Author Description

The term 'location-specific advantages' (LSAs), including location savings and market premiums, is a novel concept originating from the transfer pricing practice in China and India. The term refers to the general features of a specific geographical location that may (positively) influence the profitability of a multinational enterprise (MNE). International consensus has been reached that LSAs are comparability factors and that local comparables can capture the value of LSAs. Following such rule, countries with LSAs (i.e. host countries) are entitled to tax only a very limited amount of MNEs' business profits when only low-functionality nexuses exist locally. Modern MNEs increasingly use the principal/central entrepreneur structure and digitalization in their operating business models, strategically arrange low-functionality nexuses in host countries and therefore pay reduced or minimized taxes in those countries, while continuing to exploit their LSAs. This practice will eventually disrupt the allocation of global taxing rights to host countries vis-à-vis home countries (where the entrepreneur entity resides). Doubt therefore arises as to whether the arm's length principle is still an appropriate or the preferred approach for global profit allocation. Notably, the OECD has proposed a profit allocation system that partially departs from the arm's length principle under BEPS 2.0 Pillar One to address the tax challenges arising from digitalization. Against such background, this book focuses on how to amend the profit allocation rules based on the arm's length principle when there is only a low-functionality nexus in the host country, acknowledging that the current guidance and practical rules in respect of applying the arm's length principle have not sufficiently recognized the LSAs of host countries. It aims to strengthen the taxing rights of host countries and to restore confidence in the arm's length principle in transfer pricing.