Section 25114 - Presumptions Arising from Federal Audits(a) Examinations. (1) In general. The Franchise Tax Board shall examine the tax returns of all taxpayers that have made an election pursuant to Revenue and Taxation Code section 25110. In those cases in which such review or inspection reveals that there may be potential noncompliance with arm's-length standards involving the transfer of goods, services or intangibles, or the lending of money between those entities whose income and apportionment factors are required to be considered pursuant to Revenue and Taxation Code section 25110 and other affiliated corporations, an examination of such transactions may be conducted unless the taxpayer has been, or is currently, under examination by the Internal Revenue Service with respect to the same year on the same issue.(2) Principles under which a transfer pricing examination is to be conducted. The Franchise Tax Board shall use the principles and procedures followed by the Internal Revenue Service in conducting examinations under Internal Revenue Code section 482 to prevent the evasion of taxes or to clearly reflect the income of two or more organizations, trades, or businesses.(b) Presumptions regarding examinations by the Internal Revenue Service. (1) Examinations. With respect to those taxpayers which have been subject to an examination by the Internal Revenue Service involving the application of Internal Revenue Code section 482, it shall be presumed that: (A) if a final adjustment was made under the authority of Internal Revenue Code section 482, it is correct and that no further adjustment is required for the issue or transaction adjusted,(B) if no adjustments have been made or proposed under the authority of Internal Revenue Code section 482, none are necessary.(2) Overcoming presumption. The presumptions set forth in paragraph (1) may be overcome by either the Franchise Tax Board or the taxpayer by a showing that: (A) an adjustment or a failure to make an adjustment was erroneous,(B) the result of any possible adjustment would produce a minimal federal tax change because of correlative or offsetting adjustments, including the operation of net operating losses, the federal foreign tax credit or the shifting of income or deductions between years, or(C) substantially the same result was obtained under other sections of the Internal Revenue Code. EXAMPLE:
T, a U.S. incorporated entity, has had operating losses of $1,000,000 for each of the five preceding years, 1-5, giving rise to a $5,000,000 net operating loss carry forward. In year 6, a possible pricing adjustment was considered between T and its foreign subsidiary F. The adjustment would increase T's income by $1,000,000. For years 7, 8 and 9 T has operating losses of $500,000 a year. There are no pricing adjustments between T and F which could affect their federal income tax liability for such years. The Internal Revenue Service makes no adjustment with regard to year 6. There is no presumption attached to the failure to make an adjustment because no federal revenue change would occur.
(3) Lack of examination. No presumption of correctness arises with respect to any transaction which has not been subject to an examination by the Internal Revenue Service pursuant to Internal Revenue Code section 482.(4) Internal Revenue Service examination For purposes of this section, a transfer pricing examination of a transaction or issue by the Internal Revenue Service requires a referral to an International Examiner and his/her direct participation in the examination of the taxpayer as documented by notice that the examination was being conducted pursuant to Internal Revenue Code section 482 with respect to such transaction or issue.(c) Use of federal regulations. Effective as of January 1, 1988, in making distributions, apportionments, and allocations pursuant to Revenue and Taxation Code section 25114, the Franchise Tax Board shall follow the rules, regulations and procedures of the Internal Revenue Service in conducting examinations under Internal Revenue Code section 482 as described in the regulations to such section applicable to the taxable year being examined.(d) Definitions. For purposes of this section, the following definitions are applicable: (1) Examine. To examine is to review or inspect a tax return, which may or may not include an audit of the return.(2) Examination. An examination is an audit for a tax return including a desk audit as well as a field audit.(e) The amendments made to this regulation shall apply to examinations commenced by the Franchise Tax Board on or after January 1, 2008. An examination will be considered commenced when a taxpayer is first contacted by the Franchise Tax Board concerning any examination with respect to the taxpayer's return.Cal. Code Regs. Tit. 18, § 25114
1. New section filed 1-3-89; operative 1-3-89 (Register 89, No. 4).
2. Change without regulatory effect amending section and NOTE filed 4-2-2002 pursuant to section 100, title 1, California Code of Regulations (Register 2002, No. 14).
3. Editorial correction of subsection (c) (Register 2003, No. 33).
4. Amendment of subsections (a)(1)-(b)(1)(A), (b)(2)(B) and (b)(3)-(c) and new subsections (d)-(e) filed 5-21-2009; operative 6-20-2009 (Register 2009, No. 21). Note: Authority cited: Section 19503, Revenue and Taxation Code. Reference: Section 25114, Revenue and Taxation Code.
1. New section filed 1-3-89; operative 1-3-89 (Register 89, No. 4).
2. Change without regulatory effect amending section and Note filed 4-2-2002 pursuant to section 100, title 1, California Code of Regulations (Register 2002, No. 14).
3. Editorial correction of subsection (c) (Register 2003, No. 33).
4. Amendment of subsections (a)(1)-(b)(1)(A), (b)(2)(B) and (b)(3)-(c) and new subsections (d)-(e) filed 5-21-2009; operative 6-20-2009 (Register 2009, No. 21).