Part 1 - AL-Tax
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Part 1 - AL-Tax

Part 1 - AL-Tax Part 1 - AL-Tax

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Chapter 6APAs are intended to supplement the traditional administrative, judicial, andtreaty mechanisms for resolving transfer pricing issues and tax base allocation. Theyare assumed to be most useful when traditional mechanisms to allocate incomeof related-party business within the multinational group fail or are difficult todeploy because of a lack of institutionalization in international taxation and thetransfer pricing systematic.Based on this analysis, we can make some recommendations on governing internationaltaxation in the field of transfer pricing and international tax base allocation:In the long run, state activity such as taxation finds its transaction cost-efficient governancestructure – as for private sector transactions. In the case of taxing MNCs, thetax base allocation is in some instances efficiently governed in a nonbureaucraticform (nonhierarchical) as a cooperative mechanism based on principled negotiation.International tax policies should consider that cooperative, nonadversarialmechanisms can be a helpful tool to resolve transfer pricing and tax base controversieswhich could otherwise not be governed properly, leaving both the taxpayer andthe tax authorities involved with deadweight losses.However, nonbureaucratic governance may not be the most efficient policy designunder all circumstances – as the prevalence of bureaucratic taxation mechanisms inalmost all tax jurisdictions proves. In international taxation, as international regimesand international organizations begin to provide problem-solving principles, rules,norms, and provisions to both the taxpayer and the tax administration, resolvingtransfer pricing disputes ex-ante through the APA vehicle is likely to be a temporarymechanism. If, by means of, say, better tools or principles, transfer pricing becomes astandardized mechanism in international tax base allocation, bureaucratic governancemay supersede the hybrid APA governance mode. However, such a prospecteddisappearance of nonbureaucratic governance in the field of international tax baseidentification and allocation may be accompanied by a shift in some elements of taxsovereignty from the nation state to supranational and/or international jurisdiction.AcknowledgmentsThis chapter emerged from a research project on advance pricing agreements at theDepartment of Political Sciences of the FernUniversität Hagen (Germany), and itwas completed during a teaching and research visit of the first author at the IndianInstitute of Management, Ahmedabad, India. The research was completed in late2005. We are grateful to both academic institutes for fruitful seminar discussionsand resources provided to launch this paper. Also, we thank Martin Galdia, RebeccaSimmons, and P.S. Seshadri for research assistance.141

