The traditional rationale of the arm’s length approach to transfer pricing : should the separate accounting model be maintained for modern multinational entities?

This article examines the current transfer pricing regime to consider whether it is a sound model to be applied to modern multinational entities. The arm's length price methodology is examined to enable a discussion of the arguments in favour of such a regime. The article then refutes these arguments concluding that, contrary to the very reason multinational entities exist, applying arm's length rules involves a legal fiction of imagining transactions between unrelated parties. Multinational entities exist to operate in a way that independent entities would not, which the arm's length rules fail to take into account. As such, there is clearly an air of artificiality in applying the arm's length standard. To demonstrate this artificiality with respect to modern multinational entities, multinational banks are used as an example. The article concluded that the separate entity paradigm adopted by the traditional transfer pricing regime is incongruous with the economic theory of modern multinational enterprises.

The traditional rationale of the arm's length approach to transfer pricing - should the separate accounting model be maintained for modern multinational entities?

This article examines the current transfer pricing regime to consider whether it is a sound model to be applied to modern multinational entities. The arm's length price methodology is examined to enable a discussion of the arguments in favour of such a regime. The article then refutes these arguments concluding that, contrary to the very reason multinational entities exist, applying arm's length rules involves a legal fiction of imagining transactions between unrelated parties. Multinational entities exist to operate in a way that independent entities would not, which the arm's length rules fail to take into account. As such, there is clearly an air of artificiality in applying the arm's length standard. To demonstrate this artificiality with respect to modern multinational entities, multinational banks are used as an example. The article concluded that the separate entity paradigm adopted by the traditional transfer pricing regime is incongruous with the economic theory of modern multinational enterprises.

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.

The taxation of multinational banking income : is the traditional rationale correct?

This article argues that multinational banks have characteristics which are unique and distinguishable from traditional multinational entities. The first distinguishing feature is the unique nature of the services and consequent products supplied by multinational banks, which are aimed at meeting client global demand. The second distinguishing feature is the non-traditional organisational structure that is adopted. This structure, also designed to meet client global demand, introduces issues previously not recognised in the traditional taxation system, which is designed for the structure of traditional multinational entities. The unique differences between traditional multinational entities and multinational banks means there may be the need for a distinct international tax regime. It is argued that there are “outmoded economic assumptions” upon which the present tax laws relating to multinational banks are based. An examination of the unique nature of multinational banks leads to the conclusion that the appropriate tax treatment of these banks is different from the appropriate tax treatment of multinational entities generally.

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.

The taxing effects of the advance pricing arrangement program: A review of APAs and their impact on stakeholders

The current transfer pricing rules contained in Australia’s taxation regime are designed to counter the underpayment of tax by businesses engaged in international related-party dealings. Currently, these transactions must take place at an arm’s length price, a requirement which is becoming increasingly difficult to demonstrate. This results in an increased risk of an audit by the Australian Taxation Office. If a taxpayer wishes to avoid the risk of an audit, and any ensuing penalties, there is one option: an advance pricing arrangement (‘APA’). An APA is an agreement whereby the future transfer pricing methodology to be used to determine the arm’s length price is agreed to by the taxpayer and the relevant tax authority or authorities. This article investigates the use of APAs as a solution to the problem of transfer pricing and considers their impact on stakeholders. It is argued that while APAs provide a valuable practical tool for multinational entities facing the challenges of the taxation of global trading under the current regime, they may not be a practical long term solution.

Advance pricing arrangements : an Australian Tax Office success or a legislative failure?

Australia’s domestic income tax legislation and double tax agreements contain transfer pricing rules which are designed to counter the underpayment of tax by businesses engaged in international dealings between related parties. The current legislation and agreements require that related party transactions take place at a value which reflects an arm’s length price, that is, a price which would be charged between unrelated parties. For a host of reasons, it is increasingly difficult for multinational entities to demonstrate that they are transferring goods and services at a price which is reflective of the behaviour of independent parties, thereby making it difficult to demonstrate compliance with the relevant legislation. Further, where an Australian business undertakes cross-border related party transactions there is the risk of an audit by the Australian Tax Office (ATO). If a business wishes to avoid the risk of an audit, and any ensuing penalties, there is one option: an advance pricing arrangement (APA). An APA is an agreement whereby the future transfer pricing methodology to be used to determine the arm’s length price is agreed to by the taxpayer and the relevant tax authority or authorities. The ATO views the APA process as an important part of its international tax strategy and believes that there are complementary benefits provided to both the taxpayer and the ATO. The ATO promotes the APA process on the basis of creating greater certainty for all parties while reducing compliance costs and the risk of audit and penalty. While the ATO regards the APA system as a success, it may be argued that the implementation of such a system is simply a practical solution to an ongoing problem of an inherent failure in both the legislation and ATO interpretation and application of this legislation to provide certainty to the taxpayer. This paper investigates the use of APAs as a solution to the problem of transfer pricing and considers whether they are the success the ATO claims. It is argued that there is no doubt that APAs provide a valuable practical tool for multinational entities facing the challenges of the taxation of global trading under the current transfer pricing regime. It does not, however, provide a long term solution. Rather, the long term solution may be in the form of legislative amendment.

