SFA: A Reform for All Seasons

SFA: A Reform for All Seasons

Sales Factor Apportionment for All Seasons SALES FACTOR APPORTIONMENT: A REFORM FOR ALL SEASONS?  by Bill Parks and Jerry Wegman 

Reprinted with permission from “Sales Factor Apportionment: A Reform for All Seasons,” Tax Notes, January 19, 2015, p. 395.


The U.S. system for taxing multinational corporations is broken.[1] Increasingly sophisticated tax avoidance techniques have resulted in zero or near zero rates for some companies, while others pay close to the full or “rack” rate.  The last straw has been the current wave of tax inversions that has caused publications from Fortune[2] to Rolling Stone[3] to lambaste the current system.  These are so flagrant that they have even caught the attention of comedians and late-night TV hosts[4].

U.S. multinational companies have long complained that the current tax system reduces their international competitiveness for two reasons: (1) While most countries employ a territorial system that taxes companies’ earnings only in their home country (territory), the U.S. employs a worldwide system that attempts to tax U.S. companies’ worldwide earnings. (2) The U.S. tax rate of 35% is higher than the rate in almost every other country.

At the same time, some liberals insist on continuing the worldwide system and they decry the inversions, income shifting, deferral and other practices some companies use to avoid paying taxes.  They point to examples like GE in 2010 that paid no federal income tax, in spite of earning $14.2 billion.[5] Both liberal and conservative critics have legitimate complaints. Liberals are correct that sophisticated tax avoidance strategies have allowed some companies to avoid carrying their fair share of the tax burden. Conservatives are correct that our worldwide tax system and high rates over-tax some companies and impair our international competitiveness.

But an alternative tax system exists that would satisfy the objectives of all parties. It provides the territorial system that conservatives crave, and it also closes egregious tax-avoidance loopholes, including inversions, that liberals abhor. It is called Sales Factor Apportionment (SFA). It or its predecessors have been used by the U.S. states and the Canadian provinces for over a hundred years to tax the earnings of companies that operate in several tax jurisdictions.

We will first briefly describe how the current multinational tax system has failed, then how SFA would correct those failures. We will then consider objections to SFA, and how those objections can be overcome. Finally we will review ancillary benefits of SFA.


Critics point to excessive tax avoidance by some companies. This has come about in spite of the U.S. using an ambitious worldwide tax system. Avoidance is made possible because of a large exception: deferral of taxation of offshore earnings. If a U.S. multinational earns a billion dollars overseas, the company owes no tax on that income until it is brought home, or “repatriated”.  Those untaxed earnings can continue to grow, and they can be invested abroad, all free of U.S. income tax. As Judge Learned Hand pointed out[6], companies are entitled to use every legal means to reduce their taxes. They have made aggressive use of the deferment rule; the amount of deferred overseas income is now estimated to be over two trillion dollars.[7] This is a problem for both the Treasury and the companies.  The Treasury is denied needed tax revenue, and the companies’ access to their funds is inhibited by the fact that repatriation will trigger a 35% tax liability, less a credit for foreign taxes paid. As a result, companies like Apple now hold $54 billion[8] abroad, much of it in short term financial accounts earning close to zero interest.

A common tax-avoidance strategy is income shifting. When accounting income is reduced, income tax obligation is correspondingly reduced.  If a U.S. multinational with an effective tax rate of 30% shifts a million dollars of U.S. earnings to a subsidiary in Cayman Islands, which has no corporate income tax[9], then it has reduced its U.S. tax obligation by $300,000.

There are three common strategies for income shifting: (1) Transferring intellectual property such as patents to a tax haven subsidiary which then charges the U.S. parent corporation high rates for using its intellectual property. (2) Using internal “transfer prices” that reduce the parent company’s profit, when the tax haven subsidiary is part of the firm’s supply chain. (3) Having the tax-haven subsidiary issue loans to the U.S. parent; interest payments on those loans are tax-deductible costs to the U.S. parent. Also, the parent has now accessed its overseas profits without paying the repatriation tax.[10]

These are just the simplest and most common methods. Today there is a proliferation of extremely complex methods that multinational corporations use to lower their effective tax rates.

Other critics agree that our current system has failed, but for different reasons. They argue that our worldwide tax system over-reaches and is more burdensome compared with other countries’ territorial systems.[11]  These critics also assert that our relatively high corporate income tax rate of 35% further exacerbates our competitive disadvantage in international markets. As a result, they argue, companies have had to resort to self-help in the form of exploiting the deferral rule, using tax havens, and even becoming domiciled in foreign countries through the process of inversion.


Sales Factor Apportionment is a system for taxing firms that operate in multiple tax jurisdictions. It is territorial because the tax would apply only to the economic activity that takes place within the U.S. Profits attributed to overseas economic activity are not taxed. They may be repatriated immediately and with no repatriation tax. SFA uses sales as a proxy for economic activity and a corporation’s global profits as the tax base. The U.S. and most other countries have been using earnings as a proxy for economic activity when assessing income tax. But this proxy has proven to be ineffective, because earnings can be easily shifted to low tax jurisdictions and tax havens under our current system.

