Essays in international taxation, 1976.

Mode of access: Internet.

Taxation of multinational banks : using formulary apportionment to reflect economic reality (Part 1)

Formulary apportionment does not attempt to undertake a transactional division of a highly integrated multinational entity. Rather, it allocates income to the jurisdictions based on an economically justifiable formula. Opposition to formulary apportionment is generally based on the argument that it is not a theoretically superior (or optimal) model because of the implementation difficulties. The conclusion that the unitary taxation model may be theoretically superior to the current arm's-length model that applies to multinational banks, despite significant implementation, compliance, and enforcement issues, is based on the unitary taxation model providing greater alignment with the unique features of these banks. The formulary apportionment model looks to the economic substance of the multinational entity and, in this sense, adopts a substance-over- form approach. Formulary apportionment further recognizes the impossibility of using arm's-length pricing for economically interdependent multinational entities. A final advantage to formulary apportionment, which is also a consequence of this model achieving greater inter-nation equity, is the elimination of double taxation.

Taxation of multinational banks : using formulary apportionment to reflect economic reality (Part 2)

As stated in Part 1 of this article, formulary appointment does not attempt to undertake a transactional division of a highly integrated multinational entity; rather, it allocates income to the jurisdictions based on economically justifiable formula. This article argues that the unitary taxation model is superior to the current arms-lenght model for the taxation of multinational banks despite significant implementation, complicance and enforcement issues. Part one of the article gave some background on the taxation of multinational banks, followed by a discussion of their uniqueness, and the theoretical benefits of the unitary tax model for multinational banking. Part 2 below covers the practical implications of accepting formulary apportionment as an 'optimal' regime for taxing multinational banks.

Unitary taxation : The case for global formulary apportionment

Unitary taxation is the taxation of the worldwide income of a multinational enterprise (MNE) and is normally based on a formulary apportionment method, which allocates income to the relevant jurisdictions based on a percentage of the MNE's world-wide profits. The unitary taxation model has several advantages over the existing arm's length model: 1. Where MNEs are highly integrated, unitary taxation has greater consistency with economic reality. 2. Greater certainty is provided to taxpayers. 3. Unitary taxation conforms to the aim of efficient operations within the MNE. 4. The aim of unitary taxation, to find an equitable split of profits between the jurisdictions, should ultimately be the overall aim of any tax regime. The advantages and disadvantages associated with the adoption of a unitary taxation model through the implementation of a formulary apportionment approach to the taxation of MNEs are examined.

The inherent international tax regime and its constraints on Australia's sovereignty

Neither an international tax, nor an international taxing body exists. Rather, there are domestic taxing rules adopted by jurisdictions which, coupled with double tax treaties, apply to cross-border transactions and international taxation issues. International bodies such as the OECD and UN, which provide guidance on tax issues, often steer and supplement these domestic adoptions but have no binding international taxing powers. These pragmatic realities, together with the specific use of the word ‘regime’ within the tax community, lead many to argue that an international tax regime does not exist. However, an international tax regime should be defined no differently to any other area of international law and when we step outside the confines of tax law to consider the definition of a ‘regime’ within international relations it is possible to demonstrate that such a regime is very real. The first part of this article, by defining an international tax regime in a broader and more traditional context, also outlining both the tax policy and principles which frame that regime, reveals its existence. Once it is accepted that an international tax regime exists, it is possible to consider its adoption by jurisdictions and subsequent constraints it places on them. Using the proposed changes to transfer pricing laws as the impetus for assessing Australia’s adoption of the international tax regime, the constraints on sovereignty are assessed through a taxonomy of the level adoption. This reveals the subsequent constraints which flow from the broad acceptance of an international tax regime through to the specific adoption of technical detail. By undertaking this analysis, the second part of this article demonstrates that Australia has inherently adopted an international tax regime, with a move towards explicit adoption and a clear embedding of its principles within the domestic tax legislation.