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.

Country-by-country reporting: A critical analysis

This thesis evaluates the recent work of the Organisation for Economic Cooperation and Development and civil society groups in creating requirements for multinational entities to disclose financial information on a Country-by-Country basis. Country-by-Country reports may identify profit-shifting activities and enable various stakeholders to hold multinational entities accountable for their global conduct, through the provision of transparent and decision-useful information. This thesis identifies inadequacies in current disclosure requirements and develops a standardised Country-by-Country model, which is applied to the disclosures of three multinational entities to illustrate its pragmatic feasibility and the improvement in quality of financial information available to users.

The system of Transfer Pricing in a multinational

Transfer prices are used by the majority of firms worldwide when intermediate products or services are transferred within the same organization. These prices are reported as revenue for the selling entity (division, unit, department etc.) and as cost for the buying entity. Nevertheless, transfer prices lead to many disputes among managers in the same organization as transfer prices influence the performance of their entities. In cross-border transactions, transfer prices can be used by firms to reduce corporate taxes and thus, increase total firm profits. In order to fight against this firms’ practice, tax authorities require firms to establish a transfer pricing system in accordance with OECD1 Transfer Pricing Guidelines.

Corporate governance options for the local subsidiaries of multinational enterprises

While the corporate governance literature generally focuses on the parent legal entity, many organisations are now multinational enterprises (MNEs) with subsidiaries that are most often legal entities in their host countries. Despite the strengthening of corporate governance regimes internationally, the boards of these subsidiaries are in many instances perfunctory. This paper examines the question of whether developments in corporate governance theory and practice can add value for the local subsidiaries of MNEs. This paper provides a theoretical basis for evaluating governance models in MNEs. The paper commences with a review of the key concepts from the MNE and conglomerates literature with respect to core MNE strategies. The paper then discusses what the "governance roles" are that must be performed in MNE subsidiaries. We propose four governance frameworks for subsidiary corporations. These frameworks are: (1) Direct Control; (2) Dual Reporting; (3) Advisory Board; (4) Local Board. We consider the strengths and weaknesses of each model in relation to international strategy theory. We conclude with recommendations for the conditions under which the various models may be appropriate and practical guidelines for the utilisation of corporate governance theory to improve MNE performance.

The adjustment of leadership styles in intercultural workplace – some evidences from the multinational construction companies in Hong Kong

This study investigates the existence of intercultural adjustment in the multicultural construction workplaces by examining the leadership orientations (task-/people-orientation), communication and conflict resolution skills (high/low-context culture), and power relationship styles (high/low power distance) of local Chinese and the British expatriate project managers in the multinational construction companies in Hong Kong. A sample of project managers (N = 40) and their subordinates (N = 61) were surveyed using the structured questionnaires. Statistical techniques (independent-samples t-test, and Pearson correlation analysis) were employed to evaluate the data. The results revealed a number of interesting findings. First, it was found that both project manager groups equally considered the importance of task performance and interpersonal relationship. The results of correlations analysis provide support for the linkages of the length of working abroad with the change in task/people orientation for Chinese and expatriate managers. The analysis revealed that those Chinese managers who have the longest length of time living or working in Western countries tended to measure higher on task-orientation. Similarly, those British expatriate managers who have the longest period of working in Hong Kong tended to be less task-orientated. Second, local Chinese managers were found to be more confrontational when they strongly disagree with their team members than their British expatriate counterparts. It would appear that stress from project deadline which increase the directness and terseness in communication acts, and retain the composure of project managers in dealing with the subordinates. Finally, our findings show that there is significant difference between local Chinese and British expatriate managers in their power relationship with subordinates. This implies that although the intercultural adjustment might influence perceptions of local and expatriate managers, some dominant deep-rooted cultural values and beliefs are still not easily altered. Conclusions are presented along with suggestions for future studies.

Unincorporated associations as entities : a matter of balance between regulation and facilitation?

Small non-profit organisations play a vital role in the creation of social capital and resilience of civil society in Australia. A number of government inquiries have recently been commissioned to propose reform to non-profit enterprise and it is timely to examine the suitability of legal structures available for small non-profit organisations. This article reviews the characteristics of small Australian non-profit organisations and the legal treatment of similar associations in New Zealand, the United Kingdom, Europe, Canada and United States to inform possible reform strategies. Reforms are then proposed for small Australian unincorporated organisations which allow them access to the benefits of separate legal entity status, but with regulation proportionate to the risks posed to the broader community.