SFA is not a sales tax; it is method of allocating earnings for income tax purposes. It uses sales to determine how much of a company’s worldwide income should be taxed in a given jurisdiction. Worldwide income includes both income from operations and passive income from investments[12]. For example, if half of a firm’s sales are in the U.S., then half of its worldwide income would be taxed in the U.S. With SFA, Foreign sales, operations, and profits are not taxed, exactly the same as with a conventional territorial system.

Why not then simply adopt a conventional territorial tax system?  Because it would make matters worse—far worse. Under a conventional territorial system multinationals would have an even greater incentive to shift income to tax havens. As noted above, for every dollar shifted, a dollar of taxable U.S. income is taken away. All of the current tax avoidance practices would be intensified. The lost revenue to the Treasury would increase, and would have to be made up by higher tax rates or reduced spending.

SFA may be described by the following formula:

TL = [(USS/WWS) x (WWP)] x CT


TL = tax liability

WWS = worldwide sales


USS=U.S. Sales

FS=Foreign Sales

WWP = Worldwide pretax profit

CT = corporate tax rate

The ratio of U.S. sales to worldwide sales may be called the SFA ratio.


Sales Factor Apportionment will meet the objections of both conservative and liberal critics. It provides a territorial tax system; it eliminates U.S. multinationals’ competitive disadvantage; and it will eliminate most egregious tax avoidance schemes currently used by some companies.

Provide A Territorial System

Sales Factor Apportionment is territorial because it assesses income tax only on the economic activity that takes place within the U.S. As noted above, sales are used as a proxy for economic activity. With SFA no attempt is made to tax economic activity that takes place abroad. Currently, income is determined by rules based upon an arms-length pricing standards for international economic activity, but income shifting to tax havens has made that proxy ineffective. The states of the United States rejected using income as a proxy for economic activity over a hundred years ago.[13] Their experience showed that a formula based apportionment approach was superior. While they began with three-factor apportionment formulas that included payroll and property as well as sales, in recent decades they have migrated to sales-only or sales-weighted formulas. Because sales are a company’s overriding goal, it will only withdraw from a market under extreme duress.

Eliminates Competitiveness Disadvantage

Conservatives and others complain that the U.S. suffers a competitive disadvantage[14] in international markets because our worldwide tax system is more burdensome than other countries’ territorial systems.[15] SFA eliminates this disadvantage by leveling the competitive playing field in all countries. Consider the following examples:

First, a U.K. company, “Dundee Spirits” with 20% of its whisky sales in the U.S., competes with a Tennessee company, “Black Daniels” selling whisky here. Both Black Daniels and Dundee Spirits must pay U.S. corporate income tax related to their U.S. sales, at a rate of 35%. They both experience the same tax environment: a perfectly level playing field.

This is true so long as the U.K. company maintains a “permanent establishment” in the U.S.[16]

Second, consider those same two companies competing for whisky sales in the U.K.  Under SFA there is zero U.S. federal income tax related to Black Daniels’ sales in the U.K. But Black Daniels must pay the U.K. corporate income tax at a rate of 21%.  Dundee Spirits, a U.K. company, must also pay U.K. corporate income tax at the same rate. Again, both companies enjoy a perfectly level competitive playing field.

Finally, consider the same two companies competing for whisky sales in Mexico. Under SFA there is no U.S. corporate federal income tax related to Black Daniels’s sales in Mexico. Under U.K. law there is also no U.K. corporate income tax on Dundee Spirits’ sales in Mexico, because the U.K. uses a territorial system.  Both companies are subject to Mexico’s corporate rate of 30%[17] if they maintain permanent establishments there. Again, the result is a perfectly level playing field between the U.S. Company and its multinational competitor.

Some critics also claim that our relatively high U.S. corporate rate of 35% imposes additional harm to our international competitiveness.[18]  SFA corrects this by making disparate national corporate income tax rates irrelevant. Note that in the examples above, U.K.-based Dundee Spirits and U.S.-based Black Daniels both experience exactly the same income tax environments, in spite of their disparate domestic rates. They both pay 35% in the U.S., 21% in the U.K., and 30% in Mexico. Their domestic rates make no difference to their competitiveness.

Now consider investment under SFA. Let’s assume that Black Daniels wants to increase its worldwide sales. In order to do that it plans to build a new distillery.  Will the higher U.S. rate discourage location of that distillery in the U.S.? Regardless of where the distillery is built, corporate income tax will be related to sales.  It will be 35%, 21%, or 30% depending on where those sales occur. Location of the distillery will make no difference to income tax liability.

Countries can still compete for investment on the basis of climate, workforce, location, availability of natural resources, or other factors.  So Black Daniels might decide to locate its new distillery in the U.K. in order to be closer to the European market. But corporate income tax rates will not affect that decision.

If other countries follow the lead of the U.S. and also adopt SFA, the international system would eliminate the pernicious, destructive “race to the bottom” in income tax rates that threatens the integrity of many countries’ tax systems. Countries would be free to set their corporate income tax rates where they want, without fear of “beggar thy neighbor” tactics from other countries. But success of SFA in the U.S. does not require adoption of apportionment in other countries.

