Court of Appeals affirms combined reporting for Tractor Supply tax dispute

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The South Carolina Department of Revenue proved the retailer’s separate entity reporting method failed to fairly represent its business activity in the state because intercompany transfer pricing arrangements artificially shifted income to affiliated entities, the South Carolina Court of Appeals has ruled, affirming a determination requiring Tractor Supply Company to use combined unitary reporting to calculate its state corporate income tax liability.

The dispute arose from a Department of Revenue audit covering tax years 2014 through 2016. South Carolina generally requires corporations to file tax returns on a separate-entity basis, with multistate businesses apportioning income using a sales-factor formula that compares in-state sales to total sales. However, state law permits the Department to require an alternative apportionment method if the standard formula does not fairly represent a taxpayer’s business activity within the state.

Tractor Supply derives approximately 99 percent of its revenue from retail operations. In 2001, the company restructured its operations by creating two subsidiaries, Tractor Supply Company of Michigan, LLC and Tractor Supply Company of Texas, LP. Under the new structure, inventory procurement functions were transferred to the Texas entity, which charged the retail operations a 9.7 percent markup on inventory purchases. Although the procurement function formally moved to Texas, the same employees continued performing the work from the company’s Tennessee headquarters. The Department argued that the markup substantially exceeded an arm’s-length rate and enabled Tractor Supply to shift approximately $300 million in income from the South Carolina taxpayer entity to the Texas subsidiary while generating only about $13 million in cost savings.

Following an administrative hearing, the Administrative Law Court found that the transfer pricing arrangement distorted Tractor Supply’s South Carolina income and upheld the Department’s use of combined unitary reporting, which calculates tax liability by considering the income and sales of the entire affiliated business group rather than a single entity. The court determined that the affiliated companies operated as a unitary business and that combined reporting eliminated the effects of the inflated transfer pricing arrangement.

The Court of Appeals affirmed, rejecting Tractor Supply’s argument that the Department was limited to adjusting the transfer price itself rather than requiring combined reporting. The panel concluded that South Carolina’s apportionment statute broadly authorizes the Department to employ “any other method” that reasonably and equitably reflects a taxpayer’s business activity when the standard formula creates distortion. Relying heavily on the South Carolina Supreme Court’s decision in Media General Communications, Inc. v. South Carolina Department of Revenue, the court held that combined unitary reporting is a permissible alternative apportionment method.

The court also rejected challenges to Revenue Ruling 15-5, finding it merely provided guidance regarding the Department’s exercise of discretion and did not constitute an improperly promulgated regulation under the state Administrative Procedures Act.

Tractor Supply Company v. South Carolina Department of Revenue (Lawyers Weekly No. 011-025-26, 18 pp.) (Kristi F. Curtis, J.) Appealed from The Administrative Law Court (Ralph King Anderson, III, J.) John C. Von Lehe, Jr., Bryson Moore Geer, Robert T. Streisel, all of Nelson Mullins Riley & Scarborough, LLP, of Charleston, and C. Mitchell Brown, of Nelson Mullins Riley & Scarborough, LLP, of Columbia, all for Appellant. Marcus Dawson Antley, III, Wayne Allen Myrick, Jr., and Jason Phillip Luther, all of Columbia, for Respondent. South Carolina Court of Appeals