Double tax agreements and the international allocation of business income in Australia

Increasingly, the effectiveness of the present system of taxation of international businesses is being questioned. The problem associated with the taxation of such businesses is twofold. A system of international taxation must be a fair and equitable system, distributing profits between the relevant jurisdictions and, in doing so, avoiding double taxation. At the same time, the prevention of fiscal evasion must be secured. In an attempt to achieve a fair and equitable system Australia adopts unilateral, bilateral and multilateral measures to avoid double taxation and restrict the avoidance of tax. The first step in ascertaining the international allocation of business income is to consider the taxation of business income according to domestic law, that is, the unilateral measures. The treatment of international business income under the Australian domestic law, that is, the Income Tax Assessment Act 1936 (Cth) and Income Tax Assessment Act 1997 (Cth), will depend on two concepts, first, whether the taxpayer is a resident of Australia and secondly, whether the income is sourced in Australia. After the taxation of business profits has been determined according to domestic law it is necessary to consider the applicability of the bilateral measures, that is, the Double Tax Agreements (DTAs) to which Australia is a party, as the DTAs will override the domestic law where there is any conflict. Australia is a party to 40 DTAs with another seven presently being negotiated. The preamble to Australia's DTAs provides that the purpose of such agreements is 'to conclude an Agreement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income'. Both purposes, for different reasons, are equally important. It has been said that: The taxpayer hopes the treaty will prevent the double taxation of his income; the tax gatherer hopes the treaty will prevent fiscal evasion; and the politician just hopes. The first purpose, the avoidance of double taxation, is achieved through the provision of rules whereby the Contracting States agree to the classification of income and the allocation of that income to a particular State. In this sense DTAs do not allocate jurisdiction to tax but rather provide an arrangement whereby the States agree to restrict their substantive law. The restriction is either through the non-taxing of the income or via the provision of a tax credit.

A nation’s role in addressing base erosion and profit shifting : balancing sovereignty with international collaboration and coordination

The notion of sovereignty is central to any international tax issue. While a nation is free to design its tax laws as it sees fit and raise revenue in accordance with the needs of its citizens, it is not possible to undertake such a task in isolation. In a world of cross-border investments and business transactions, all tax regimes impact on one another. Tax interactions between sovereign states cannot be avoided. Ultimately, the interactions mean that a nation must decide whether to engage in both collaboration and coordination with other nations and supranational bodies alike or maintain an individualised stance in relation to its tax policy. Whatever the decision, there is arguably an exercise in national sovereignty in some form. In the context of an international tax regime, whether that regime is interpreted broadly as meaning international norms generally adopted by nations around the world or domestic regimes legislating for cross-border transactions, rhetoric around national fiscal sovereignty takes on many different forms. At one end of the spectrum it is relied upon by financial secrecy jurisdictions (tax havens) as a defence to their position on the basis that ‘other’ nations cannot interfere with the fiscal sovereignty of a jurisdiction. At the other end of the spectrum, it is argued that profit shifting and international tax avoidance if not stopped is, in and of itself, a threat to a nation’s fiscal sovereignty on the basis that it threatens the ability to tax and raise the revenue needed. This paper considers a modern conceptualisation of sovereignty along with its role within international tax coordination and collaboration to argue that a move towards a more unified approach to addressing international base erosion and profit shifting may be the ultimate exercise of national fiscal sovereignty. By using the current transfer pricing regime as a case study, this paper posits that it is not merely enough to have international agreement on allocation rules to be applied, but that the ultimate exercise of national sovereignty is political agreement with other states to ensure that it is governments which determine the allocational basis of worldwide profits to be taxed. In doing so, it is demonstrated that the arm’s length pricing requirement of the current transfer pricing regime, rather than providing governments with the ability to determine the location of profits, is providing multinational entities with the ultimate power to determine that location. If left unchecked, this will eventually erode a nation’s ability to capture the required tax revenue and, as a consequence, may be deemed a failure by nation states to exercise their fiscal sovereignty.