Eliminates Most Tax Avoidance

With SFA it does not matter where income is earned, since SFA taxes a percentage of a company’s worldwide income.[19] Whether an extra billion dollars was earned in the U.S. with its 35% rate or in the Cayman Islands with its zero % rate, would make no difference.  The extra billion dollars would add to the company’s worldwide income.  If half its sales were in the U.S., the company would owe income tax on half its worldwide income, including the extra billion dollars, regardless of where that money was technically earned.

As a result, there would be no incentive to use creative accounting or uneconomic practices to shift U.S. earnings to tax havens. Tax avoidance practices like patent transfers, transfer pricing, and internal loans to create interest deductions in high-tax countries would be pointless.  Tax havens would lose their raison d’être. The incentive for a corporation to invert would be eliminated, at least with respect to future earnings. Collectively, companies would reduce substantially reduce their costs in legal, accounting and administrative fees by not having to maintain complex income-shifting programs[20].


While the advantages of apportionment as an alternative international taxation system have been amply researched[21], objections have been raised. These will be dealt with individually below.

The Conduit Problem

A primary objection to SFA has been called the “conduit problem”.  This involves the use of foreign third party agents who serve as conduits for export goods to be re-sold in the U.S. [22] In this way a firm’s U.S. sales are made to appear as non-U.S. sales. The effect is to reduce the firm’s SFA ratio, and therefore its taxable income.

If all of a firm’s sales would fall neatly and easily into the categories of either U.S. sales or non-U.S. sales, SFA would work flawlessly.  Alas, in the real world there will be some crossover between these two categories: some goods sold abroad will ultimately be re-sold in the U.S., and some goods initially sold in the U.S. will ultimately be resold and consumed outside the U.S. However, as we will show, this problem is minimal and manageable.

There are only two ways in which a company’s U.S. sales can be made to appear to be non-U.S. sales: intentionally, or non-intentionally.  We will first consider intentional, willful attempts by a company to use conduits in order to make some of its U.S. sales appear to be non-U.S. sales.

Intentional Crossover

As noted above, the ratio of U.S. sales to worldwide sales may be called the SFA ratio.  If a company lowers its SFA ratio, it lowers its tax liability. Companies will not want to actually lower their U.S. sales, because that will lower their profits.  But if companies can make it appear that they have lower U.S. sales, their tax obligation declines.  In order to do this, they would be tempted to enter into sales contracts with independent third party agents located in foreign counties. Those agents would serve as conduits, shipping the goods to the US.

There are at least four ways to defeat an intentional, willful conduit strategy.

First, SFA rules could require that any firm claiming non-U.S. sales must have its CEO personally certify that SFA rules were complied with, including rules prohibiting willful conduit sales. CEO certification has been long been required by the Securities Exchange Commission for certain reports[23] submitted to it.     This has enhanced the reliability of those reports.

Second, SFA rules could require that all non-U.S. sales must be confirmed by documentation that the goods actually left the U.S. or were manufactured and sold outside the U.S.  SFA rules could include “safe harbor” practices that exporting firms could employ that would insulate them from liability in the event that export goods were ultimately sold in the U.S. These safe harbor practices could include:

  1. Having the U.S. firm exercise due diligence to determine the bona-fides of foreign buyers.
  2. Policing their U.S. distributors to make certain that they are not selling the firm’s re-imported goods.
  3. Terminating the distributorships of violators who sell re-imported goods.
  4. Applying serial numbers that could be tracked by U.S. Customs Service.
  5. Marking “not for sale in the USA” on export goods.
  6. Requiring that all export contracts contain provisions barring re-sale in the U.S.
  7. Implanting inexpensive RFID chips that could be tracked by U.S. Customs Service.

Third, SFA rules could include penalties making willful conduit sales a violation resulting in confiscation and fines. After all, willful violation is a form of tax fraud. These rules could make repeated willful conduit sales an offense punishable by jail sentences.  SFA regulators would perform spot check audits of companies claiming export sales, to discover cheating and to deter violators.  While there will always be a small number of rogue companies, like Enron, the great majority of U.S. firms seek legitimate profits.

Fourth, SFA could make effective use of the International Harmonized Tariff System[24] (HTS). This system uses an internationally established code that uniquely describes each product. When a company exports its product, the HTS code is noted.  If a company then imported that same product, the HTS codes would match, and it would be easy to demonstrate that this was a conduit sale.

These four methods of preventing intentional conduit sales will discourage the practice, making this problem de minimis.

Unintentional Crossover

In spite of good faith efforts by corporations, a small amount of innocent non-intentional crossover is likely to occur. Consider the following examples:

A U.S. company, U.S. Motor (USM), manufactures fractional horsepower electric motors. This company sells its products primarily in large lots to other companies that use them as components in their own products.  USM makes half its sales to customers in the U.S., and half to non-U.S. customers. Its SFA ratio is 50%.

