Advertisement

Profit Split, the Future of Transfer Pricing? Arm’s Length Principle and Formulary Apportionment Revisited from a Theoretical and a Practical Perspective

  • Heinz-Klaus Kroppen
  • Roman Dawid
  • Richard Schmidtke
Chapter
Part of the MPI Studies in Tax Law and Public Finance book series (MPISTUD, volume 1)

Abstract

This article compares the Profit Split Method (“PSM”), one of the transfer pricing methods for the application of the arm’s length principle, with Formulary Apportionment (“FA”) which is discussed as an alternative to the arm’s length principle as such. In the course of this article, we analyze and compare both approaches, in particular by considering compliance costs, resource allocation, and transition costs. Even though at a first glance FA might be viewed as similar to the PSM (or even more advanced), we demonstrate that there are crucial differences between both approaches. Based on our analysis, we conclude that FA is not an alternative to the application of the PSM. In contrast, we believe that the PSM will gain more and more importance in future. Therefore, we present our proposals to further improve the institutional framework for the application of the arm’s length principle in general and the PSM in particular. Our proposals will help to decrease double taxation, and it will lead to lower compliance costs for the taxpayers as well as for the tax authorities.

Keywords

Transfer Price Compliance Cost OECD Guideline Related Party Double Taxation 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

Preview

Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.

