Contents - AL-Tax
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Contents - AL-Tax

Contents - AL-Tax Contents - AL-Tax

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Part IEconomic and Accounting Ratesand Concepts Should Not be Conflated

Chapter 2Economic vs. Accounting Profit RatesThis chapter contains a brief overview of the key differences between economicand accounting measures of profit rates, and the “big picture” practical implicationsof substituting accounting measures for economic measures in the transfer pricingregulations.The transfer pricing methodologies written into the U.S. and OECD regulationsand guidelines are loosely founded on economic concepts of equilibrium under specificcompetitive conditions. These concepts are taken to justify comparisons of ratesof return (and other “profit level indicators”) across firms. Such comparisons are thecornerstone of our current transfer pricing regimes. More particularly, individualmembers of a multinational firm are generally likened to a set of quasi-comparablestandalone companies, and their gross or operating profits are determined, for taxpurposes, by imputing the independent sample companies’ rates of return, grossmargins, operating margins or other measures of profits thereto.In theory, economic rates of return in product markets are equalized (albeit onlyin the infamous “long run” under competitive conditions). However, as noted, theU.S. and OECD transfer pricing regulations and guidelines substitute accountingmeasures of profit, rates of return and asset values for economic profits, rates ofreturn and asset values. As described below, accounting measures do not play thesame signaling and resource allocation roles that economic rates of return play inan economy. Therefore, they would not be equalized even in competitive marketspoised in long–run equilibrium, much less in the imperfectly competitive marketsin various states of disequilibrium that are the norm. Stated differently, there is noreasonable basis for assuming that one firm will earn the same accounting rate ofreturn as a similarly situated competitor. This observation applies equally to otheraccounting measures of profit.The fields of economics and accounting serve very different purposes. Microeconomicand financial theories seek to explain the allocation of resources in aneconomy through firm, consumer and investor behavior and market mechanisms.Economic profits drive firm behavior and lead to the maximization of shareholders’wealth (and, thereby, their lifetime consumption). The calculation of such profitsreflects the actual timing of investments (rather than smoothing out periodic capitalexpenditures via depreciation) and incorporates all costs, including the cost ofE. King, Transfer Pricing and Corporate Taxation,DOI 10.1007/978-0-387-78183-9 2, C○ Springer Science+Business Media, LLC 20097

Part IEconomic and Accounting Ratesand Concepts Should Not be Conflated

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