USM might legitimately make 20% of its non-U.S. sales to a large, foreign distributor of component parts in the U.K., called United Kingdom Parts (UKP). UKP could assure USM that it did not intend to resell USM’s goods in the U.S. market, and the USM-UKP sales contract would contain the anti-import provisions described in safe harbor (f) above. Thus USM will have acted in full compliance with SFA rules, and is shielded from liability. Now let us assume that there is a worldwide shortage of fractional horsepower motors and UKP sells some USM motors through brokers to U.S. manufacturers or distributors. Even though USM in good faith believed that the motors it sold to UKP would remain outside the U.S., some have unintentionally crossed over back into the U.S. market.

But countervailing sales would also occur. As noted above, USM makes half its sales in the U.S. Let us assume that 10% of MSM’s U.S. sales are to a large U.S. distributor of component parts, called U.S. Parts (USP). Due to the shortage of fractional horsepower motors, USP sells half its USM motors to a Swedish firm to drive that firm’s high-tech vacuum cleaners. Most of those vacuum cleaners are sold in Europe. In that case some of USM’s U.S. sales have unintentionally crossed over and become non-U.S. sales.

Even though there will be a small amount of innocent crossover in both directions, the net effect will likely be minimal and not worth pursuing.  For SFA rules to require documentation of the complete supply chain would be unduly burdensome and inefficient.  So long as companies make a good faith effort to comply with SFA rules, they will not be penalized. No taxation system is perfect[25], and this minor imperfection is vastly outweighed by other benefits of SFA.

Component Crossover

A U.S. company might find sales opportunities overseas in which it knows that its products will become component parts of a product that will be sold in the U.S. For example Qualcomm, a manufacturer of computer chips, sells a million chips to Apple’s manufacturing facility in China which are then used as component parts of Apple’s iPhones.  If some of those iPhones are then sold in the U.S., should Qualcomm’s chips still count as non-U.S. sales for SFA purposes?

There are two possibilities.  One is to require that a company claiming non-U.S. sales must provide    evidence of the entire supply chain, in order to demonstrate that exported goods have not returned to the U.S. This places a significant record-keeping burden on U.S. exporting companies, and may not be feasible in all cases. A second possibility would be to allow component parts to return to the U.S. and still count as non-U.S. sales.

We favor the second approach.  If a company like Qualcomm were taxed on its returning component sales, then it would be at a competitive disadvantage with respect to marketing its product in China. Apple’s Chinese facility can source its needed chips from any country. There would certainly be no benefit to the Treasury if Apple chose to source those chips from Samsung in Korea, or from some other country. By choosing Qualcomm’s chips, U.S. exports are increased and our balance of trade is improved. Our tax code is filled with instances of favorable tax treatment for desirable activities, and this would be one more instance.

Is this an imperfection in SFA as a tax system? Perhaps. But as noted below, no tax system is perfect, and this is a small flaw in an otherwise very efficient and effective system.

This is another situation in which the International Harmonized Tariff System[26] (HTS) would be useful. The imported iPhones would have a different HTS code from the exported chips, clearly indicating that this was not a conduit sale situation.

Can the U.S. Act Alone?

While coordinated international adoption of sales factor apportionment may be desirable, it is not a prerequisite for U.S. adoption. Different countries might choose different apportionment formulas, much as the U.S. states have.  California uses a sales-only formula, while North Dakota uses a three factor formula with equal weight on sales, payroll and property. Each country is free to select a formula that meets its particular needs, just as each country selects its own tax rate. Writing in support of a unitary system of multinational taxation, Professor Sol Picciotto has stated that while it is “desirable that the allocation formula should be agreed among states … an agreed formula is not essential”[27].

The U.S. multinational tax system is already unique. While almost all other countries utilize a territorial system, we use a worldwide system. Our corporate rate is also out-of-step with most other countries. Moreover under the current system different countries use different transfer pricing rules and they have different standards for what constitutes a “permanent establishment”. If the U.S. adopted SFA it is likely that other countries would follow our lead. The European Union has been considering moving to an apportionment system for at least a decade.

Following U.S. adoption of SFA, foreign-based multinationals would observe the advantages this system provides. Export sales are incentivized because SFA does not assess income tax related to foreign sales. Labor organizations in foreign countries would see how domestic labor is favored under our sales-only formula, so they might also encourage SFA for their own countries. And all foreign multinationals would envy the relative simplicity and reduced compliance costs of our system. Eventually most high consumption countries would adopt SFA or a variant of it.

Impact of Apportionment on Less Developed Countries

Some critics agree that SFA is clearly beneficial for the U.S. but worry that it would further disadvantage less developed countries, particularly those with export driven economies with underdeveloped consumption sectors. However, the goal of a completely uniform worldwide tax system is not only unrealistic, but undesirable. While a sales-only apportionment formula will work best for the U.S. and perhaps other mature economies, there is no reason why every country should adopt that same formula. Countries like Malaysia or Nigeria, with export-based economies, might be best served by a formula that emphasized employment or investment.

The experience of the U.S. states has proven that tax jurisdictions with diverse apportionment formulas can co-exist profitably.  California’s sales-only formula serves the needs of that state, while North Dakota’s three part formula works well there. Diverse apportionment formulas could also profitably co-exist internationally.

