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VideoPepsi v. Illinois: Transfer Pricing and State Tax Implications | Podcast
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In this episode, Josh Finfrock breaks down the Pepsi v. Illinois case and its implications for state income tax and transfer pricing planning. He explains how economic substance and arm’s length behavior factored into the court’s decision and what this case signals for multistate and global tax planning.
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Detailed Description of Pepsi v. Illinois: Transfer Pricing and State Tax Implications
00:00:00
Josh: Hi, I’m Josh Finfrock, and I lead the transfer pricing practice at Weaver. I want to talk about another transfer pricing-related topic and a court case that’s really more of a state income tax-related court case: Pepsi v. the State of Illinois.
00:00:15
Josh: The case revolves around a matter of an 80/20 company, and what that refers to is a company that would have 80% of its payroll and activity, outside the United States, thereby allowing it, from an Illinois state perspective to be excluded from the Illinois tax apportionment. So this is something that Pepsi structured around a global mobility entity that they set up. And the state of Illinois assessed an over $10 million deficiency related to this.
00:00:45
Josh: So, what were the key parts of the case and the argument?
Well, Illinois won this case, and the court sided with the argument that there was not economic substance here — that this was really a shell company. And these economic substance arguments are being used as well at the federal level in transfer pricing cases.
00:01:04
Josh: And so now, to see an outcome like this at a state level, is quite interesting.
I think another thing that was interesting in this case is that, in part of making the argument that this entity didn’t really have any purpose outside of the tax benefit it provided, was to show the evidence of arm’s length behavior that wasn’t in place.
00:01:24
Josh: This global mobility entity employed all these people providing services all over the world, on secondment to different units, but it was only ever reimbursed at the cost of providing that activity.
00:01:37
Josh: The other piece was that the Pepsi organization had a significant HR department that supported the global mobility function and all these employees that were temporarily employed for periods of a few years in that entity.
And they never allocated arm’s-length charges for the HR support services to the global mobility entity, which were points brought out in the case as evidence that this entity wasn’t really functioning as an independent business purpose and that there was really only the tax benefit at play here.
00:02:13
Josh: The Illinois state had won this case, and this provides some interesting guidance to us to start thinking about when we’re planning. Just one more point to consider how much business purpose and non-tax reasons play into tax planning, transfer pricing planning and the like.
00:02:32
Josh: Thanks. Bye.
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