References

  1. Avi-Yonah, R. S., K. A. Clausing and M. C. Durst (2008), Allocating Business Profits for Tax Purposes: A Proposal to Adopt Formulary Profit Split. John M. Olin Center for Law & Economics Working Paper Series, Paper 95, Michigan: Berkeley Electronic Press.Google Scholar
  2. Baghadasarayn, D., D. Dreyer Lassen, S. B. Nielsen and P. Raimondos-Møller (2010), True Profit-Shifting, CESifo Conference Working Paper, Munich: CESifo.Google Scholar
  3. Bartelsman, E. J. and R. M. W. J. Beetsma (2003), Why Pay More? Corporate Tax Avoidance Through Transfer Pricing in OECD Countries, Journal of Public Economics, 87, 2225 – 2252.Google Scholar
  4. Bernard, A. B., J. B. Jensen, and P. K. Schott (2006), Transfer Pricing by US-based Multinational Firms, NBER Working Paper 12493, NBER.Google Scholar
  5. Blumenthal, M. and J. Slemrod (1995), The Compliance Cost of Taxing Foreign-Source Income: Its Magnitude, Determinants, and Policy Implications, International Tax and Public Finance, 2, 37 – 53.CrossRefGoogle Scholar
  6. Bucovetsky, S. and A. Haufler (2008), Tax Competition When Firms Chose Their Organizational Form: Should Loopholes For Multinationals Be Closed?, Journal of International Economics, 74, 188 – 201.CrossRefGoogle Scholar
  7. Buettner T., N. Riedel, and M. Runkel (2008), Strategic Consolidation under Formula Apportionment, CESifo Working Paper No. 2484, Munich: CESifo.Google Scholar
  8. Buettner, T. and G. Wamser (2007), Internal Debt and Multinationals' Profit Shifting Empirical Evidence from Firm-Level Panel Data, Oxford University Centre for Business Taxation Working Paper 0918, Oxford: Oxford University.Google Scholar
  9. Buettner, T., M. Overesch, U. Schreiber, and G. Wamser (2009), Taxation and Capital Structure Choice- Evidence from a Panel of German Multinationals, Economics Letters, 105, 309 – 311.CrossRefGoogle Scholar
  10. Clausing, K. A. (2003), Tax-Motivated Transfer Pricing and US Intrafirm Trade Prices, Journal of Public Economics, 87, 2207 – 2223.CrossRefGoogle Scholar
  11. Clausing, K. A. and R. S. Avi-Yonah (2007), Reforming Corporate Taxation in a Global Economy: A Proposal to Adopt Formulary Apportionment, The Hamilton Project – Discussion Paper 2007 – 08, Washington DC: The Brooking Institution.Google Scholar
  12. Collins, J. H., D. Kemsley, and M. Lang (1998), Cross-Jurisdictional Income Shifting and Earnings Valuation, Journal of Accounting Research, 36, 209 – 230.CrossRefGoogle Scholar
  13. Commission of the European Communities (2001), Company Taxation in the Internal Market.Google Scholar
  14. Davies, R. B., P. J. Norbäck and A. Tekin-Koru (2009), The Effect of Tax Treaties on Multinational Firms: New Evidence from Microdata, The World Economy, 32, 77 – 110.CrossRefGoogle Scholar
  15. Deloitte (2010), German Income Tax Audits – Survey on the experiences of inbound investors.Google Scholar
  16. Demirgüc-Kunt, A. and H. Huizinga (2001), The Taxation of Domestic and Foreign Banking, Journal of Public Economics, 79, 429 – 453.CrossRefGoogle Scholar
  17. Desai, M. A., C. F. Foley, and J. R. Hines (2004), A Multinational Perspective on Capital Structure Choice and Internal Capital Markets, Journal of Finance, 59, 2451–2588.CrossRefGoogle Scholar
  18. Desai, M. A., C. F. Foley, and J. R. Hines (2006), The Demand for Tax Haven Operations, Journal of Public Economics, 90, 513–531.CrossRefGoogle Scholar
  19. Desai, M. A., C. F. Foley and J. R. Hines (2007), Dividend Policy Inside the Multinational Firm, Financial Management, 36, 5 – 26.CrossRefGoogle Scholar
  20. Devereux, M. P. (2006), The Impact of Taxation on the Location of Capital, Firms and Profit: A Survey of Empirical Evidence, Oxford University Centre for Business Taxation Working Paper Series 07/02, Said Business School, Oxford: Oxford University.Google Scholar
  21. Dischinger, M. (2007), Profit Shifting by Multinationals: Indirect Evidence from European Micro Data, Munich Economics Discussion Papers, No. 2007-30, Munich: University of Munich.Google Scholar
  22. Eichner, T., and M. Runkel, Corporate Income Taxation in a General Equilibrium Mode”, Journal of Public Economics, forthcoming.Google Scholar
  23. Freedman, J. and G. Macdonald (2007), The Tax Base For Ccctb: The Role Of Principles, Oxford University Centre For Business Taxation, Working Paper 08/07. Oxford: Oxford University.Google Scholar
  24. Gordon, R. and J. D. Wilson (1986), An Examination Of Multijurisdictional Corporate Income Taxation Under Formula Apportionment, Econometrica, 54, 1357 – 1373.CrossRefGoogle Scholar
  25. Grubert, H. and J. Mutti (1991), Taxes, Tariffs, and Transfer Pricing in Multinational Corporate Decision Making, Review of Economics and Statistics, 73, 285 – 293.Google Scholar
  26. Grubert, H. (1998), Taxes and the Division Of Foreign Operating Income among Royalties, Interest, Dividends and Retained Earnings, Journal of Public Economics, 68, 269 – 290.Google Scholar
  27. Grubert, H. and J. Slemrod (1998), The Effect of Taxes on Investment and Income Shifting to Puerto Rico, Review of Economics and Statistics, 80, 465 – 373.CrossRefGoogle Scholar
  28. Grubert, H. (2003), Intangible Income, Intercompany Transactions, Income Shifting, and the Choice of Location, National Tax Journal, 56, 221 – 242.Google Scholar
