DETERMINIG APPROPRIATE INTERNATIONAL TRANSFERS PRICES: ECONOMICS AND ADMINISTRATIVE RATIONAL FOR USING ASSET-BASSED PROFIT SPLIRS UNDER SECTION 482 OF THE U.S. TAX CODE

Rebecca J. Klemm, Douglas W. Dwyer and Thomas L Brewer

Determining an arm's length transfer price for international transactions within a multinational enterprise (MNE) is becoming an increasingly contentious issue between the United States government and MNEs with either parent or subsidiary corporations in the U.S. The issue has become especially controversial, however, for international transactions between U.S. subsidiaries and their foreign-owned parent corporations because of the recent introduction of the issue into the public political domain. This paper presents an asset-based profit split method for determining an appropriate transfer price and demonstrates its economic validity. Although the method is formulary in nature, it is also economically consistent with arm's length pricing. Four advantages of this method over commonly used profit split methods are discussed: (1) it is simple to administer; (2) it does not impose unrealistic comparability requirements; (3) it reduces firms' opportunities to distort the geographic distribution of their profits and tax liabilities; and (4) it is grounded in economic theory. The profit split method, therefore, combines the economic reasoning of the arm's length standard with the administrative ease of formulary methods. The asset-based profit split method should not be applied without a detailed knowledge of the economic role played by the subsidiary in relation to the parent company's overall economic activity.