Apportionment may be more beneficial to less developed countries than the current system. After selecting a formula that meets their needs, less developed countries would find that administration and tax collection are less costly than the complex system used today. Problems with transfer price determination and arm’s length principles (ALP) discussed below, would disappear. The greater simplicity and transparency of apportionment would help less developed countries to collect income tax from sophisticated multinational corporations.

If problems like “stateless income” (see below) should arise, they can be dealt with in a manner similar to how those issues are dealt with by the states of the U.S. The fact that formulary apportionment has operated successfully in the U.S. for over a hundred years has demonstrated that it is a workable, practical system.

Stateless Income[28]

Stateless income is income that is not taxed in any jurisdiction. It is an unfortunate feature of our current system.  It has become the holy grail of multinational tax avoidance, and multinationals have become adept at it. Professor Kleinbard has called stateless income a “pervasive presence”[29]. An apportionment tax system, such as SFA, will not entirely cure this problem. However, the simplicity and transparency of SFA’s unitary tax approach will likely help. In the apportionment system used by the U.S. states it is called “nowhere income”[30]. The U.S. experience is illustrative.

An example of nowhere income is when a company has all of its management and production in California, which uses a sales-only apportionment formula, but it sells all of its products in other states. That company’s SFA ratio is zero, therefore it owes zero California income tax. If that company had no significant out-of-state operations, [31] (or “nexus”, a concept analogous to the “permanent establishment” concept used internationally) then the California company would pay no state income tax on its U.S. income.

This potential problem was recognized early on. In 1957 the Uniform Division of Income for Tax Purposes Act (UDIPTA) addressed this problem with a “throwback rule”. Under this rule when a corporation makes an out-of-state sale in a state where that corporation had no nexus (and therefore the income associated with that sale was not taxed) then that sale is treated as a sale within the home state. Throwback was subsequently adopted by the state legislatures of about half the states[32]. If the U.S. adopts SFA, it should also include a throwback rule.

There are other provisions for correcting anomalous results that might arise under apportionment. The U.S. Multistate Tax Commission has an alternative dispute resolution program to resolve claims by either taxpayers or collectors. Also, UDIPTA’s Section 18 includes an “Equitable Adjustment” provision that can be applied by the courts of the taxing jurisdiction. These correctives could also be adopted in an international context.

Persuading Congress

Adoption of SFA in the U.S. will require Congressional action. This will be difficult, but not impossible. Difficult, because fundamental change is hard to accept under any circumstances, as Copernicus discovered. Before Congress makes fundamental changes to our multinational tax law, extensive debate will be required. The stakes are too high for anything less. In that policy debate, many voices will be raised in favor of retaining the current system, albeit with tweaks here and there. Those voices are not motivated by venal, unpatriotic motives. They are responding rationally to a tax system that was devised a century ago for a different world. Some of the voices resisting fundamental change will belong to tax experts who have spent decades refining their understanding of our current system. If the U.S. adopts SFA, most of their expertise and intellectual investment disappears. It is natural for them to resist that loss. As Max Bazerman has pointed out in his pioneering work on business decision-making[33], a sub-conscious bias exists that favors decisions that are consistent with self-interest.

Other voices in favor of retaining the status quo will come from multinational corporations that have invested millions developing complex tax avoidance programs that have lowered their effective rates. These corporations have exploited loopholes to the hilt, which is arguably their fiduciary responsibility to their shareholders. As noted elsewhere, one of the ancillary benefits of SFA is that it will make available additional revenue to the Treasury, so that rates may be lowered. That additional revenue will not fall like manna from the sky; it will come from corporations like GE and Apple that will lose their low effective rates made possible by tax avoidance. It is only natural that they will vigorously oppose that loss.

Yet other voices resisting change will come from legislators who are anxious at the thought of stepping off the solid ground of a century of experience with the current system. A change from our current system of worldwide taxation and separate accounting, even with its malfunctioning transfer pricing and ALP formulas[34] would indeed be a sea change. Better the devil you know will be the feeling of many. And some of those legislators depend on campaign contributions from the large multinationals that will be fighting to retain their tax advantages. Other legislators will have constituents in their districts that fear a loss of jobs as a result of change. It is only natural that these legislators will resist fundamental change such as SFA, at least initially.

But if SFA receives a full and fair hearing, many of the objections and reservations described above will fall away. The benefits of SFA are so great – improved efficiency and profitability, reduced cost of tax administration, better competitiveness and more exports, more jobs, and a tax system that is both more transparent and is also seen to be more fair – those benefits are so great that Congress might, just might, decide to adopt a fundamental reform that gives all parts of the political spectrum the reforms that they have sought.

Tax inversions have shown a spotlight on the crisis in our multinational tax system. With more than $2 trillion dollars of untaxed, off-shored profits, and climbing, the irrationality and manifest unfairness of the current system have prompted widespread calls for reform.[35] Apportionment and unitary taxation, ideas that date back a century, are beginning to receive the attention they deserve. Perhaps Winston Churchill was right when he said, “you can always count on Americans to do the right thing – after they’ve tried everything else[36]”. Perhaps SFA is an idea whose time has come.


