Taxation And Finance

Tax Jurisdictions

The current transfer pricing regime produces inequitable results. Because the
existing transfer pricing laws and regulations are not based on defensible economic principles, or on transparent rules that all countries apply uniformly, they produce arbitrary results. Arbitrary apportionments of multinational firms’ income across the countries in which they operate are inherently inequitable.

Multinational and domestic firms are not treated uniformly for tax purposes. In the abstract, the arm’s length principle appears to ensure that domestic and multinational firms will be treated uniformly for tax purposes, essentially by definition. However, individual standalone competitors in a given market often report markedly different operating results in the same reporting period. By requiring individual members of a multinational group to report gross margins, markups or accounting rates of return that are contained in the interquartile range of third parties’ results (a U.S. regulatory provision that the OECD Guidelines do not endorse), multinational firms are treated more favorably for tax purposes than a subset of their domestic counterparts, and less favorably than others.

Inequity is inherently problematic, and uncertainty is costly, both for tax authorities and individual corporations and from an economy-wide perspective. Explicit costs, from tax authorities’ perspectives, include costs incurred in conducting audits and analyzing transfer pricing issues, and in resolving conflicts over income allocations with their opposite numbers in other tax jurisdictions.

Tags: Tax Jurisdictions

Taxpayers And Tax Authorities

Tax authorities in different jurisdictions are likely to allocate individual multinational firms’ consolidated income across countries in different ways. This statement would be true even if tax authorities utilized the same transfer pricing methodology, given the sensitivity of one’s results to the particular “comparable companies” included in one’s sample (and, in the case of the CPM, the particular profit level indicator used).

However, as a practical matter, tax authorities are likely to use different transfer pricing methodologies in analyzing a given case.Most countries endorse the arm’s length standard in principle, and the U.S. and OECD provisions contain the same specific set of transfer pricing methodologies . However, the IRS has a clear predilection to use one particular profits-based method (the CPM), while OECD countries prefer transactions-based methods.

Different approved methodologies will generally produce different allocations of income, because the assumed unifying foundation across methods—primarily the basic concept of market equilibrium—does not in fact apply. The large number of cases handled by the competent authorities of different countries attests to this conundrum, which in turn creates the potential for double taxation on a significant scale.

Individual multinational corporations cannot accurately anticipate their country-specific tax liability in the absence of an Advance Pricing Agreement.Corporate taxpayers and tax authorities, respectively, also frequently utilize different firm samples and/or transfer pricing methodologies to determine their tax liability (taxpayers before an audit and tax authorities during an audit). Because the use of different samples and/or methods will often produce inconsistent results, firms acting in good faith may report substantially less income in a given jurisdiction than the tax authority in that jurisdiction believes is warranted.

Tags: Authorities, Tax, Taxpayers