What Is an Advance Determination Ruling?

An advance determination ruling (ADR) is a decision or ruling issued by the Internal Revenue Service to a taxpayer about a taxation or pricing matter. While determination letters from the IRS usually address transactions that have already occurred, they may also be issued on the tax consequences of proposed transactions, hence the term "advance." It is also known as an "Advance Pricing Agreement." The IRS has broad discretion in refusing to consider an advance determination request and also has broad discretion in refusing to issue a ruling even though it may have agreed to consider the ADR request.

Understanding Advance Determination Ruling (ADR)

Most advance determination rulings (ADRs) concern the tax-exempt status of organizations and employee benefit plans. Determination letters are issued to tax-exempt organizations, for example, showing the determination of the IRS that the organization is indeed tax exempt and which provision of the tax code is the basis for the exemption. The determination letter is binding on the IRS so long as the facts and law underlying the determination remain in place. If the taxpayers' facts or the law changes, the letter may no longer be valid. While companies may prefer to obtain an advance determination ruling before any transaction whose tax aspects are unclear, it may not always be possible from a practical standpoint.

ADR and Transfer Pricing

ADRs often involve matters about transfer price, which is the price at which divisions of a company transact with each other, such as the trade of supplies or labor between departments. For example, consider a transaction that involves transfer pricing between a U.S. company and its foreign subsidiary. If this transaction is concluded before the ADR is obtained from the IRS, in the event of an adverse ruling, the company may have to adjust or reverse the transaction and also be potentially subject to fines. The IRS recognizes that international transfer pricing cases can often lead to lengthy and expensive administrative appeals and litigation.

The purpose of the ADR procedure is to reduce the uncertainties and improve the predictability for both the taxpayer and the government due to international transactions, and also to ease the cost burden and expense of an examination necessary to resolve transfer pricing controversies for both the taxpayers and the governments involved. The IRS will make a judgment about the request after analyzing the information supplied by the taxpayer, along with other relevant information. The IRS will review the submission, and if necessary, discuss it with the taxpayer, and, if found acceptable, issue a ruling.