Recognising the Sales Component of Profit: Allocating Market Jurisdictions a Share of Taxing Rights on the Profits of Multinational Enterprises

Abstract

Traditional international taxation generally allocates taxing rights to the residence country and supply-side source countries that make labour or capital contributions. However, sales factor, which represents the demand side, does not share any profits under this system. This is problematic because online sales may separate sales and supply-side activities, meaning the market jurisdictions may not receive any taxing rights over Multinational Enterprises’ profits at all. To address this issue, the Organisation for Economic Co-operation and Development proposed a new approach named “Amount A” in the inclusive framework of the Two-Pillar Approach in 2019.

While this thesis agrees that the market jurisdictions should have some taxing rights merely for hosting sales, it argues that the Amount A’s formulary apportionment approach is not a viable solution for political reasons. Instead, the thesis suggests that transfer pricing methodologies could be used to allocate an appropriate portion of taxing rights to market jurisdictions without a paradigm shift. Specifically, a creative interpretation of the arm’s length principle that uses marketing intangibles and the profit split method could be well effective.

This thesis takes a market jurisdiction’s perspective. It outlines the obstacles they face in taxing residual profits, including physical presence, the ownership of marketing intangibles, enhancing the value of the existing intangibles, and transfer pricing methods that could be advantageous. The thesis uses the Chinese model as an example of how a market jurisdiction could interpret the traditional OECD model and proposes a “market-source-residence” paradigm as an alternative to the current income allocation approach.

Overall, this thesis provides valuable guidance to policymakers on a viable and achievable solution to the problem of recognising sales as a source of profit that can be taxed by the country providing this crucial source element.