International taxation and intrafirm pricing in transnational corporate groups

Picciotto, Sol (1992) International taxation and intrafirm pricing in transnational corporate groups. Accounting, Organizations and Society, 17 (8). pp. 759-792. ISSN 0361-3682

Abstract

Since early this century, with the introduction of direct taxes on income or profits by most developed capitalist states, tax authorities have been concerned to prevent manipulation of transfer prices between related firms, especially within transnational corporate groups (TNCs). By the 1930s most states had introduced a broad power to adjust such prices to conform with the "arm's length" criterion, since it was felt that either the application of national taxes directly to foreign parent or subsidiary companies, or taxation on a unitary or consolidated basis, would exacerbate overlapping or double taxation. However, both theory and a detailed examination of practice show that the arm's length criterion cannot in most cases be applied on the basis of "market" prices, since the raison d'être of an integrated firm is economies of scale and scope and generation of synergy profits. Microeconomic methods also can only identify these, but provide no basis for their allocation. Criteria for allocation of the costs and profits of an integrated TNC must have a political dimension: for the firm, it entails issues of strategy, and for the states, the control of oligopolistic powers over investment and allocation of the benefits of international economic integration. The tax authorities of the main OECD countries have developed close administrative co-operation through which these issues can be bargained on an ad hoc basis; but these bureaucratic and secretive methods lack the important element of legitimation. Formula apportionment based on unitary or consolidated accounts has been attacked as Utopian in the absence of a political basis for international agreement on principles or procedures. However, unitary taxation is now accepted (up to the water's edge) for U.S. state taxation, and either a unitary or consolidated basis is likely to become necessary in Europe: while formula allocation of fixed or overhead costs and a bargained division of profits has become the international practice. Still lacking are legitimating procedures and criteria.