidance

measures that lacked a valid business purpose or economic substance. Consequently,

the Court cannot find that the Department properly collapsed RAC East’s business

structure into one tax entity by compelling it to file a combined income tax return on this

basis.

                                 C. Management Fees

         The Department also argues that because a portion of the Uniform Partnership

Act, Indiana Code § 23-4-1-18(f), prohibits partners from receiving compensation for

providing services to the partnership, RAC East, the general partner of RAC Texas,

improperly used its payment of management fees to RAC Texas to reduce its Indiana

AGIT liability. (See Resp’t Br. at 36-37; Resp’t Reply Br. at 9-10; Resp’t Des’g Evid.

Ex. A at 282).) Indiana Code § 23-4-1-18(f) states that “[t]he rights and duties of the

partners in relation to the partnership shall be determined, subject to any agreement

between them, by the following rule[]: . . . No partner is entitled to remuneration for

acting in the partnership business, except that a surviving partner is entitled to

reasonable compensation for his services in winding up the partnership affairs.” IND.

CODE § 23-4-1-18(f) (2003) (emphasis added). In other words, “a partner is not entitled

to compensation for [the] services rendered to the partnership unless there is an

agreement to the contrary.” United Farm Bureau Mut. Ins. Co. v. Schult, 602 N.E.2d

173, 175 (Ind. Ct. App. 1992) (emphasis added) (citations omitted).

         The designated evidence reveals that RAC East and RAC Texas executed a

limited partnership agreement, but the designated portion of that agreement does not

address the compensation of partners. (See Resp’t Des’g Evid. Ex. A at 280, 282.)



                                           17
Accordingly, the designated evidence does not show whether RAC East’s payment of

management fees to RAC Texas contravened Indiana Code § 23-4-1-18(f). Moreover,

because the Department has stipulated that RAC Texas was formed for valid business

purposes and that the management fee payments were made at arm’s-length rates,

the Court cannot conclude that RAC East used its payment of management fees to

RAC Texas to avoid its Indiana AGIT liability. Thus, the Department has not shown

that RAC East’s payment of management fees to RAC Texas distorted its Indiana

source income and necessitated the filing of a combined income tax return.

                              III.   RAC East’s Profits

      Finally, the Department claims that RAC East’s use of a separate return did not

fairly reflect its Indiana source income because RAC East reported an Indiana income

tax liability in the tax years before it restructured, but in 2003, post-restructuring, it

reported an Indiana AGIT liability of zero and requested nearly a half-million dollar

refund. (See, e.g., Resp’t Reply Br. at 1-2, 17, 27-28; Resp’t Des’g Evid., Ex. N ¶¶ 5-6.)

Indeed, the Department points out that 2003 was a record-setting year for RAC East

and the RAC Group because RAC East’s Indiana property, payroll, and sales factors all

increased and because the RAC Group’s revenues increased 10.9% to $2.2 billion with

RAC East contributing more than two-thirds of the increase. (See Resp’t Br. at 23-24,

34-35 (citing Resp’t Confd’l Des’g Evid. Exs. I at 2-3, J at 2-3; Resp’t Des’g Evid. Ex.

F).) The Department also explains that 1) the RAC Group’s store base increased by

10% and Indiana ranked 9th in the nation in terms of the number of stores; 2) the RAC

Group posted record earnings in the first two quarters of 2003; 3) the RAC Group’s net

earnings increased 22.6% between 2002 and 2003; 4) the Board of Directors declared a



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5:2 stock split paid as a dividend; and 5) while the RAC Group’s 2003 tax rate only

decreased by 6.7% nationwide, RAC East’s 2003 Indiana tax rate decreased by 100%.

(See Resp’t Br. at 23-24, 34-35 (citing Resp’t Des’g Evid., Exs. A at 71-72, C, D, F;

Resp’t Confd’l Des’g Evid., Ex. L at ¶¶ 17-18).) While these facts do not facially support

a taxpayer reporting a zero tax liability in any state where it does business, they do not

trigger the Department’s authority to combine non-resident affiliates in RAC East’s

Indiana return in this instance.

       Initially, the difference between RAC East’s 2002 and 2003 Indiana income tax

liabilities may be explained because Indiana’s 2002 and 2003 corporate income tax

laws were amended. Specifically, prior to 2003, Indiana corporations paid the greater of

the gross income tax or the AGIT, plus the supplemental net income tax. See Longmire

v. Indiana Dep’t of State Revenue, 638 N.E.2d 894, 896 (Ind. Tax Ct. 1994); IND. CODE

§ 6-2.1-1-1 to -8-10 (2002) (regarding gross income taxes); IND. CODE § 6-3-8-1 to -6

(2002) (regarding supplemental net income taxes).             In 2003, however, Indiana

corporations paid the AGIT only. See P.L. § 192-2002(ss), § 191 (repealing, among

other things, Indiana Code sections 6-2.1 and 6-3-8). The designated evidence in this

case indicates that RAC East paid gross income tax and supplemental net income tax in

2002, not AGIT. (See Resp’t Confd’l Des’g Evid., Ex. I at 1-2.) Consequently, the

decrease between RAC East’s 2002 and 2003 Indiana income tax liabilities is not by

itself sufficient to demonstrate that its use of a separate return did not fairly reflect its

Indiana source income.