A company claiming non-U.S. sales will have the burden of proof to document its non-U.S. sales for the IRS. The firm’s accountants would first calculate total world-wide sales. Then they would subtract non-U.S. sales from the total.  In documenting the subtraction, they would use the “safe harbors” that insulate the firm from liability.  They could also use other reasonable documentation.

Because CEO/CFO certification would always be required, the firm would be incentivized to take reasonable steps to assure that its non-U.S. sales were legitimate. Manufacturers use similar strategies today within the U.S. to assure that their goods are sold only by authorized distributors.[37] Similarly, distributors would be incentivized to avoid potential liability by learning the provenance of the goods they sell.

SFA should be much easier to administer than the current separate accounting system. In order to curb egregious tax avoidance through the use of transfer pricing, countries attempt to use the “arm’s length principal” (ALP) that bases transfer prices on comparable market prices Unfortunately ALP has failed because of the absence of comparables for intangibles like intellectual property, inconsistency in different countries’ ALP rules, and abuses like the Swiss pharmaceutical company Hoffman-LaRoche’s transfer price of £ 922 per kilo for an ingredient that could be obtained for £20  per kilo.[38] As the U.S. General Accounting Office (GAO) stated “IRS can seldom find an arm’s length price on which to base adjustments but must instead construct a price. As a result, corporate taxpayers cannot be certain how income on inter-corporate transactions that cross national borders will be adjusted and the enforcement process is difficult and time-consuming for both IRS and taxpayers[39]”. The GAO Report went on to recommend that the Treasury Department study formulary apportionment as an alternative to the current system.


While many will agree that apportionment is the preferred alternative, there is diversity of opinion over what is the best apportionment formula. Three factor apportionment (equal weights for sales, assets and payroll) was the preferred formula first used by the states. The logic of a three factor formula worked well in the early twentieth century, particularly when taxing railroads. However, other industries found that they could reduce their state income taxes by moving assets and payroll out of the taxing state. In order to prevent these losses, more and more states have either reduced or eliminated payroll and property from their apportionment formulas. As Professor Stiglitz has pointed out, it is best to avoid taxing desirable things; employment and investment are desirable. This past summer, the U.S. Multistate Tax Compact unanimously voted to change UDIPTA’s evenly weighted three factor formula to one that places more emphasis on sales[40].

Economists tell us that any tax will create distortions in the economy. A sales-only apportionment formula will create the least amount of distortion because companies might make tax-motivated decisions with regard to locating employment or investment, but they will almost never sacrifice sales.

We believe that a sales-only formula will work best for the U.S. There are at least four reasons for this. 1) Of all of the factors commonly used for apportionment, sales is the least fungible and is the factor that companies will be least likely to forgo. As a result, a formula based solely on sales causes the least amount of economic distortion, thus maximizing economic efficiency. 2) It eliminates any competitive disadvantage that U.S. multinationals face because of our relatively high corporate tax rate. Income from sales in foreign countries would be taxed at those countries’ rates. 3) It encourages exports because income from export sales is not taxed. 4) It levels the competitive playing field between U.S. domestic and all multinational companies.

While a sales-only apportionment formula will work best for high-consumption economies like the U.S. , there is no reason why every country should adopt that same formula. Countries like Malaysia, with export-based economies, might be best served by a formula that emphasized employment or investment. The experience of the states of the U.S. has proven that tax jurisdictions with diverse apportionment formulas can co-exist profitably.  California’s sales-only formula serves the needs of that state, while North Dakota’s three part formula works well there. Diverse apportionment formulas could also profitably co-exist internationally.


Unitary Taxation

Perhaps the chief ancillary benefit of SFA is that it will provide the unitary tax system that many scholars have long advocated[41]. With a unitary system, a parent corporation and its foreign subsidiaries and affiliates are treated as one integrated unit. A multinational’s total world-wide income is then calculated and attributed, or apportioned, for tax purposes to units in different tax jurisdictions, based on the economic activity that takes place in each jurisdiction.  SFA uses sales as a proxy for economic activity.

The current system of multinational taxation, both in the U.S. and world-wide, is not unitary. It is based upon a “separate accounting” of profits in each taxing jurisdiction[42]. Each foreign subsidiary or affiliate of a multinational parent is treated, for accounting and tax purposes, as an independent entity.

The separate accounting regime is what has enabled income shifting from high-tax jurisdictions to low-tax jurisdictions (tax havens).  It has been described as “the biggest single obstacle to tax fairness”[43]. Separate accounting requires complex and costly administration, as governments seek to limit tax avoidance by tightening transfer pricing and other rules, while corporations devise ever more creative ways to exploit loopholes. Separate accounting is also problematic for multinationals, because it does not allow for offsetting losses in one country against profits in another.

Because unitary taxation is simpler and more closely corresponds to economic reality, it avoids the economic distortions and inefficiencies of the separate accounting system in use today.

