Beware States Offering Unilateral Advance Pricing Agreements for Transfer Pricing

August 26, 2020

As state revenue agencies train their auditors in traditional IRC §482 transfer-pricing methodologies or outsource transfer-pricing audits to third-party specialists, a recent initiative by the Indiana Department of Revenue follows another, alternative federal transfer-pricing compliance tool: advance pricing agreements (APAs).

There are numerous fact-and-circumstance-specific factors for taxpayers to consider when determining whether the benefits of applying for an APA outweigh the risks, but the primary benefit of an APA is “certainty” with respect to an intercompany transaction. That benefit appears illusory in the case of new state APA programs, however, unless or until other states agree to the results in a bilateral and multilateral manner.

State Investment in Transfer-Pricing Compliance Expands – Advance Pricing Agreements

As highlighted in our previous LawFlash, many states are focusing their tax enforcement efforts on transfer-pricing issues to increase their tax bases, and the growing state budget shortfalls resulting from the coronavirus (COVID-19) pandemic have only intensified states’ focus on intercompany transactions.[1]

The Indiana Department of Revenue (IDOR) has been a leader in this regard. In FY 2019, Indiana expanded its newly constituted transfer pricing team within its Audit Operations, continued working “with a collaborative group of 13 states to share information regarding transfer pricing” and acquired the services of an expert economist.[2] According to the IDOR, the “team’s work is paying off,”[3] and it now is looking to expand its ability to collect additional transfer-pricing-related income through a new APA program.[4]

APAs have been part of federal and international transfer-pricing regimes since the early-to-mid 1990s, but this appears to be the first formal program offered at the state level.[5] “In general, an APA is an agreement between the taxpayer and [a government] that binds the taxpayer to a defined transfer pricing method and that provides, in return, that…the [government] will not challenge on audit whether the [intercompany] transactions…covered by the agreement have been conducted at arm’s length.”[6] APAs can be unilateral (with one government) or, where tax treaties exist, bilateral or multilateral (between or among two or more governments and the relevant related parties within each country). Generally, taxpayers must apply with the relevant governments for an APA (which requires significant upfront fact and economic disclosures) in the hope that the governments accept the APA application. Even when the governments accept the application, there is no assurance that the governments and taxpayer will reach a final agreement.

From the taxpayer’s perspective, the primary benefits of an APA are certainty of their future transfer-pricing results (which may also include a rollback to prior years), the avoidance of protracted audits and controversy, and the avoidance of double tax (in the bilateral/multilateral context). For its part, the IDOR states expressly that the removal of uncertainty is the benefit of its APA program.[7] Taxpayers must carefully weigh this benefit (and others) against potential and perhaps significant risks, such as, for example, voluntarily disclosing facts and economic opinions to the IDOR that may be shared with other states besides Indiana.[8]

Little is known about how the IDOR plans to implement its APA program,[9] but one significant issue is obvious: Indiana’s program will provide for unilateral APAs only. Due to the robust international tax treaty network, taxpayers often have the option of applying for bilateral or multilateral APAs for their international transactions, which is necessary to lock in real “certainty” with respect to the intercompany transactions in each relevant geography (both sides of the transaction) and avoid double tax.[10] No such bilateral or multilateral option exists at the state level. Without assurances that other states (which are also looking to expand their own tax bases through transfer-pricing adjustments) will respect the transfer-pricing results agreed to between a taxpayer and Indiana, taxpayers will not have certainty that the results of their intercompany transactions will not be subject to audit, adjustment, and double tax by other states.[11]

The expansive information sharing between Indiana and other states exacerbates this problem, because the other states can now take advantage of the information provided by taxpayers to the IDOR in seeking an APA. No part of Indiana’s APA program forecloses the state from sharing taxpayer provided information with other states. In short, by seeking an APA with Indiana, taxpayers may be compromising their positions with other states where they may or may not be under any sort of transfer-pricing audit. Unless states agree to respect the results of APAs entered into between taxpayers and other states, it appears that few taxpayers will be interested in applying for APAs under Indiana’s APA program. Indeed, doing so could cause more state transfer-pricing controversy and uncertainty, not less.


As expected, state revenue agencies are looking to transfer pricing as a means to generate more revenue to make up deficits, whether by looking to the past like North Carolina or to the future like Indiana. To its credit, Indiana has proposed an APA program that taxpayers often find to be a particularly effective way to obtain certainty with respect to their future transfer pricing. Until the results from a state APA or other voluntary disclosure lead to certainty in the other states for which the cross-border transactions relate, however, taxpayers should approach the opportunity with some trepidation and recognize that these programs could create more controversy and not less.


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If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Thomas V. Linguanti

Justin D. Cupples

New York
Cosimo A. Zavaglia 

[1] Michael Bologna, “States Target Missed Tax Collections From Intercompany Transfers” Bloomberg Law News Daily Tax Report (Aug. 13, 2020); see also “States Grappling With Hit to Tax Collections” Center on Budget and Policy Priorities (Aug. 12, 2020) (showing that most state budget shortfalls will reach 10% in FY 2020 (ending June 30, 2020) and over 20% in FY 2021 (ending June 30, 2021)).

[2] FY 2019 Indiana Annual Report at 46.

[3] Id.

[4] Indiana Department of Revenue Tax Resource Advisory Counsel (TRAC) Committee Presentation, “Transfer Pricing” (Dec. 4, 2019), slide 14.

[5] Although not addressing future years like an APA but the past, the North Carolina Department of Revenue (NCDOR) appears to be following a similar, voluntary-disclosure path as the IDOR. On July 30, 2020, NCDOR announced a “Voluntary Corporate Transfer Pricing Resolution Initiative” that allows taxpayers to participate in an expedited review of their prior related-party transactions to “provide certainty and uniformity to taxpayers, reduce time in disputes, and form an efficient basis for resolution…for all open tax years.” North Carolina Department of Revenue, “Important Notice: North Carolina Announced Voluntary Corporate Transfer Pricing Resolution Initiative” (July 30, 2020).

[6] 6920-1st T.M., Transfer Pricing: Advance Pricing Agreements. See also Rev. Proc. 2015-41, 2015-35 I.R.B. 263.

[7] Indiana Department of Revenue TRAC Committee Presentation, “Transfer Pricing” (Dec. 4, 2019), slide 14

[8] The facts-and-circumstances analysis of the numerous pros and cons of applying for an APA in any particular case is beyond the scope of this LawFlash.

[9] See Indiana Department of Revenue TRAC Committee Presentation, “Transfer Pricing” (Dec. 4, 2019), slide 14 (stating that “DOR and the Taxpayer will agree to the pricing methods and comparables used on a ‘going forward’ basis,” which will typically be good for two audit cycles (six years)).

[10] At the federal level, bilateral or multilateral APA applications compose the vast majority of all APA applications. See Announcement and Report Concerning Advance Pricing Agreements 2019-03 (showing that over 80% of all US APA applications filed in 2018 were bilateral or multilateral).

[11] NCDOR’s “Voluntary Corporate Transfer Pricing Resolution Initiative” is subject to many of the same concerns.