  29. Harris, D. G. (1993), The Impact of U.S. Tax Law Revision on Multinational Corporations’ Capital Location and Income-Shifting Decisions, Journal of Accounting Research, 31, 111 – 140.Google Scholar
  30. Harris, D., R. Morck, J. Slemrod, and B. Yeung (1993), Income Shifting in U.S. Multinational Corporations, in: Giovannini, A., R. G. Hubbard and J. Slemrod (eds.), Studies in International Taxation. Chicago: University of Chicago Press.Google Scholar
  31. Hellerstein, W. and C. E. McLure (2004), The European Comission’s Report on Income Taxation: What the EU can learn from the Experience of the US States, International Tax and Public Finance, 11, 199 – 220.CrossRefGoogle Scholar
  32. Hines, J. R. (1999), Lessons from behavioral responses to international taxation, National Tax Journal, 52, 304 – 322.Google Scholar
  33. Hines, J. R. (2003), Sensible Tax Policies in Open Economies. Journal of the Statistical and Social Inquiry Society of Ireland, 32, 1 – 36.Google Scholar
  34. Hines, J. R. (2010), Testimony to the Committee on Ways and Means, United States House of Representatives in July 22, 2010. Hearing on “Transfer Pricing Issues in the Global Economy”.Google Scholar
  35. Hines, J. R., and E. Rice (1994), Fiscal Paradise: Foreign Tax Havens and American Business, Quarterly Journal of Economics, 109, 149 – 182.CrossRefGoogle Scholar
  36. Huizinga, H. and L. Laeven (2008), International Profit Shifting Within Multinationals: A Multi-Country Perspective, Journal of Public Economics, 92, 1164 – 1182.CrossRefGoogle Scholar
  37. Klassen, K., M. Lang and M. Wolfson (1993), Geographic Income Shifting by Multinational Corporations in Response to Tax Rate Changes, Journal of Accounting Research, 31, 141 – 173.CrossRefGoogle Scholar
  38. Keuschnigg, C. and M. P. Deveureux (2009), The Distorting Arm’s Length Principle, University of St. Gallen Discussion Paper No. 2009-20, St. Gallen: University of St. Gallen.Google Scholar
  39. Klein, J. and R. Schmidtke (2009), Transfer Pricing Regulations and Business Relocations, in: Klein, J., Three Essays in Industrial Organization Competition Policy and Regulation. Ph.D. Thesis, Munich: Ludwig-Maximilians-Universität München.Google Scholar
  40. Mazerov, M. (2001), The “Single Sales Factor” Formula for State Corporate Taxes: a Boon to Economic Development or a Costly Giveaway?, State Tax Notes, 20, 1775 – 1817.Google Scholar
  41. Mintz, J. and M. Smart (2004), Income Shifting, Investment, and Tax Competition: Theory and Empirical Evidence from Provincial Taxation in Canada, Journal of Public Economics, 88, 1149 – 1168.Google Scholar
  42. OECD (2004), Are the Current Rules for Taxing Business Profits Appropriate for E-Commerce? – Final Report, Centre for Tax and Policy Administration.Google Scholar
  43. OECD (2010), OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. Paris: OECD.CrossRefGoogle Scholar
  44. Overesch, M. and U. Schreiber (2008), R&D Intensities, International Profit Shifting, and Investment Decisions. University Of Mannheim Discussion Paper, Mannheim: University Of Mannheim.Google Scholar
  45. Overesch, M. (2006), Transfer Pricing of Intrafirm Sales as a Profit Shifting Channel – Evidence from German Firm Data, Zentrum für Europäische Wirtschaftsforschung (ZEW) Discussion Paper No. 06-84, Mannheim: ZEW.Google Scholar
  46. Roin, J. (2007), Can the Income Tax be Saved? The Promise and Pitfalls of Unitary Formulary Apportionment, Public Law and Legal Theory Working Paper No. 170, Chicago: University of Chicago.Google Scholar
  47. Raimondos-Møller, P. and K. Scharf (2002), Transfer Pricing Rules and Competing Governments, Oxford Economic Papers 54, 230 – 246.CrossRefGoogle Scholar
  48. Slemrod, J. and V. Venkatesh (2002), The Income Tax Compliance Costs of Large and Mid-Sized Businesses. Report to the Internal Revenue Service Large and Mid-Size Business Division. Office of Tax Policy Research, University of Michigan.Google Scholar
  49. Sullivan, M. A. (2010), Testimony to the Committee on Ways on Means, United States House of Representatives in July 22, 2010. Hearing on “Transfer Pricing Issues in the Global Economy”.Google Scholar
  50. Stöwhase S. (2005), Taxes and Multinational Enterprises in the EU: Location Decisions and Income Shifting. Ph.D. Thesis, Munich: Ludwig-Maximilians-Universität München.Google Scholar
  51. U.S. Department of the Treasury (2007): Report to the Congress on Earnings Stripping, Transfer Pricing and U.S. Income Tax Treaties.Google Scholar
  52. U.S. Government Accountability Office (GAO) (2008): U.S. Multinational Corporations. Effective Tax Rates Are Correlated with Where Income Is Reported. Report to the Committee on Finance, U.S. Senate.Google Scholar
  53. Volkering, B. and J. De Haan (2001), Tax ratios: A critical survey, OECD Tax Policy Studies, No. 5., Paris: OECD.Google Scholar
  54. Weichenrieder, J. A. (2009), Profit Shifting in the EU: Evidence from Germany, International Tax and Public Finance, 16, 281 – 297.CrossRefGoogle Scholar

Copyright information

© Springer-Verlag Berlin Heidelberg 2012

Authors and Affiliations

  • Heinz-Klaus Kroppen
    • 1
  • Roman Dawid
    • 2
  • Richard Schmidtke
    • 3
  1. 1.Deloitte GermanyFrankfurtGermany
  2. 2.Transfer pricing team of DeloitteFrankfurt am MainGermany
  3. 3.Deloitte’s German Transfer Pricing teamMunichGermany

Personalised recommendations