Replacing separate entity accounting and the arm's length principle with formulary apportionment

Abstract

Because of well-known difficulties encountered in implementing separate entity accounting and the arm's length principle (SA/ALP), some have suggested that formulary apportionment (FA) should replace that approach as the international standard for measuring the income of multinational corporations. FA would sidestep the difficult problems of economic interdependence and transfer pricing which plague SA/ALP. It applied to corporate groups, FA would render tax havens ineffective. However, FA is not without problems. FA does not attempt to determine precisely where income originates, as the methodology based on SA/ALP purports to do; rather, it uses a formula to attribute income to various jurisdictions. FA has no clear theoretical foundation and is inherently arbitrary. Not to be underestimated are the political and administrative problems of shifting to a new system based on FA from the one based on SA/ALP that has been the international standard for at least 75 years.