Paul L. Caron

Tuesday, November 12, 2019

The Arm's Length Standard Is Not The Problem

Lorraine Eden (Texas A&M), The Arm's Length Standard Is Not the Problem, 48 Tax Mgmt. Int'l J. 10 (Oct. 11, 2019):

The historical approach to taxing intrafirm transactions of multinational enterprises — the arm’s-length standard (ALS) — has been criticized as unworkable, out of date and on death’s door. Criticisms of the ALS fall into two broad categories. First are concerns that MNEs have been deliberately engaging in abusive transfer pricing that is extensive, unfair and draining development. Second is that the transfer pricing rules are too difficult to implement for various reasons, of which the two most important reasons are the lack of arm’s-length comparables (e.g., for hard-to-value intangibles) and that MNE have synergies not available to unrelated parties. As a result, many academics and policy makers advocate getting rid of the ALS and shifting to global formulary apportionment (GFA). Even the OECD, long a supporter of the ALS and opponent of GFA, now includes fractional apportionment as a possible method for attributing income among countries under its Pillar 1 proposals for taxing the digital economy. My views are different. My preferred policy response to the income shifting problem is two-fold.

First, I believe that many of the criticisms of the arm’s-length standard in terms of abusive transfer pricing are misdirected; the criticisms should be more appropriately aimed at weak international tax rules that need to be fixed. The OECD’s BEPS project goes a long way to correcting many of the inconsistencies and loopholes in the international tax system. As the BEPS Action Items are adopted at the country level and diffused across countries through the Multilateral Instrument, many of the most egregious incentives for income shifting should disappear. Second, I believe that the arm’s-length standard remains the appropriate international norm for taxing MNEs. New thinking, particularly for the digital business models that are now starting to dominate international production, is probably needed. Fine tuning the ALS for the 21st century is the appropriate solution. My conclusion: The arm’s-length standard is not the problem. Don’t shoot the messenger!

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