International Taxation HandbookNotes1. Irving (2001) reports litigation periods of up to 15 years (also see Walpole, 1999; Erard, 2001).2. Around four-fifths of parent companies and nearly all subsidiaries consider transfer pricing asthe most crucial tax issue nowadays; APAs are understood by around half of multinationals asa potential dispute avoidance mechanism in corporate taxation (cf. Ernst & Young, 2001; Seealso http://www.legalmediagroup.com/default.asp?Page1&SID15032).3. TPMs are transaction-based methods, such as Comparable Uncontrolled Price (CUP), Cost Plus(C), Resale Price Minus (R), Transactional Net Margin Method (TNMM). Examples of profitbasedmethods are Residual Profit Split Method (RPS), Comparable Profit Method (CPM), and ProfitSplit Methods (PS). Some countries also consider Formula Apportionment using certain allocationfactors (often, assets, sum of wage, turnover) as an appropriate TPM (cf. Eden, 1998).4. Also, many emerging countries such as China, India, or Brazil lack a sound body of transfer pricingcase law – as compared to the USA or many European Union-15 countries.5. As is often misunderstood in the public debate on tax reforms and tax burdens, the key challengein both domestic and international taxation is not the size of the tax rate but whether principlessuch as tax withholding vs. revenue sharing with information exchange between countries areapplied (Keen and Ligthart, 2005). Under the latter case, the determination and identification of thetax base is the core problem. One reason for the misleading discussion on the relevance of (nominal)tax rates on the total tax burden of a taxpayer might be caused by the economic models usedfor cross-country comparisons of the tax burden. These models normally assume comparable proceduresand methods to identify the tax base on which a different tax rate is applied and for whataffect it will have on the taxpayer (investment behavior). Often the large variance across countriesto define the tax base is not reflected, especially in the field of practiced transfer pricing with itshuge dependency upon the definition of expenses and cost in a given jurisdiction of accountingprinciples. Transfer pricing plays a key role in identifying the tax base, hence constituting a ‘hottopic’ in international taxation (Eyk, 1995; Bartelsman and Beetsma, 2000; Ernst & Young, 2003).6. All major tax and business consultancies, including audit units (PricewaterhouseCoopers, Ernst &Young, KPMG, Deloitte & Touche, Transfer Pricing Associates, GlobalTransferPricing Business Solutions),run a global team of top transfer pricing experts providing services to their internationalclients. Consultancy fees for transfer pricing services are among the highest in the tax consultingservice industry segment.7. This can also be illustrated by the fact that, if a certain tax case enters the process of so-calledMutual Agreement Procedures (MAP), in many countries the Ministry of Foreign Affairs needsto be involved to meet the requirements of such a country to interact internationally.8. Of course, in addition to the taxation mechanism, a sovereign state can also generate budgetthrough nonadministrative activities such as running firms, taking part in capital and currencymarkets through publicly owned banks and through central banks, imposing tariffs and fees onservices, etc.9. We follow Williamson’s (1999, p. 316) remediableness criterion, which holds that an extant modeof organization is efficient if no feasible alternative can be described and implemented withexpected net gains.10. For an examination of the distinction between costs of equalizing asymmetric informationand costs of apprising an arbiter of the true information condition, see also Williamson (1996,142

Chapter 6APAs are intended to supplement the traditional administrative, judicial, andtreaty mechanisms for resolving transfer pricing issues and tax base allocation. Theyare assumed to be most useful when traditional mechanisms to allocate incomeof related-party business within the multinational group fail or are difficult todeploy because of a lack of institutionalization in international taxation and thetransfer pricing systematic.Based on this analysis, we can make some recommendations on governing internationaltaxation in the field of transfer pricing and international tax base allocation:In the long run, state activity such as taxation finds its transaction cost-efficient governancestructure – as for private sector transactions. In the case of taxing MNCs, thetax base allocation is in some instances efficiently governed in a nonbureaucraticform (nonhierarchical) as a cooperative mechanism based on principled negotiation.International tax policies should consider that cooperative, nonadversarialmechanisms can be a helpful tool to resolve transfer pricing and tax base controversieswhich could otherwise not be governed properly, leaving both the taxpayer andthe tax authorities involved with deadweight losses.However, nonbureaucratic governance may not be the most efficient policy designunder all circumstances – as the prevalence of bureaucratic taxation mechanisms inalmost all tax jurisdictions proves. In international taxation, as international regimesand international organizations begin to provide problem-solving principles, rules,norms, and provisions to both the taxpayer and the tax administration, resolvingtransfer pricing disputes ex-ante through the APA vehicle is likely to be a temporarymechanism. If, by means of, say, better tools or principles, transfer pricing becomes astandardized mechanism in international tax base allocation, bureaucratic governancemay supersede the hybrid APA governance mode. However, such a prospecteddisappearance of nonbureaucratic governance in the field of international tax baseidentification and allocation may be accompanied by a shift in some elements of taxsovereignty from the nation state to supranational and/or international jurisdiction.AcknowledgmentsThis chapter emerged from a research project on advance pricing agreements at theDepartment of Political Sciences of the FernUniversität Hagen (Germany), and itwas completed during a teaching and research visit of the first author at the IndianInstitute of Management, Ahmedabad, India. The research was completed in late2005. We are grateful to both academic institutes for fruitful seminar discussionsand resources provided to launch this paper. Also, we thank Martin Galdia, RebeccaSimmons, and P.S. Seshadri for research assistance.141

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