I am pleased to have the opportunity to appear at this

ring regarding administration by the Internal Revenue Service of ernational transfer pricing rules.

Summary

For many years I have practiced tax law in Washington, Recently, I published a paper in which I recommended that asury adopt formulary apportionment as a principal means of cermining the U.S. taxable income of multinational firms ltinationals).1/

dation.

Today I reiterate and explain that recom

Formulary apportionment in most cases should replace the sting "comparable price" methodology. That current method uires the Internal Revenue Service to find transactions among elated parties that look like the transactions among members of è multinational group being examined. It then must deduce the rrect" U.S. taxable income of the multinational from the prices ed in the outside transactions.

The process invites continuous,

Tax Notes, January 25, 1993, pp. 485-493.

ervice of

shington, nded that

means of

al firms

at recon

place the

nt method

ons among embers of

leduce the

the prices Ontinuous,

Some Treasury officials and taxpayer

recently have said that U.S. formulary apporti worldwide net income of multinationals will inevit double taxation because apportionment contradicts a international taxation, and indeed would violat treaty obligations of the U.S.

I disagree. In my view I.R.S. use of f tionment in appropriate cases under section 482 C Revenue Code is not prohibited by any U.S. tax tr more likely to generate double taxation than any methods now employed by the I.R.S., and by foreign t to test the transfer pricing mechanisms of multina

Tax treaty rules on the subject are stated amorphous terms. In substance the treaties only r country may adjust the tax liability of one compan tional group whenever the financial arrangement members is different from what those arrangements if the companies had been independent. However multinationals that local affiliates of

assure

empowered by internal law to make adjustments among related ies and that double taxation could result in individual cases he absence of bilateral consistency.

The newer treaties put in place procedures under which two tax authorities are committed to discussing whether an stment by one country that increases the tax liability of one wo related parties warrants a correlative adjustment by the nd country in favor of the other related party. These edural agreements do not impinge on the unilateral authority of country to decide for itself what means it will use to cify the taxable income of a domestic affiliate of a multina

l.

The United States has never agreed in any treaty to re to any particular methodology in determining what adjusts among related parties are appropriate as a matter of domestic Conversely, no country has ever agreed in a tax treaty with United States simply to accept adjustments that are grounded on particular methods stated in the I.R.S. transfer pricing lations, either as they now exist or as the I.R.S. might change in the future.

1g related

dual cases

der which

hether an ty of one nt by the

These

hority of

1 use to multina

reaty to

: adjustdomestic

eaty with

Sunded on

pricing

at change

B. Background

My original understanding of transfer developed while I was an attorney in the Office of Tax Counsel at the Treasury Department in the perio 1972. I designed and executed the first Treasury-s of I.R.S. administration of the original transfer tions, and I drafted the report of that study ultima by Treasury in January 1973.

As a member of Treasury's internationa participated in numerous tax treaty negotiations, had particular responsibilities regarding the relate of the treaties and the implications of the O transfer pricing regulations in relation to those t

Immediately following my Government servi paper at the request of the United Nations on t international transfer pricing administration and

Members of this Committee have expressed the present system for identifying the correct U.S.

2/ International Allocations of Income: Problems of and Compliance, 9 Jl. of International Law and Econ

t of the problem and how to solve it, but virtually all agree a substantial problem exists.

It is not my purpose today to establish that a problem s or the extent of it. I assume that it exists and address

to do about it.

he Comparable Price Method Generally Does Not Work and Cannot e Made to Work.

Current regulations under section 482 invoke the "arm's h" standard and establish three methods for testing whether a of property between related parties meets that standard. Each e three methods requires identification of the price at which ated parties actually completed a comparable transaction lving either the direct sale of property, the allowance of a e markup to a selling intermediary, or the allowance of a plus markup to a selling manufacturer). Similar rules of

rability apply in cases of payments for intangibles, services, property rentals.

We sometimes lose sight of the fact that under these U.S. 3 an outside transaction must be found as a condition to ing any one of the three available methods, and not just the

and preferred, "comparable uncontrolled price" method.