United States: Indiana Tax Court Rules Transfer Pricing Studies Should Be Respected When Determining Indiana Income

On December 18, 2015, the Indiana Tax Court granted a taxpayer's motion for summary judgment and held that the Indiana Department of Revenue improperly adjusted the taxpayer's Indiana source income to correct a perceived unfair reflection based on application of Indiana's standard sourcing rules.1 The Court noted that the Department's available remedy was limited to the use of reasonable alternative methods to divide the taxpayer's tax base and that the intercompany transactions between the taxpayer and its parent and affiliate included in the computation were conducted at arm's-length rates. Therefore, the standard sourcing rules fairly reflected the taxpayer's Indiana source income. Further, the Court stated that even if the income had not been fairly reflected under standard sourcing rules, the Department's proposed adjustments to the taxpayer's Indiana source income were unreasonable.


Columbia Sportswear, Inc. (Columbia), the taxpayer at issue in this matter, sells and distributes the sporting/hiking apparel, footwear, and related accessories/equipment of its parent, Columbia Sportswear Company, Inc. (CSC), and its affiliate, Mountain Hardwear, Inc. (Mountain) throughout the United States, including in Indiana. For the years at issue, both CSC and Mountain purchased these products from independent foreign manufacturers and resold them to Columbia. The price which Columbia paid for the products included value derived from CSC and Mountain's research, design, sourcing, manufacturing and advertising activities. As evidence of this value, Columbia provided transfer pricing studies conducted by an independent accounting firm documenting arm's-length pricing for these intercompany sales.

For its 2005, 2006 and 2007 tax years, Columbia filed Indiana adjusted gross income tax (AGIT) returns on a separate company basis. In 2008, Columbia filed amended returns for the 2005 and 2006 tax years requesting a refund of the AGIT that had been paid.2 Subsequently, the Department audited Columbia and adjusted its net income based on its conclusion that intercompany transactions had improperly distorted Columbia's Indiana source income.

On September 24, 2010, the Department issued assessments for the 2005, 2006 and 2007 tax years of $948,369.69 in AGIT, as well as additional penalties and interest. Columbia protested the assessments, and following a hearing, the penalties were waived.

On April 28, 2011, Columbia Sportswear initiated an original tax appeal. Both parties submitted motions for summary judgment with the Indiana Tax Court.3

Department's Authority to Modify Calculation of Indiana Source Income

Indiana taxes the portion of a corporation's adjusted gross income derived from sources within Indiana.4 Each corporation with Indiana adjusted gross income generally reports its tax liability on a separate company basis using statutory apportionment rules.5 Separate filing is the default method, but if the standard apportionment provisions do not fairly represent the taxpayer's income from sources within Indiana, the taxpayer may petition for or the Department may require an alternative apportionment method.6 In the case of organizations, trades or businesses owned by the same interests, the Department has the authority to distribute, apportion or allocate the income derived from sources within Indiana between and among the organizations, trades or businesses to fairly reflect the income derived within Indiana by the various taxpayers.7

Alternative Apportionment

In its assessment, the Department initially relied upon its authority to apply an alternative apportionment method to fairly reflect the taxpayer's Indiana source income.8 Specifically, the Department applied the following steps in its calculation of Columbia's source income adjustment:

Step 1: Determined the average net profit ratio of the federal consolidated group for each of the years at issue by dividing the group's gross receipts by net income;

Step 2: Recalculated Columbia's net income for each of the years at issue by multiplying Columbia's gross receipts by the average net profit ratios determined in Step 1;

Step 3: Ascertained the additional amount of Columbia's net income to be attributed to Indiana for each of the years at issue by subtracting Columbia's federal taxable income as reported on each year's federal pro forma income tax return9 from the applicable amount in Step 2; and

Step 4: Finally, applied Columbia's original apportionment percentage from its Indiana AGIT returns to the amount determined in Step 3.

In considering the Department's approach, the Court noted that the Department did not actually recalculate Columbia's apportionment percentage. Rejecting the Department's assertion that its computation "merely 'allocated' back the sales that Columbia Sportswear improperly sent away from Indiana to ensure that the Department had 'an accurate starting point' for determining Columbia Sportswear's AGIT liability," the Court clarified that the "concepts of allocation and apportionment under Indiana Code Sec. 6-3-2-2(l)(4) involve the division of the tax base among the states, not the computation of the tax base itself." In support of this conclusion, the Court cited similar statutory language included in the Uniform Division of Income for Tax Purposes Act (UDITPA), which deals solely with division of income, rather than determination of the tax base.10 Thus, the Court found that the statute did not grant the Department authority to adjust Columbia's net income tax base, but only to divide its tax base differently, so the requested adjustments were improper.

Distribution of Income Between Related Corporations

The Department alternatively based its assessment upon Indiana law which provides that "in the case of two or more organizations, trades, or businesses owned or controlled directly or indirectly by the same interests, the department shall distribute, apportion, or allocate the income derived from sources within the state of Indiana between and among those organizations, trades or businesses in order to fairly reflect and report the income derived from sources within the state of Indiana by various taxpayers."11 The Court agreed that if the standard sourcing rules do not fairly reflect a taxpayer's Indiana source income, this law authorizes the Department to adjust intercompany expense deductions that reduce a taxpayer's Indiana tax base, such as deductions for the cost of goods sold to an affiliate. However, with the language at issue being similar to language contained in a regulation interpreting Internal Revenue Code Sec. 482,12 the Court found the Indiana provision to serve a similar purpose, to ensure that taxpayers clearly reflect income attributable to controlled transactions and to prevent the avoidance of taxes with respect to such transactions.

