Taxation And Finance

Tax Purposes

The transfer pricing methodologies written into the U.S. and OECD regulations and guidelines are loosely founded on economic concepts of equilibrium under specific competitive conditions. These concepts are taken to justify comparisons of rates of return (and other “profit level indicators”) across firms. Such comparisons are the cornerstone of our current transfer pricing regimes.

More particularly, individual members of a multinational firm are generally likened to a set of quasi-comparable standalone companies, and their gross or operating profits are determined, for tax purposes, by imputing the independent sample companies’ rates of return, gross margins, operating margins or other measures of profits thereto.

In theory, economic rates of return in product markets are equalized (albeit only in the infamous “long run” under competitive conditions). However, as noted, the U.S. and OECD transfer pricing regulations and guidelines substitute accounting measures of profit, rates of return and asset values for economic profits, rates of return and asset values. As described below, accounting measures do not play the same signaling and resource allocation roles that economic rates of return play in an economy.

Therefore, they would not be equalized even in competitive markets poised in long–run equilibrium, much less in the imperfectly competitive markets in various states of disequilibrium that are the norm. Stated differently, there is no reasonable basis for assuming that one firm will earn the same accounting rate of return as a similarly situated competitor. This observation applies equally to other accounting measures of profit.

Tags: Purposes, Tax