Global profit split: An evolutionary approach to international income allocation

International taxation is concerned mainly with the equitable allocation of cross-border income between countries in which income-earning activities take place. Such allocation has traditionally been governed by the arm’s-length principle, which has been interpreted as requiring a comparable transactional pricing approach. This approach assumes that each member of a multinational enterprise (MNE) group is a separate entity and that the transactions between related parties can be separated and compared with arm’s-length transactions. It has, however, proved difficult to apply comparable transactional pricing to internationally integrated businesses, especially those involving intangibles and services, and formulary apportionment has been suggested as an alternative. Essentially, formulary apportionment treats the MNE group as a single economic entity. The group’s profit is allocated to members according to a formula that reflects the particular member’s contribution to the production of that profit. A rich academic literature exists which either defends or attacks this alternative approach. The OECD and national governments have rejected formulary apportionment mainly on the ground that it violates the arm’s-length principle. This article proposes a global profit split (GPS) method for allocating international income. The GPS would allocate the global profit of an integrated business to each country in accordance with the economic contributions made by components of the business located in that country. The allocation would be based on a formula that would reflect the economic factors that contribute to profit making. While the GPS draws on elements of the traditional formulary apportionment and profit split methods, it also differs from them. The author discusses in detail the key issues involved in designing the GPS. She also presents and evaluates the main policy and pragmatic justifications for the adoption of this innovative approach. The author argues that the GPS is not only theoretically and practically superior to traditional income allocation methods, but also consistent with the arm’s-length principle. On the basis of historical developments, interpretation of article 9 of the OECD model tax convention, and international tax policy considerations, the author establishes that the GPS is not a radical departure from the arm’s-length principle, but rather a natural development in its evolution. She concludes that the law of evolution ison the side of reform because the GPS would provide for a fair and effective allocation of income derived from globally integrated business activities.

Interjurisdictional allocation of multinational banking income : aligning taxation principles with economic activity

This thesis argues that one type of multinational entity – the multinational bank – poses particularly significant challenges to the international tax regime in terms of its current profit allocation rules. Multinational banks are a unique subset of multinational entities, and as a consequence of their unique traits, the traditional international tax regime foes not yield an optimal interjurisdictional allocation of taxing rights. The opportunity for tax minimisation, achievable because of the unique traits, and realised through exploitation of the traditional source and transfer pricing regime, results in a jurisdictional distribution of taxing rights which does not reflect economic reality. There are two distinct ways in which the traditional international tax regime fails to reflect economic activity. The first way that economic activity may not be reflected in the distribution of the taxing rights to income from multinational banking is through the application of traditional source rules. The traditional sources rules allocate income where transactions are completed rather than where the intermediation services are arranged. As a result of their unique commercial role as financial intermediaries, by separating intermediary economic activity from legal transactions with third parties, multinational banks may distort the true location of the activity giving rise to income. The second way in which the traditional tax regime may fail to reflect economic activity is through the traditional transfer pricing regime requiring related or internal transaction to be undertaken at an arm’s length price. The arm’s length pricing requirement is theoretically deficient in its failure to recognise the highly integrated nature of multinational banking. In practice, the arm’s length pricing requirement is also difficult, if not impossible, to apply to multinational banks because of the requirement of comparability. The difficulties associated with the current model have resulted in a subtle move by multinational banks towards global formulary apportionment. This thesis concludes that, for the international taxation of multinational banks, the current source regime should be replaced with a system that allocates profits for tax purposes on the basis of income source, with source determined using a unitary taxation or global formulary apportionment system. It is argued that global formulary apportionment is a theoretically superior model that provides both jurisdiction to tax and allocated profits on the basis of the economic activity that generates the income.

Arm’s length pricing and multinational banks : an old fashioned approach in a modern world

In “Arm’s Length Pricing and Multinational Banks: An Old Fashioned Approach in a Modern World”, Kerrie Sadiq, describes the high level of integration of multinational financial institutions and argues that treating each element within a given operation as a separate entity for transfer pricing purposes is not economically or legally realistic. She proposes instead formulary apportionment as a device for managing this complexity.

