Formulary Apportionment in the European Union

Sammanfattning: The European Union has discussed the idea of a potential shift from a system of dividing the EU source income of multinational companies based on separate accounting and the arm's length principle, to one based on consolidated base taxation with formulary apportionment. EU businesses have for several years highlighted numerous tax obstacles in the EU that prevent them from operating on the basis consistent with the Single Market. Companies may have to apply up to twenty-five different tax systems. Losses occurred in one Member State cannot be offset against profits in another Member State. Enterprises find it difficult to reorganise their structures. There is a risk for double taxation and the there are problems associated with the separate entity accounting with the arm's length principle. The Commission has presented four comprehensive methods and all these would require an allocation formula. The formula apportionment addresses the problems related to economic interdependence between related entities and the transfer pricing issues. Formulary apportionment is though not without problems. It does not determine the precise origin of an income. The formula implies that each unit of a factor earns the same rate of return. There is no theoretical reason for profits to be a fraction of payroll, property and sales. Formulary apportionment could replace both the residence-based and the source-based taxation. The logic of formulary apportionment advocates that tax should be paid where the apportionment factors are located. An issue that has to be addressed is the definition of the territorial scope of application. If the allocation formula would be limited to the EU, the separate entity accounting with the arm's length principle would continue to be applied with respect to transactions with third countries. Another issue that will arise is the definition of income. The income could be divided into apportionable and non-apportionable income. However, one of the most fundamental issues will be to define a group and the EU has to take several features like legal-, economic- and political aspects into consideration. When designing a formula the EU has to decide if the formula should be based on micro- or macro factors. Some argue that the most important thing is to agree on a common formula and that the choice of the factors is not so important. The formula should however reflect how income is generated and recognise the contributions made by the manufacturing and marketing states. The three-factor formula does not always have to be the right formula but it strikes a balance between the competing influences. Companies doing business in several jurisdictions can employ a variety of techniques to minimise their tax liability under an allocation formula. Under the separate entity accounting with the arm's length principle, tax planning might take the form of manipulating transfer prices while under formulary apportionment the tax planning might take the form of manipulation of the location of the factors. A current move from the present system to a system based on formula apportionment is impossible before the Member States can evaluate the impact on their revenue and this cannot be done knowing neither the base nor the formula.