Background

　　The word economy comes from the Greek word oikonomos for “one who manages a household”. A household must allocate its scarce resources among its various members, taking into account each member’s abilities, efforts, and desires.

　　Like a household, a society faces many decisions. A society must allocate people to various job and the output and services that they produce. The management of society’s resource is important because resources are scarce. So economic is about the allocation of scarce resources.

　　In the view of classical economist, participants in the economy are motivated by self-interest and that the invisible hand of marketplace guides this self-interest into promoting general economic well-being. So they think rational individuals are usually best left to their own devices, without the heavy hand of government guiding their actions.

　　　　Although markets are usually a good way to organize economic activity, there are two abroad reasons for a government to intervene in the economy: to promote efficiency and to promote equity. The invisible hand sometimes does not work. Economists use the term market failure to refer to a situation in which the market on its own fails to allocate resources efficiently. One possible cause of market failure is an externality. An externality means a situation in which a market left on its own fails to allocate resources efficiently. Another possible cause is market power which means the ability of a single economic actor to have a substantial influence on market prices. Although the invisible hand usually leads markets to allocate resources efficiently, it is even less able to ensure that economic prosperity is distributed fairly. So that is most policies aim either to enlarge the economic pie and to divide pie fairly to achieve a more equitable distribution of economic well-being. Through tax policies governments not only collect revenues but also impose regulation on the economic entities to optimize the allocation of resources and distribution of incomes.

　　During the years of closed-economy the game between economic entities and government is within the territory. So the allocation of profit is not cross the borderline. It is comparatively simple to define the scope of public services and the relationship between tax & its price. And scholars have agreed on the public finance theory.

　　　　With the development of trade, each person consumes goods and services produced by many other people both in our country and around the world. Globalization may contribute a severe challenge to individual but also sovereigns. Individuals may consider every factor to carry out investment. And sovereigns may encounter the restriction or expansion of jurisdiction. So the consideration will concentrated in the effective and economic relationship.

　　　　International investment is essentially mobile. The main features of a tax system that a potential foreign investor is likely to focus on in making choices on the location of his investment – home or abroad – as well as which among possible foreign alternatives. The parties of game extend abroad. And the game among countries is vital to a successful tax collection that would be essential for tax policy of sovereign.

　　Transfer Pricing and its Regulation

　　Along with expand of capital market and the enterprise institution’s modernization, form of enterprise group prevails and intra enterprise’s transactions have spread. Transfer pricing is a main method in business among associated enterprises. No matter what is the motive of the transfer price, transfer pricing may also redistribute the tax all over the world and may harm the tax benefit. What associated enterprises mean, what transfer pricing means, are regulated in many domestic law and tax treaty.

　　　　Transfer pricing – also called intra-company or internal pricing – refers to the prices on internalized transaction between related units of the same company. When those enterprises engage in cross-border production, transfer pricing raises complex problem, not only for transaction corporations, but also for the governments concerned. In a world where capital is mobile, tax system become interdependent. Whenever interdependency occurs there is scope for co-ordination. So negotiations can lead to arrangements that are advantageous to all parties involved.

　　　　China has made the clauses concerning associated enterprises in tax treaty.[1] And the development of the Chinese transfer pricing legislation can be traced back to 1991, when there was a clear article under the foreign enterprise income tax law ( Art.13 of the Income Tax Law for Enterprises with Foreign Investment and Foreign Enterprises, 1991 Income Tax Law). The detail rules for 1991 Income Tax Law provides a special charter of regulations on business-associated enterprises. Later the scope of associated enterprises extends to the all enterprises within the territory.[2] With the development of the legislation artifice, the regulations become much more concrete and manipulable. 2004 the State Taxation Administration issued a Circular of Tax management Measures Concerning Business among Associated enterprises (2004 Measures). The measures have made brief explanations to Income Tax Law and 2001 Administrative Law including the procedure. The process reflects the reorganization to transfer pricing has gone further.

　　With accordance to the 2001 Administrative Law and 2004 Measures, tax authority has wide investigative power to the following: inspect documents, physical goods, and operations at the site of the taxpayer; obtain proof of tax payments; inquire about tax matters; inspect bank accounts; obtain support and assistance from other government departments and third parties; make necessary records or relevant information. If taxpayers disagree, they only can choose administrative reconsideration for remedy.

　　The game among taxpayers and tax authority during adjustment on transfer pricing can be illustrated by the following model. We assume that sum profit is zero when there is not additional cost under cooperation. When taxpayers do not cooperate, cost of tax avoidance a may occur and the investigation cost of tax authority b arises.

