Indiana Department of Revenue Concentrates on Transfer Pricing & New APA Process
The Indiana Department of Revenue (IN DOR) recently launched a campaign to focus on transfer pricing enforcement with its corporate taxpayers. On December 4, 2019, the IN DOR held a meeting in Indianapolis, Indiana, to provide an update on its transfer pricing enforcement initiative and outline common issues the IN DOR focuses on when reviewing and disputing transfer pricing documentation. The IN DOR’s main area of concern related to transfer pricing is taxpayers that file tax returns in separate filing states and consolidated filing states, as well as the shifting of income that may occur to lower a taxpayer’s effective tax rate. Its goal is to ensure that Indiana receives its fair share of taxable income from businesses.
The IN DOR has employed third-party transfer pricing professionals to provide knowledge and train its staff so it can develop its own subject matter experts (SME). Therefore, every taxpayer examination with a transfer pricing component has a SME assigned to it. These SMEs also will work with third-party consultants on complex issues. The presentation by the IN DOR on December 4, 2019, included a discussion on common deficiencies or problem areas the IN DOR sees in the transfer pricing documentation it reviews. Here is a brief summary of these issues:
- Timeliness of Comparable Companies’ Financial Data: The IN DOR believes the three most recent years of financial data should be used to calculate an arm’s-length range. This implies that transfer pricing analyses should be updated each year and prepared contemporaneously with the tax return filing.
- Geographic Area of Comparable Companies: The IN DOR believes that using U.S. comparable companies is the most appropriate and accurate data set. It will eliminate comparable companies domiciled in other countries, including Canada.
- Inclusion of Loss-Making Comparable Companies: The IN DOR will remove loss-making companies from the set of comparable companies, thereby not including them in the arm’s-length range calculation. It believes that loss-making companies do not have the same risks as many of the corporate taxpayers it examines and therefore are not comparable to the taxpayer’s intercompany transaction.
- Inappropriate Adjustments to Financial Data: The IN DOR routinely examines any adjustments made to comparable companies and scrutinizes them closely to ensure the adjustments are relevant and not merely a mechanism to modify the arm’s-length range.
- Best Method & Financial Ratio Selections: The IN DOR is highly scrutinizing transfer prices determined using the comparable uncontrolled price method, comparable uncontrolled transaction method or comparable uncontrolled services price method as the best method. In addition, if the comparable profits method is used, then the IN DOR will examine the profit level indicator that was selected for the analysis to make sure it was the most applicable.
In addition to its transfer pricing initiative, the IN DOR also is implementing an advance pricing agreement (APA) program. This program is similar to the APA program offered by the IRS, but the application fee is currently nil. The IN DOR’s APA program facilitates a prospective agreement between the IN DOR and the taxpayer on a transfer price and will typically be applicable for six years, i.e., two audit cycles. The IN DOR is encouraging APAs for corporate taxpayers that are regularly under examination as a way to make the audit examination process more efficient. There is currently one APA being negotiated by the IN DOR.
If you have questions related to state transfer pricing issues or want more information about the IN DOR’s APA process, please reach out to your BKD trusted advisor or use the Contact Us form below.
For additional information on this topic, read Amy Hamilton’s article, “Indiana to Scrutinize Transfer Pricing Studies, Offer APAs,” published by Tax Analysts and featuring Elizabeth Hazzard.