Increased Corporate Profitability

Under SFA’s unitary approach, our economy would become more efficient and more profitable. Companies would save the administrative, legal and accounting costs of maintaining expensive tax-avoidance practices. They would not allocate scarce resources to uneconomic, tax-motivated programs.  Multinationals would have instant access to their overseas income, without the impediment of deferral rules or repatriation taxes. And they would not need to tie up their earnings in overseas financial accounts, often bearing near-zero interest rates. Moreover, under SFA domestic multinationals would enjoy more equitable tax treatment of their foreign passive income because under subpart F rules almost all foreign source passive income is subject to current U.S. taxation.[44]  Multinationals would finally be freed from the worldwide tax system that they complain of. And the relatively higher U.S. corporate income tax rate would not affect their competitiveness, as the U.S. corporate income tax rate would be irrelevant under SFA.

Competitive Fairness

Domestic U.S. corporations would finally enjoy a level playing field with their multinational competitors. Many domestic companies are unable to exploit the loopholes of our current system to lower their effective tax rates.  Consequently they pay close to the full “rack rate” 35% corporate income tax, and often state income tax as well.  These domestic corporations face some multinational competitors that under the current system pay far lower effective rates. By eliminating aggressive multinational tax avoidance practices, SFA levels the playing field for the domestics.

Export Stimulation

U.S. exports will be stimulated because under SFA export sales would be free of income tax. This added incentive will reduce the U.S. trade deficit that has existed for the last 30 years. Foreign competitors, seeing the benefits of SFA, might demand that their own governments adopt SFA also.  This could help bring about the ideal condition where all nations use apportionment to equitably tax profits from multinational operations. But the success of SFA in the U.S. does not depend upon other nations also adopting an apportionment regime, as explained above.

Potential Rate Reduction

Finally, by eliminating aggressive tax avoidance practices and broadening the tax base, SFA will make increased revenue available to the Treasury. It is estimated that adopting SFA could add at least $100 billion in annual tax revenue.[45] In addition, increased U.S. exports will increase investment and employment in U.S. export sectors. The economic multiplier will operate to increase spending, further increasing tax collections. The increased Treasury revenue could be used to lower rates, to help rebuild our crumbling infrastructure, or to meet other national needs. [46]


Sales Factor Apportionment is a reform for all seasons because it offers a more rational, efficient and transparent system of taxation while satisfying the demands of both liberal and conservative critics. It gives conservatives both the territorial system they want, and the competitiveness they need. It gives liberals an end to excessive tax avoidance strategies like income shifting and inversions that allow some companies to avoid paying their fair share.

SFA’s unitary taxation approach is more rational and efficient because it more closely corresponds to economic reality. The current separate accounting system artificially treats foreign subsidiaries and affiliates as independent entities. Maintaining this fiction requires significant resources and complex, expensive tax administration both for corporations and for government taxing agencies.

SFA is not perfect, but its problems are manageable. There will be winners and losers, and probably unforeseen difficulties.  But that will be true of any reform program. Winston Churchill once observed that “Indeed, it has been said that democracy is the worst form of Government except for all those other forms that have been tried from time to time..[47]” The same might be said of SFA as a multinational tax system. It will not completely level the playing field between all companies in all industries. It will not frustrate every future tax avoidance plan that creative lawyers and accountants might devise. It will not be perfectly fair to everyone. But SFA will be a significant improvement over the current system. It will end the current crisis over tax inversions while stimulating U.S. exports. SFA will level the playing field between U.S. domestic and multinational companies.  It will increase revenue available to the Treasury that can be used to reduce rates or to fund needed spending. SFA is not perfect, but it may be the least imperfect system of multinational taxation available.

The current wave of tax inversions might be the impetus that finally rouses Congress to action.  When Congress considers fundamental reforms, SFA should be at the top of its list.


 Bill Parks is a retired finance professor and founder of NRS, Inc., an Idaho-based paddle-sports accessories maker with $35 million plus in annual sales that is now 100% employee owned.

Jerry Wegman is a retired professor of business law at the College of Business and Economics at University of Idaho. He is also a former prosecuting attorney and judge.

The authors are grateful for the assistance of David Morse in preparing this paper and Michael Udell for his helpful comments.

[1] Nitti, “Could State Taxes Cause Dwight Howard To Flee L.A. For Houston?” Forbes Magazine, Apr. 23, 2013.

[2] Sloan, “Positively un-American tax dodges” Fortune Magazine, July 21, 2014.

[3] Dickinson, “The Biggest Tax Scam Ever” Rolling Stone Magazine, Aug. 27, 2014

[4] Stewart, “Episode 137: Inversion of the Money Snatchers” The Daily Show with Jon Stewart, July 30, 2014.

[5] Kocienewski, “G.E.’s Strategies Let It Avoid Taxes Altogether” New York Times, Mar. 24, 2011.

[6] Helvering v. Gregory, 69 F.2d 809, 810-11 (2d Cir. 1934).

[7] Dickinson, supra note 3 (How to deal with the two trillion dollars of deferred overseas income is a separate issue not addressed in this paper.  Adoption of SFA would prevent this problem in the future).
[8] Rubin, “Cash Abroad Rises $206 Billion as Apple to IBM Avoid Tax”, Bloomberg News, Mar. 12, 2014 (Ironically much of this cash is held in U.S. Treasury notes and bonds in banks in New York, but for tax purposes this still counts as “abroad”).
[9] Pomerleau, “Corporate Income Tax Rates around the World, 2014” Tax Foundation Fiscal Fact No. 436, Aug. 20, 2014.
[10] Udell and Vashist, “Sales-Factor Apportionment of Profits to Broaden the Tax Base”, Tax Notes,

July 15, 2014.

