Advance pricing is a type of pricing arrangement between two parties that is negotiated and agreed upon at some time prior to the actual start of a working relationship between the two. In the United States, advance pricing is often associated with what is known as an advance pricing agreement (APA), a financial arrangement between the Internal Revenue Service and a taxpayer. The terms associated with the pricing are considered binding to both parties as long as neither party defaults on the provisions found in the agreement.
As part of a general business contract, advance pricing often refers to customized or discount pricing that is extended to a client at the beginning of the contract period. The pricing is normally extended with the understanding that the client will generate a specified minimum volume of business with the supplier over the course of the contract. In the event that the contract period ends and the client has failed to generate that minimum amount of business volume, the supplier may exercise provisions within the contract to assess a penalty that in effect offsets the discount on goods and services received over the term of the agreement. While this type of advance pricing agreement normally includes this type of provision, the execution of the provision is up to the vendor, who may choose to waive the penalty if the client is willing to enter into a new contract or roll the old contract into another term.
The concept of advance pricing is also common to structuring and remitting payments on taxes. With this approach, the tax agency and the taxpayer will come to terms on what is known as a transfer pricing methodology. This is simply the scheduling and formatting of a series of payments to the tax agency over a specified period of time as means of managing projected tax debt. When an advance pricing agreement is put into place between the taxpayer and the tax agency, the terms of the agreement are considered legally binding. Typically, the provisions of the agreement prevent the tax agency from seeking any type of price adjustment for any transaction covered in the agreement terms, as long as the taxpayer is filing returns and managing the covered transactions in a manner that is in compliance with the terms of that agreement.
There are actually two different types of agreements that involve advance pricing. The bilateral APA involves the taxpayer working with more than one tax agency, and is especially helpful for businesses that operate in several different countries. This is because the terms of the agreement help to prevent the incidence of double taxation on revenues produced. A unilateral advance pricing agreement is usually between a taxpayer and a single tax agency, and the terms of that agreement are not binding on any business operations that the company may have outside the jurisdiction of the agency that is part of the APA.