　　Tax authority vs. Taxpayers:

　　When (trust, cooperation), outcome matrix will be (t1, -t1);

　　When (trust, non-cooperation), outcome matrix will be (t2, -t2-a);

　　When (distrust, non-cooperation), outcome matrix will be (t3-b, -t3-a);

　　That condition (distrust, non-cooperation) does not exist.

　　　　So we draw a conclusion that the sum profit may arrive the maximum only when both parties cooperate. But adjustment to transfer pricing is based on the unreliability of taxpayers. Tax authority may pay great deal of investigation cost. And diversity methods are based on the consideration that associated enterprises have the same profit margin as independent companies. And the premise may cause an unreasonable and unfair profit margin. So one program that is called advance pricing arrangement may be alternative.

　　Bilateral APA

　　An advance pricing arrangement is an arrangement between the tax authority and the taxpayer that determines, in advance of control transaction, an appropriate set of criteria for the determination of the transfer pricing for those transactions over a fixed period of time. An APA is an agreement that can be unilateral, bilateral, or multilateral. APA is formally initiated by a taxpayer and requires negotiations between the taxpayer, one or more associated enterprises, and one or more tax mechanisms for resolving transfer pricing issues. An APA starts from pre-filing meetings and moves on to the filing of a proposal, its evaluation by the tax authorities, the discussion and conclusion of the mutual agreement, the implementation of that mutual agreement and finally the monitoring of the agreement and possible renewal.

　　　　An unilateral APA is agreed by the taxpayer and only one tax authority. An UAPA is an in advance adjustment compared with aftertimes before. In an international taxation setting, tax burden in one country is related to the worldwide income. For adjustment to TPM may affect the tax liability of associated enterprises in other tax jurisdiction, when there is a lack of cooperation, double taxation may occurs. And international tax cooperation on TPM becomes a popular topic.

　　　　Relationship between sovereigns in international setting may be explained by the following outcome matrix which assumed that the non-cooperation cost is 2 and when one party chooses non-cooperation, he can make an excess income equal to 50% of the other party’s outcome in the condition of mutual cooperation.

　　 Country B

　　 cooperation non-cooperation

　　Country A operation 10，8 5，11

　　 non-cooperation 12，4 8，6

　　　　As the outcome matrix the sum is the most when cooperation but not a equilibrium. The equilibrium comes forth only when both countries choose non-cooperation. This matrix could explain not only why we should cooperate on APA but also how we can prevent the harmful international tax competition.

　　　　Because of concerns over the double taxation, , many countries prefer bilateral or multilateral APA, and indeed sometimes will not grant a unilateral APA to taxpayers in their jurisdiction. BAPA or MAPA is agreed by a taxpayer and two or more tax authorities. BAPA or MAPA by Tax authorities is not only with respect to national law but also the international law. Meanwhile BAPA or MAPA may not gain maximum profit for sovereigns for sometimes the arrangement is a restriction to tax jurisdiction to an extent. So it is accepted that economy development may be prior to tax benefit. The bilateral approach is far more likely to ensure that the arrangement will reduce the risk of double taxation, will be equitable to all tax administrations and taxpayers involved, and will provide greater certainty to the taxpayers concerned. So international tax cooperation is helpful for both taxpayers and tax authorities to arrive an understanding with each other and achieve the goal of mutual profit.

　　　　Now China does not enact the regulations on APA but for article 48 of the 2004 Measures. And China has signed the first Bilateral Advance Pricing Arrangement with the government of Japan in May 2005. In order to achieve further cooperation on APA, China’s tax authorities should:

　　　　First, we should establish the database of tax information and strengthen the exchange of international tax information through BAPA.

　　　　Second, ensure the open and transparent procedure. Generally secret information is excluded in BPAP. So it sets an new criterion and would be a challenge for us.

　　　　Third, ensure the principle of honesty. The documentations taxpayers submit to support the reasonableness of their proposal cannot be deemed as a proof for tax authorities to charge penalty. When taxpayers apply for an APA, the former TPM can be uniformized as the later APA.

　　　　Forth, constitute the legal system of APA by learning from others’ experience.

　　　　Nowadays faced with global economy, A tax system can be expected to influence the international allocation of a given pool of foreign capital. As an consequence, tax policy changes in one country affects not only in that country but in other countries as well. And strong tax administration and international cooperation are vital to ensure the sovereignties’ tax revenue and economic safety, also would constitute a fairy circumstance for cross-border taxpayers. For China there is a long way to run.