Formulary Appointment in the U.S. International Income Tax System: Putting Lipstick on a Pig?

An affiliated corporate group consists of two or more corporations linked by sufficient stock ownership to cause them to function as an economic unit instead of as independent economic actors. Thus, an affiliated corporate group engaged in international business is often referred to as a multinational enterprise (MNE), a term that we will use throughout this Article. When corporate members of an MNE engage in transactions among themselves, the prices they employ (transfer prices) will significantly affect the amount of overall MNE income that is allocated to each member and, hence, to the tax bases of the various countries in which the members are resident or do business. Because MNE members have common ultimate owners and function as and comprise an economic unit, they share a common economic objective—maximization of the MNE’s aggregate after-tax profits. Consequently, the prices they charge in intra-MNE transactions will be set to achieve this objective instead of maximizing the after-tax profits of individual MNE members, as each member would try to do if it were an independent actor bargaining with other members at arm’s length. This leads to the phenomenon of tax-motivated transfer pricing, which involves setting prices in intra-MNE transactions that are higher or lower than an arm’s-length price so that income is shifted to the country or countries that confer the most favorable tax consequences on the MNE as a whole.