Transfer Pricing versus Formulary Apportionment

Abstract

Abstract This chapter assesses formulary apportionment (FA) as an alternative towards transfer pricing for the allocation of corporate profits among taxing jurisdictions. Although FA has been a relatively old operational notion in subnational corporate taxation, especially in the USA and Canada, it was not generally used in international taxation, other than in theoretical exercises. This is bound to change, as FA is currently the basis of major reform proposals aiming to reregulate the cross-border allocation of taxing powers. FA is usually juxtaposed with transfer pricing and with the arm’s-length principle (ALP). However, the idea of a full or even partial FA goes much further than simply replacing transfer pricing and the ALP: FA challenges the very essence of the allocation rules of the current double tax convention (DTC) network, i.e. source and residence as allocation principles. While formally the constitutive elements of a formula are no nexus, FA modifies the consequences of source and residence in a way that effectively replaces the means used by the source/residence principles and by the DTCs in order to allocate profits. This is done by substituting the world income principle and the attraction force of residence, by profoundly altering the rules deriving from the source principle, and, finally, by rendering the current DTCs obsolete.