The Comparison Of Separate Accounting And Formula Apportionment

With the economic globalization, multinational enterprises expand the scale of foreign direct investment. This phenomenon accelerates the development of world economic to some extent, but at the same time, brings in some new problems.This paper will focus on one of the most important problems:transfer pricing.Multinationals sometimes transfer their profits among different countries through transfer pricing, in order to minimize their tax burdens. This directly results in the tax spillovers in some country. United States released a tax legislation concerning about transfer pricing in1917as to regulate the related transactions prices in MNC.Many countries followed the step took by U.S.and released their own ordinations. Nowadays, there are about50countries which have legislations targeting transfer pricing.With the maturation and standardization of this tax legislation, there gradually became two methods in common use:Separate Accounting and Formula Apportionment. Under the system of Separate Accounting, the income earned by the legally separate entities are required to price internal transactions with their related entities at the level that would have prevailed had these transactions happened with unrelated parties. Then these separate entities will pay their taxes to the local tax authorities respectively, according to the adjusted profits.Under the system of Formula Apportionment, a corporate group first calculates its net income for the entire group and then apportions that income to each location where it does business using a formula. Each entity then pay taxed according to the distributed income.During the last century, many scholars conducted studies about these two methods. Based on previous studies, this paper derives some new conclusion by comparing these two different systems through model analysis. The results shows that, the extent to which Formula Apportionment alleviate the degree of transfer pricing is related to some factors, including the decision mechanism of corporate group, the factors in the apportionment formula and the cooperation between tax authorities. What’s more, in some circumstances, Formula Apportionment can aggravate the situation of tax spillovers in some country.