Contents - AL-Tax

2 1 Introductionof specific transfer pricing methods. As applied to profits-based transfer pricingmethods in particular, they are caused, or compounded, by the substitution ofaccounting rates of return (and other accounting measures of profitability) for economicrates of return. While accounting measures of profitability serve numeroususeful purposes in other contexts, they are not compatible with the transfer pricingregulations’ economic foundations. The use of accounting rates of return in lieuof economic rates of return to allocate multinational firms’ income among the taxjurisdictions in which they operate yields arbitrary and unpredictable results.Leaving aside the logical flaws in the current transfer pricing regimes, the rangeof methods that individual countries sanction, each of which presupposes a certaindivision of labor or type of transaction among members of a multinational group, isno longer consonant with the much wider range of fact patterns that one observes“on the ground,” due in significant part to the emergence of new, Internet-basedactivities and the growing influence of hedge and private equity funds. The Internethas caused the rapid depreciation of certain traditional intangible assets, given rise tonew types of intangible assets (e.g., online user communities), transformed marketingand distribution activities and altered (or eliminated) the division of labor amongaffiliated companies. The development of global private equity funds, with portfoliocompanies headquartered in numerous countries, has resulted in the segmentationof capital-raising, due diligence and investment management functions. The samesegmentation between distribution and investment advisory functions is evident inthe hedge fund industry as well.It is relatively uncommon for individual members of a multinational group thathas evolved organically to maintain separate research facilities, or otherwise independentlydevelop intangible assets other than trademarks. Some notable exceptionsto this general observation, ironically, are e-commerce companies. Despite the factthat such firms often have a limited physical presence, and national boundaries donot exist in cyberspace, there are numerous impediments to the formation of genuinelyborder-free e-commerce websites. Such obstacles include (a) language; (b)local customs, tastes and preferences, not only for particular types of goods andservices but also for the “look and feel” of sites and user interface features; (c)legal protections vis-a-vis the transfer of personal information on the Internet, andconsumers’ comfort level in doing so; (d) legal restrictions on the types of productsthat can be sold on the Internet; (e) the extent to which users benefit from freespeech protections; (f) currency; (g) payment mechanisms; (h) customs duties; and(i) shipping.As a result of these impediments to the development of border-free Internetsites, certain affiliated companies with Internet-based operations have separatelydeveloped their own, distinct user communities. Conversely, certain other types ofInternet-based businesses, where user communities as such are not overly important,have originated in one country, and expanded by replicating the same businessmodel in other countries (with relatively minor or cosmetic adaptations to accommodatecountry-specific preferences, laws and regulations). This pattern of internationalexpansion generally entails the transfer of a bundle of intangible assets,including the business model, proprietary IT and marketing tools and strategies.