The Department relied upon this provision to impose its audit adjustments,13 noting that they were necessary to correct for the impact of sales that had been erroneously sourced outside Indiana and ensure that the taxpayer had an "accurate starting point" to determine its AGIT liability. In response, Columbia produced transfer pricing studies as evidence that its intercompany transactions were conducted at arm's-length rates and, thus, its Indiana source income was fairly reflected under the standard sourcing rules.

Based on the recent Rent-A-Center Tax Court decision,14 the Court dismissed the Department's arguments against reliance on the transfer pricing studies, including that Indiana had not adopted or enacted any legislation similar or related to IRC Sec. 482 and that IRC Sec. 482's purposes are in no way related to the Indiana Code. Also discharged was an assertion by the Department that a disclaimer included in the relevant documents stating that they did not "reach any conclusions regarding state tax issues," rendered the transfer pricing studies irrelevant. Therefore, the Court found that Columbia's intercompany transactions were conducted at arm's-length rates and, since the standard sourcing rules fairly reflected its Indiana source income, the proposed adjustments were invalid.

Finally, even if the Court assumed that Columbia's Indiana source income was distorted under the standard sourcing rules, the Court found the Department's adjustments to Columbia's net income tax base to be unreasonable. Specifically, the Department's adjustments attributed over 99 percent of the gross income of the group to a single entity, Columbia. The Court found this attribution to be out of all appropriate proportion to its Indiana business activities as evidenced by its property, payroll and sales factors, which were accepted by the Department.


This decision illuminates the Tax Court's view of the Department as an administrative agency and its own role in limiting the Department to its legislatively granted power. Interestingly, as an alternative to the proceeding, the Department requested that the Court remand this case so that it could require Columbia to file a combined income tax return as an alternative method to address its finding that application of Indiana's standard sourcing rules did not clearly reflect Columbia's Indiana source income.15 As the Department itself found this approach inapplicable during the audit, the Court declined to grant the request.

This decision provides positive support for taxpayers that rely on transfer pricing studies to properly reflect the impact of intercompany transactions, and is consistent with the recent Rent-A-Center Tax Court decision issued by the same judge. In both cases, the Court found that the Department was incorrect in its requirement that the taxpayer calculate Indiana source income using an alternative method imposed by the Department, rather than the standard approach found in Indiana law. Further, the Court confirmed in both cases that transfer pricing studies that had been conducted to determine intercompany charges were both relevant to the calculation of Indiana source income, and that Indiana income was fairly stated.

The Court has made it very clear with both of these decisions that for the purpose of fairly reflecting the taxpayer's Indiana source income, the Department must recognize transfer pricing studies that have been conducted, even if such studies were not specifically performed to address a taxpayer's state income tax posture. In addition, in both cases, the Department failed to provide evidence that the taxpayer was incorporating tax avoidance practices when filing its Indiana AGIT return. Of course, while the Tax Court has made itself clear on these matters, it remains to be seen if upon potential challenge by the Department, higher-level state courts will stand in agreement.


1 Columbia Sportswear USA Corp. v. Indiana Department of State Revenue, Indiana Tax Court, No. 49T10- 1104-TA-00032, Dec. 18, 2015.

2 The facts of this case did not include the reason for amending the returns.

3 The Tax Court hearing took place on July 31, 2013.

4 IND. CODE § 6-3-2-1(b).

5 IND. CODE § 6-3-2-2(a)-(k).

6 IND. CODE § 6-3-2-2(l).

7 IND. CODE § 6-3-2-2(m). As discussed below, this provision is similar to IRC § 482.

8 IND. CODE § 6-3-2-2(l)(4).

9 For the tax years at issue, Columbia, CSC and Mountain filed federal consolidated income tax returns. For state tax reporting purposes, each entity prepared a federal pro forma income tax return to compute income and losses on a separate company basis.

10 UDITPA § 18(4) provides "[i]f the allocation and apportionment provisions of this Act do not fairly represent the extent of the taxpayer's business activity in this state, the taxpayer may petition for or the [tax administrator] may require, in respect to all or any part of the taxpayer's business activity, if reasonable, the employment of any other method to effectuate an equitable allocation and apportionment of the taxpayer's income." Although Indiana has not formally adopted UDITPA, its allocation and apportionment provisions generally mirror the UDITPA provisions.

11 IND. CODE § 6-3-2-2(m).

12 Treas. Reg. § 1.482-1(a) (1).

13 Note that the audit adjustments increased Columbia's pre-apportionment income by approximately $100 million for each year at issue.

14 Rent-A-Center East, Inc. v. Indiana Department of State Revenue, Indiana Tax Court, No. 49T10-0612- TA-0106, Sept. 10, 2015. For a discussion of this case, see GT SALT Alert: Indiana Tax Court Holds Taxpayer Not Required to File Combined Return.

15 IND. CODE § 6-3-2-2(p).

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