At the heart of the current international tax architecture, which grants primary taxing rights to source countries, is the need to determine how much profit each country can tax. This raises conceptual and enforcement issues: as discussed in Chapter 3, the geographic origin of a profit may not be clear, and as noted in Chapter 6, firms will want to shift profits toward jurisdictions with lower taxation. The standard approach to address this issue is for multinational enterprises to employ the arm’s length principle when they set their transfer prices. In other words, they are supposed to charge an affiliate the same price as two independent parties would in the same transaction.

Why Reform Is Needed and How It Could Be Designed