       Second, Indiana’s AGIT scheme, unlike its gross income tax scheme, allows

certain deductions related to the cost of doing business. See 20 Ind. Prac., Business



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Organizations § 51.13 (stating that “[d]eductions for cost of doing business, losses, or

expenses are not allowed in computing [an] Indiana gross income tax liability”). The

deductions, in turn, generally reduce the amount of taxable income.      See IND. CODE §

6-3-1-3.5(b) (2003) (amended 2004) (defining “taxable income” for corporations); I.R.C.

§ 63 (2003). See also BLACK’S LAW DICTIONARY 475 (9th ed.) (providing that a “tax

deduction” is “[a]n amount subtracted from gross income when calculating adjusted

gross income, or from adjusted gross income when calculating taxable income”). The

number of deductions that a taxpayer may take from year-to-year typically varies

because deductions related to the operation of a business may be recurrent, like

insurance, telephone, utility, or management fee expenses, while others are not, such

as refinancing expenses. (Compare, e.g., Resp’t Confd’l Des’g Evid., Ex. I at 15 (RAC

East’s 2002 deductions) with Ex. J at 13-14 (RAC East’s 2003 deductions).) (See also,

e.g., Pet’r Br. at 28 (explaining that RAC East incurred a one-time refinancing fee in

2003 that ultimately increased its deduction for interest that year).)      Moreover, a

comparison of RAC East’s 2002 and 2003 deductions reveals that its 2003 expense

deductions for royalties and management fees did not substantially increase the overall

amount of its deductions.    (Compare Resp’t Confd’l Des’g Evid., Ex. I at 15 (2002

deductions) with Ex. J at 13-14 (2003 deductions).) Accordingly, the fact that RAC East

reported that its 2003 Indiana AGIT liability was zero does not establish per se that its

Indiana source income was not fairly reflected on its separate return.

      Finally, the designated evidence does not indicate that RAC East’s 2003 refund

request has any bearing on whether its Indiana source income was fairly reflected on its

separate return. Indeed, the designated evidence reveals that RAC East requested a



                                           20
refund because it had overpaid its Indiana income tax liability by making estimated tax

payments in both 2002 and the first two quarters of 2003. (See Pet’r Reply [to Resp’t

Reply Br.] at 19 (citing Resp’t Confd’l Des’g Evid., Exs. I at 1; J at 2).) In this case,

therefore, the amount of RAC East’s 2003 profits, the fact that its 2003 Indiana AGIT

liability was zero, and its nearly half-million dollar refund request do not show that its

separate return failed to fairly reflect its Indiana source income.

                                       CONCLUSION

       The Department has claimed that RAC East must file a combined income tax

return with its affiliates because it “used Indiana’s roadways to deliver . . . and offer its

products to residents all over the state” and then it improperly avoided its Indiana AGIT

liability by “siphon[ing ] the money it earned in Indiana to [RAC West] and [RAC Texas].”

(See Hr’g Tr. at 15, 20.) While the Court is aware that a taxpayer may use its business

structure and transfer pricing policies to lower its state income tax liability, the evidence

designated in this case simply does not indicate that RAC East has engaged in any

improper tax avoidance measures. See, e.g., Carmax Auto Superstores W. Coast, Inc.

v. S. C. Dep’t of Revenue, 767 S.E.2d 195, 200-01 (S.C. 2014) (holding that a taxing

official’s bald assertions and descriptions of how it recalculated a taxpayer’s income tax

liability failed to show that the statutory formula did not fairly represent the taxpayer’s in-

state business activities). Furthermore, it is undisputed that the Transfer Pricing Study

established arm’s-length rates for RAC East’s Intercompany Transactions and that the

royalty and management fee payments were consonant with the Transfer Pricing

Study’s rates. Moreover, the designated evidence as well as the parties’ stipulations do

not show that RAC East’s Intercompany Transactions can be disregarded because they



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lacked a valid business purpose or economic substance. Consequently, RAC East’s

2003 separate return fairly reflected its Indiana source income. The Court, therefore,

GRANTS summary judgment in favor of RAC East and AGAINST the Department.

      SO ORDERED this 10th day of September 2015.



                                                    Martha Blood Wentworth, Judge
                                                    Indiana Tax Court




Distribution: Francina A. Dlouhy, Daniel R. Roy, Jon B. Laramore, Andrew W. Swain,
Jessica E. Reagan, John D. Snethen.

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