Transfer Pricing in Developing Countries An Introduction
1. Abstract 2. International tax law & its sources 3. Brief history of International Tax Law 4. Who gets the pie? 5. Arm's length principle : Cornerstone of International Tax Law 6. Transfer pricing methods 7. Problems with of source taxation of MNE's 8. Internet & e-commerce : Achilles heel of current International taxation regime? 9. Formulary Apportionment (FA) 10. Existing uses of Formulary Apportionment systems in the world 11. Developing countries & Formulary Apportionment 12. Critique of Formulary Apportionment 13. Transfer pricing and Formulary Apportionment : One continuum 14. Conclusion 15. Acknowledgements 16. References
Section 1 Abstract The aim of this paper is to highlight thoroughly the problems with the current approach and practice of MNE (cross-border) taxation in general and in particular the transfer pricing methods which are used to derive an arm's length price. Further, it is substantiated as to why Formulary Apportionment (FA) should be considered as an alternative to the currently recommended transfer pricing methods, especially for developing countries. Background To understand how to move forward we first need to understand how we got here. In the next two sections we take a look at the development of international taxation and understand how the current approach of using Arm's-length prices for transactions came into being. We refer readers who are interested in tracing the history of international tax further to Jinyan Li's in-depth introduction from which we have quoted key passages below.
Section 2 International Tax Law & its sources Taxes on international income are imposed by national tax laws; “there is no global body which imposes income taxes; in that sense the term International Tax Law really refers to the tax treatment of international transactions” In reality International tax law is “domestic law rules of a given state applied to cross-border flows, taking into account (or not) that such flows may be subject to taxation in more than one jurisdiction”
Every nation has evolved its own taxation system and decides what income is appropriate to tax. Today the globalization of most countries economies have made it imperative to address international elements in the country's tax base and so countries enter into Treaties with one other voluntary. Such Treaties limit a country's tax jurisdiction and represent the compromises that two countries have reached in respect of the sharing of the tax base arising from crossborder transactions. Thus, there are 2 underlying sources of international tax law: 1. Domestic tax laws of nations 2. Law of Treaties (bilateral or multilateral) amongst Nations
Section 3 A brief history of international tax law The international tax system of a country is an integral part of its income tax system and is developed keeping in mind the country's policy objective. The basic idea, though, is always to draw as much as possible a territorial 'slice' out of the international income 'pie'. Jinyan Li describes it succinctly when she states that “the development of treaty law has been influenced by the aim of minimizing the overlap (and more recently the gap) of territorial circles drawn by competing countries in order to promote cross-border trade and investment”. The model conventions drafted by international organizations (like the UN and OECD) have served as benchmarks for actual Treaties between countries. In as much as they are the source of the actual Treaties between countries that are drawn up, the model conventions are of immense importance to the countries of the world. It must be noted that the Model conventions are for bilateral treaties, which are the most common form of Treaties prevalent in the world today. It is, thus, instructive to see how the model conventions were developed over a period of time.
3.a) League of Nations model The League of...
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