Article

Reviving transfer pricing enforcement through formulary apportionment

The international tax system is fundamentally flawed and large multinational enterprises exploit these flaws to drastically reduce their effective tax rates. Data indicates that the most powerful tool for multinational enterprises to reduce their tax liabilities is arm's-length transfer pricing. The arm's-length standard is a relic forced upon the world until it became the norm for most countries. An attractive alternative to arm's-length transfer pricing is transfer pricing based upon formulary methods. Though imperfect and maligned by the Treasury and practitioners, formulary apportionment goes a long way in alleviating the problems created under the arm's-length standard, including its inability to address the inter-company pricing of intangibles. The global financial crisis of 2007-2008 created a unique opportunity to address this flaw in the international tax system. In the wake of the crisis and through a slow economic recovery, politicians across the world grilled multinational enterprises for their exploitation of weaknesses in the international tax regime and called on the OECD to take action to strengthen it. In 2013, the OECD responded with an ambitious Action Plan and followed up with bold discussion drafts that hinted at an embrace of formulary methods when transactional methods proved insufficient. Disappointingly, the OECD backed away from this position in its final transfer pricing reports in 2015 due to immense pressure that largely came to the United States. The OECD's final reports reaffirm its adherence to the arm's-length standard and promulgated a watered-down version of country-by-country reporting. The door is closing fast for the OECD to make the changes necessary to address one of the greatest weaknesses of the current international tax regime.

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