[11] Goodman, “Let’s Abolish the Corporate Tax” Forbes Magazine, Aug. 26, 2014.

[12] 26 U.S. Code § 952 – Subpart F income defined (Passive foreign income is not deferred currently under “subpart F” of the tax code.  Domestic multinational corporations are therefore immediately obligated to pay income tax on all their foreign passive income.  Under SFA domestic multinationals would only be obligated to pay income tax on a percentage of their foreign passive income, dictated by their SFA ratio).

[13] Weiner, Joann Martens “Formulary Apportionment and Group Taxation in the European Union: Insight from the United States and Canada”, Working Papers No. 8, Taxation and Customs Union, European Commission, p. 11, March 2005.

[14] Mazzucato, “The Entrepreneurial State”, Demos, June, 2011. (Professor Mazzucato argues that international competitiveness results primarily from public and private investment in innovative technology).

[15] Mankiw, “One Way to Fix the Corporate Tax: Repeal It” New York Times, Aug. 23, 2014.

[16] “U.S. Tax Treaties Publication 901” I.R.S. Publication, Rev. Apr. 2013.

[17] “Corporate Tax Rates Table” KPMG, http://www.kpmg.com/global/en/services/tax/tax-tools-and-resources/pages/corporate-tax-rates-table.aspx

[18] Mankiw, supra note 14.

[19] Avi-Yonah and Clausing, “Reforming Corporate Taxation in a Global Economy: A Proposal to Adopt Formulary Apportionment” The Brookings Institution, June 2007.

[20] How to deal with the two trillion dollars of currently deferred income is another issue.

[21] Avi-Yonah, supra note 18.

[22] Gleckman, “Could the U.S. Fix Taxation of Multinational Corporations with a Sales-Based Formula?” Tax Policy Center, Aug. 26,, 2014.

[23] 15 U.S.C. 78m, 280(d).

[24] “Harmonized Tariff Schedule of the United States” U.S. International Trade Commission, 2014.

[25] Mazerov, “The ‘Single Sales Factor’ Formula for State Corporate Taxes, A Boon to Economic Development or a Costly Giveaway?” Center on Budget and Policy Priorities, 2005, www.cbpp.org/3-27-01sfp.pdf (States that employ SFA occasionally encounter special situations in which application of the normal rules of SFA yields illogical results.  They adopt special rules to deal with such cases).

[26] “Harmonized Tariff Schedule of the United States”, supra note 23.

[27] Picciotto, “Towards Unitary Taxation of Transnational Corporations” Tax Justice Network, 2012.
[28] Kleinbard, “Stateless Income” Florida Tax Review, Vol. 11, 2011, p. 699. (This article provides numerous examples, which are too lengthy and complex to include in this paper).
[29] Kleinbard, supra note 27.

[30] “‘Nowhere Income’ and the Throwback Rule” Institute on Taxation and Economic Policy: Policy Brief, Aug., 2011.

[31] No nexus exists if a company sells its product directly to customers in other states, without having warehouses, an out-of-state sales force, or other significant operations in those other states.

[32] “Corporate Income Tax Apportionment and the ‘Single Sales Factor’” Institute of Taxation and Economic Policy, Aug. 2012.
[33] Bazerman, “Judgment in Managerial Decision Making” Wiley, 2005.
[34] Sheppard, “Reflections on the Death of Transfer Pricing” Tax Notes Today, Sept. 17, 2008. (Scholars such as Edward Kleinbard have demonstrated the failures of transfer pricing and arms length principles [ALP]).

[35] “Overseas Earnings of Russell 1000 Tops $2 Trillion in 2013” Audit Analytics, April 1, 2014.

[36] “Quotes by Winston Churchill” National Churchill Museum, http://www.nationalchurchillmuseum.org/wit-wisdom-quotes.htm

[37] NRS, the company founded by one of the authors, is both a manufacturer and distributor. As such it has both restricted resale of its products to certain markets and been restricted in its sales of other manufacturer’s products.

[38] Picciotto, supra note 26.

[39] “IRS Could Better Protect US Tax Interests in Determining the Income of Multinational Corporations” U.S. General Accounting Office Report GGD-81-81, 1981, p.52

[40] Griffith, “Single Sales Factor Apportionment May Be Inevitable, But Is It Fair?” Forbes Magazine, Sept. 18, 2014.

[41] Picciotto, supra note 26.

[42] Gresik, “Formula Apportionment vs. Separate Accounting” European Economic Review,  Jan. 2010, p. 133-149.

[43] Picciotto, supra note 26.

[44] Mazucatto, supra note 13.

[45] Udell and Vashist, supra note 10 at Pg 22 Table 6.

[46] Udell M and Vashist, supra note 10.

[47] Churchill, Speech in the House of Commons, Nov. 11, 1947.

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