United States

Indiana department finding accepts taxpayer's transfer pricing study

Signals policy shift after recent tax court decisions


In the second half of 2015, the Indiana Tax Court issued two rulings rejecting the state’s well-known practice of ignoring taxpayer transfer pricing studies in applying its alternative apportionment powers to reallocate income between related parties engaging in intercompany transactions. While the impact of those rulings was not immediately clear, a recent Indiana Letter of Findings sustained a taxpayer’s protest of an audit’s unfounded rejection of the taxpayer’s transfer pricing study—signaling a shift in the Indiana Department of Revenue’s view of the evidentiary value of taxpayer transfer pricing studies and the burden of proof on the department to substantively rebut a study’s determinations.

The 2015 decisions  

In Rent-A-Center East v. Indiana, the Indiana Tax Court determined that the taxpayer’s transfer pricing study was relevant to demonstrate intercompany transactions were at arm’s-length after a department audit, in applying an alternative apportionment method to the taxpayer, rejected the study out-of-hand because (1) it addressed financial accounting, not tax, (2) it concerned federal law, not state law, and (3) as a study generated by the taxpayer, it was fundamentally flawed and had no binding effect on the state tax authority. The Tax Court addressed each of the department’s arguments, ultimately finding that it was undisputed that the study established the taxpayer’s intercompany transactions were conducted at arm’s-length, and rejecting the department’s contention that the taxpayer-generated transfer pricing study had no evidentiary value.

In Columbia Sportswear v. Indiana, the Indiana Tax Court, relying on its prior decision in Rent-A-Center, rejected the department’s position that a taxpayer’s transfer pricing study was irrelevant and did not rebut its audit findings. Additionally, the court rejected the department’s new argument that disclaimer language in the study limiting the scope of the study to federal law rendered the study valueless for state law purposes.  

Letter of Findings

In light of the Indiana Tax Court decisions in Rent-A-Center and Columbia Sportswear, the department’s protest division released Letter of Findings 02-20150171, finding that the state’s audit determinations did not adequately support the department’s application of an alternative apportionment methodology absent sufficient grounds for rejecting a taxpayer’s transfer pricing study.

The taxpayer under audit was an out-of-state parent company of a group of corporations in the business of selling women's clothing at retail locations in Indiana. The taxpayer purchased the clothing from an out-of-state related party that did not file an Indiana income tax return. The out-of-state related party procured the clothing from third parties. As a result of these procurement transactions, the taxpayer benefited from a substantial deduction in Indiana, the income side of which was not subject to tax in the hands of the out-of-state related party.

On audit, the department concluded that the taxpayer’s reporting methodology did not fairly reflect Indiana income because while the taxpayer deducted the payments to the subsidiary for merchandise sold in Indiana, the same payments received by the subsidiary were not reported in Indiana because the subsidiary was not required to file in the state. Accordingly, the department adjusted the income of the taxpayer to add back the deduction for payments to its out-of-state related party. In making this adjustment, the department rejected the taxpayer’s transfer pricing study as evidentiary support for the validity of the transactions because of the close relationship between the taxpayer and the out-of-state related parties and issues with certain aspects of the study substantially similar to those addressed in Rent-A-Center and Columbia Sportswear.

On administrative appeal, the department’s protest division, citing to both Rent-A-Center and Columbia Sportswear, determined that the audit did not provide sufficient grounds for applying an alternative apportionment method because the audit determination failed to adequately address the taxpayer’s transfer pricing study. In reaching this conclusion, the department’s protest division did note that the audit reasonably concluded that the study appeared weighted to minimize the taxpayer’s Indiana tax exposure, but in light of both recent tax court decisions, the audit did not establish ‘reasonableness’ to reallocate the taxpayer’s gross operating margin.  Importantly, the department’s protest division concluded that, when addressing the application of the department’s alternative apportionment powers to intercompany transactions, the burden of proof rests on the department to invalidate a taxpayer’s transfer pricing study, and merely issuing an assessment notice does not shift that burden back to the taxpayer.


Indiana taxpayers should be encouraged that the department is embracing the analysis of the department’s protest division decisions. The Letter of Findings cites to Columbia Sportswear in concluding that the application of the department’s authority to require an alternate apportionment of income is ambiguous and that those ambiguities must be resolved against the department, and places the burden of proof squarely on the department when a taxpayer offers a transfer pricing study as evidence for the validity of its intercompany transactions. For now, it appears that the department will have to meet a higher evidentiary threshold to reject a taxpayer’s transfer pricing study in an alternative apportionment case. However, taxpayers should be aware that the department may seek legislative assistance to shift the burden of proof back to the taxpayer in these situations.


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