“We shall renounce . . . the subterfuges.”
We suggested on prior blogs that operating assets (measured by property, plant & equipment) are endogenous and that structural equation estimates of return on assets produce biased coefficients. Here, we provide another alternative from biased estimates of return on assets than using exotic algorithms like two-stage least squares.
Economic models must have mathematical beauty; they must be parsimonious!
Paraphrasing Paul Dirac (1955), Physical laws should have mathematical beauty, quoted in Abraham País, Maurice Jacob, David Olive, Michael Atiyah, Paul Dirac (The Man and his Work), Cambridge University Press, 1998, p. 46.
Return 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. Assets (which combine liabilities and equity) are an accounting quagmire. The nebulous definitions provided by the OECD Transfer Pricing Guidelines (2017), ¶¶ 2.103 and 2.014 create more pain than relief. 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.