![]() For this purpose, P( t) denotes net operating profits (P = OIADP = EBIT) for a selected enterprise (whose index is implicit for simplification), A( t) denotes net Assets, G( t) denotes CAPX, which is gross investment in added property, plant and equipment, and t = 1, 2, 3 … are indices of historical years in which financials for these accounting variables are available: Hereafter, we shall focus on an important but neglected issue of assets being endogenous to the return on assets system of equations. We suggest to abandon “net profits weighted by assets” as a transfer pricing profit indicator in favor of using (depending if the tested party is an importer from related parties, exporter or service provider) operating profit margin or operating profit markup on total operating costs. To understand that academics can’t provide rescue, read inter alia Franklin Fisher (ed.), Antitrust and Regulation, MIT University Press, 1985. To be consistent with accounting and economic principles, equation (3) restricts our measure of assets to property, plant and equipment, which is different from the OECD and IRS arbitrary definitions.Īcademic research can’t rescue a fact-checker from regarding assets as an accounting inferno. This means that we must conform to an explicit asset accumulation equation, such as (3) below. Third, we question if long-term liabilities should be part of operating assets because the matching interest expenses are deducted after operating profits (EBITDA or EBIT) are calculated.įour, unlike using sales or costs from the income statement as denominators to operating profits, assets are an endogenous variable. A more recent and more rigorous survey is found in Günter Gabisch and Hans-Walter Lorenz, Business Cycle Theory (A Survey of Methods and Concepts), Springer-Verlag, 1989, including coverage of Kalecki’s fixed-investment model. Please consult Joseph Schumpeter, Business Cycles, two volumes, McGraw-Hill, 1939, for an early taxonomy of different business cycles. ![]() Aggregating these separate and distinct assets into a putty-clay lump-sum is Panglossian (like the optimistic tutor in Voltaire’s Candide (1759)). These different business cycles result from different processes thus, their underlying economic dynamics and their dependent and independent variables are distinct. These separate and distinct assets are subject to different economic cycles, which in economics are recognized by the authors Kitchin ( inventory 3-5 year cycles measured from peak to peak or measured from trough to trough), Juglar ( fixed-investment 7-12 years cycle), and Kuznets (, infrastructure or building 12-25 year cycles). Second, the OECD and the US regulations prescribe aggregating non-depreciable (inventories, accounts receivable) and depreciable (property, plant and equipment) assets. However, short-term liabilities don’t incur interest expenses, and according to accounting practices interest expenses covering long-term liabilities are deducted after operating profits are calculated. ![]() ![]() Also, they prescribe aggregating short-term (accounts payable) with long-term liabilities. Prima facie, we notice several conceptual problems with assets as a denominator to profits (understood to mean operating profits calculated before or after depreciation):įirst, the OECD and the US regulations prescribe aggregating short-term (inventories, accounts receivable) with long term (property, plant and equipment (net of depreciation)) assets. Likewise, the vague definitions provided by US 26 CRF 1.482-5(b)(4)(i) and (d)(6) are misconceived because they aggregate heterogeneous elements disrespecting short- versus long-term assets vintages (acquisition dates), assets associated and those not associated with interest deductibility, economic cycle dynamics, and different depreciation schedules. The nebulous definitions provided by the OECD Transfer Pricing Guidelines (2017), ¶¶ 2.103 and 2.014 create more pain than relief. Assets (which combine liabilities and equity) are an accounting quagmire. R eturn on assets (ROA) is ill-defined and selection of this profit indicator in transfer pricing can lead to intractable controversy between the tax administration and corporate taxpayers.
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