Research Of Tax Adjustment On Transfer Pricing—a Comparison Of Separate Accounting And Formula Apportionment

As a prominent feature of the development of the world economy, economic integration has not only brought great changes to the world economy, but also led to international tax issues. The MNEs transfer profits between tax jurisdictions by transfer pricing which results in tax loss and externalities.Most countries use separate accounting system to tax corporate income. Under an S A regime each tax authority tax multinational companies in accordance with their own accounting and tax system and implement arm’s length principle for tax adjustment of internal transactions. Some federal countries such as the USA, Canada adopt the formula apportionment system. Under an FA regime a multinational corporation should consolidate the income of its affiliates into a single measure of global income, which is then allocated among jurisdictions according to a common formula reflecting the corporate group’s activity within each jurisdiction. Each tax authority would apply the national tax rate to its part of tax base.FA system follows the trend of international tax coordination. The EU has recently proposed to establish a common corporate consolidated tax base among EU members and replace the current system of SA by FA to allocate the EU-wide consolidated tax base. In recent years China tax authority pays more attention to tax regulation of transfer pricing. China has not applied the FA system and there is a lack of domestic tax research on FA on the level of theoretical study and discussion. This paper studies the FA system using a mathematical model which has certain theoretical and practical significance on the development of China’s future international tax policy under global economic integration.Firstly this paper reviews foreign and domestic literature on transfer pricing. On this basis, this paper introduces domestic and foreign tax anti-avoidance regulations against transfer pricing emphasizing on comparison between SA and FA. Furthermore this paper develops a symmetrical model, assuming that multinationals set up two subsidiaries in both countries and shift profits to tax havens outside the two countries using transfer pricing. The model compares the difference of welfare under SA and FA, introducing tax regulatory expense into the model. The analysis shows a move from FA to will eliminate profit shifts and improve the welfare of the two countries. In conclusion, combined with the theoretical analysis, this paper proposes some policy suggestions on international tax policy to complete tax anti-avoidance regulation system of China.