Transfer pricing and multinational financial institutions : the case for replacing arm’s length price with a unitary approach

The international tax system, designed a century ago, has not kept pace with the modern multinational entity rendering it ineffective in taxing many modern businesses according to economic activity. One of those modern multinational entities is the multinational financial institution (MNFI). The recent global financial crisis provides a particularly relevant and significant example of the failure of the current system on a global scale. The modern MNFI is increasingly undertaking more globalised and complex trading operations. A primary reason for the globalisation of financial institutions is that they typically ‘follow-the-customer’ into jurisdictions where international capital and international investors are required. The International Monetary Fund (IMF) recently reported that from 1995-2009, foreign bank presence in developing countries grew by 122 per cent. The same study indicates that foreign banks have a 20 per cent market share in OECD countries and 50 per cent in emerging markets and developing countries. Hence, most significant is that fact that MNFIs are increasingly undertaking an intermediary role in developing economies where they are financing core business activities such as mining and tourism. IMF analysis also suggests that in the future, foreign bank expansion will be greatest in emerging economies. The difficulties for developing countries in applying current international tax rules, especially the current traditional transfer pricing regime, are particularly acute in relation to MNFIs, which are the biggest users of tax havens and offshore finance. This paper investigates whether a unitary taxation approach which reflects economic reality would more easily and effectively ensure that the profits of MNFIs are taxed in the jurisdictions which give rise to those profits. It has previously been argued that the uniqueness of MNFIs results in a failure of the current system to accurately allocate profits and that unitary tax as an alternative could provide a sounder allocation model for international tax purposes. This paper goes a step further, and examines the practicalities of the implementation of unitary taxation for MNFIs in terms of the key components of such a regime, along with their their implications. This paper adopts a two-step approach in considering the implications of unitary taxation as a means of improved corporate tax coordination which requires international acceptance and agreement. First, the definitional issues of the unitary MNFI are examined and second, an appropriate allocation formula for this sector is investigated. To achieve this, the paper asks first, how the financial sector should be defined for the purposes of unitary taxation and what should constitute a unitary business for that sector and second, what is the ‘best practice’ model of an allocation formula for the purposes of the apportionment of the profits of the unitary business of a financial institution.

OECD Project on Harmful Tax Practices

Materials presented in conjunction with a keynote speech delivered on May 15, 2003 at a congress on Tax Competition, organized by the European Tax College and held at Tilburg University, the Netherlands.

Hacia la aplicación de las guías de la Organización para la Cooperación y el Desarrollo Económicos (OCDE) sobre precios de transferencia para empresas multinacionales y administraciones tributarias en Colombia

Los precios de transferencia ocupan el interés de los Estados en el mundo actual al constituir uno de los retos fundamentales del Derecho Internacional Tributario. En el seno de la Organización para la Cooperación y el Desarrollo Económicos (OCDE), creada en 1961, se discutieron y desarrollaron diversas propuestas para regular el fenómeno. Estas, se materializaron en Modelos de Convenios Tributarios e instrumentos de soft law, que hoy en día constituyen los principios internacionalmente aceptados en la materia. Las Guías de la OCDE sobre precios de transferencia para empresas multinacionales y administraciones tributarias son el cuerpo normativo de soft law que se erigen, en el Ordenamiento Internacional, como el norte de las legislaciones a nivel interno para efectos de regulación de dicha temática. Su adopción por parte de los países miembros y no miembros de la OCDE se enfrenta a problemas teóricos derivados del quebrantamiento del decantado principio de reserva de ley tributaria y el respeto por la seguridad jurídica, razón por la cual su incorporación ha variado de Estado a Estado. El presente trabajo recoge la experiencia en varios países europeos y latinoamericanos y pretende proponer una fórmula de adopción en Colombia, coherente con los principios constitucionales tributarios y con virtualidad de superar las críticas realizadas por la doctrina a la aplicación directa de las Guías.