On the Frontier of Procedural Innovation: Advance Pricing Agreements and the Struggle to Allocate Income for Cross Border Taxation

Abstract:     
This article focuses on how the United States turned to innovative procedural reform to confront the most challenging and pervasive problem in international tax today - the taxation of cross border transactions and the allocation of income among different taxing jurisdictions. With the tremendous growth in international business, all countries must struggle to design a tax system that facilitates business activity yet ensures that tax revenues do not evaporate through taxpayer abuse. Truly successful reform in the international arena demands coordination with other countries.

Taking a leadership role in this global tax dilemma, the United States realized that continued substantive law refinements were inadequate and instead sought to reform administrative procedures by developing the Advance Pricing Agreement Program. The program creates a forum and framework for the U.S. government, other relevant countries and the taxpayer to address the allocation of income among competing taxing jurisdictions prior to the business transactions. The APA program is novel on many fronts, including the timing of parties' interactions, the role of the foreign countries and the nature of the resulting agreement. Introduction of the program raises questions regarding its efficacy and its relationship to the broader tax system. A central question is how much flexibility and creativity should be permitted in a domestic administrative regime to cope with the growing significance of other countries and their substantive and administrative law practices.

This paper critically examines the specific and system wide impacts of this new procedural mechanism. First, the paper considers if and why the innovation seems successful at attacking the targeted transfer pricing and income allocation problems. Second, the paper explores some of the potential costs and risks in terms of the program's impact on taxpayers not participating participating in APAs and its relationship to the tax system generally. An important theme running throughout this analysis is the tension between administrative innovation and maintenance of procedural fairness. The tax analysis is directly aided by recognizing this link between the tax system's struggle with the APA program and the broader debates within administrative law regarding design and innovation. Moreover, although the model of reform adopted for international tax is significant on its own, it also suggests an important path for administrative reform generally. Thus, the final part of the paper places the APA program in the context of current administrative law dialogue on the theoretical foundations of administrative law regimes and alternative approaches to administrative law reform.

JEL Classifications: K23, K33, K34

Working Paper Series