South Carolina Court Cancels Tractor Supply Co.’s Transfer Pricing Strategy

A recent ruling from a South Carolina judge in the Tractor Supply Co. v. S.C. Dep’t of Revenue case highlights the need for substance when implementing state tax savings strategies. The Court’s rejection of Tractor Supply Company’s (TSC) transfer pricing approach resulted in an additional $1.6 million in taxes plus interest and penalties.

TSC is one of the nation’s largest retailers specializing in maintenance products for farmers and ranchers, operating through a network of 1,600 outlets. In an effort to reduce its state tax burden, TSC reallocated taxable income to a new Texas procurement company, employing a policy of charging inventory costs plus a 9.7% profit markup from TSC-Texas to related TSC companies.

The Court was particularly troubled that the company reallocated $300 million of income to the procurement subsidiary on an annual basis when the Texas entity had only incurred an additional $13 million in costs.

KBKG Insight:

The rejection of TSC’s restructuring is a reminder of the importance of substance when implementing tax reduction strategies. The court found little evidence to support the company’s contention that the restructuring had a real business purpose beyond reducing tax liability.

As an example, one of the documents in evidence included TSC’s board meeting minutes. The board minutes labeled the program as a “tax restructuring,” with few details on operational changes.

TSC did engage a global accounting firm to establish pricing for the new TSC-Texas subsidiary. Unfortunately for TSC, the judge concluded that the transfer pricing study was primarily prepared for tax planning purposes, resulting in a “flawed and unreliable” report.

Although South Carolina is a separate entity state, auditors can enforce combined unitary reporting if the income allocated to South Carolina is deemed unreasonable.

Key Takeaways:

    • This South Carolina case highlights the importance of substance when implementing a new transfer pricing approach
    • If a transfer pricing study is not convincing from an outsider’s perspective, the study will not likely serve as sufficient support during an audit
    • Governments do notice when companies reallocate significant profits from one location to another without sufficient explanations
    • We expect other states to use the TSC case as a template for challenging similarly tax-motivated state tax structures

Transfer pricing is a highly contentious issue for companies with cross-border transactions, both state and internationally. KBKG has a proven track record of trusted advice that assists clients with complicated situations. We focus on helping clients optimize cash flow and reduce tax rates while managing audit risks.