A Formulary System for Dividing Income Among Taxing Jurisdictions (Portfolio 6938)


Michael Durst

Senior Counsel

Steptoe & Johnson LLP

At a glance

I. Starting the Conversation: Formulary Apportionment as a Replacement for the Arm's-Length Standard
II. Examining Current Formulary and Arm's-Length Approaches
III. Comparative Assessment of Formulary and Arm's-Length Regimes
IV. Choosing a Tax Base
V. Building the Formula
VI. Suggested Statutory and Regulatory Language for Implementing Formulary


Tax Management Portfolio No. 6938, A Formulary System for Dividing Income Among Taxing Jurisdictions, examines whether current arm's-length transfer pricing rules for allocating taxable income among countries should be replaced by a system of formulary apportionment. It then identifies in technical detail how, if one or more countries should decide to adopt a formulary approach, they might do so most effectively.

The goal of any system for dividing a multinational group's income is to identify where each component of value is added and to measure that value. The system must be accepted widely as fair and reasonably predictable, and must operate within the capability of real-life, resource-constrained companies and revenue administrations.

With those criteria in mind, an evaluation of the apportionment systems in use today in the United States and in Canadian provinces — as well as the current, arm's-length system — argues strongly for some type of apportionment system. One possibility is a limited type of apportionment that would apply formulas to separate measures of a taxpayer's combined income from particular business activities; another is a full-fledged, combined-income approach that — while simpler to apply and fairer — likely would encounter more resistance from policymakers.

The factors in the formula should be capable of being applied with enough precision to avoid being vulnerable to both manipulation by taxpayers and arbitrary income reallocation by tax authorities. The Portfolio contains an in-depth discussion of the sales factor, used as the only factor in the apportionment formulas of roughly half of the U.S. states, includes suggested statutory and regulatory language in the Worksheets.

The author is grateful for research support from the International Centre for Tax and Development, University of Sussex, Brighton, United Kingdom, for research support that helped make this Portfolio possible.

This Portfolio may be cited as Durst, 6938 T.M., A Formulary System for Dividing Income Among Taxing Jurisdictions.

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