Multinational Transfer Pricing, Tax Arbitrage and the Arm's Length Principle

This paper studies the multinational firm's choice of transfer prices when the firm uses separate transfer prices for tax and managerial incentive purposes, and when there is penalty for non‐compliance with the arm's length principle. The optimal incentive transfer price is shown to be a w...

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Bibliographic Details
Published in:The Economic record 2007-12, Vol.83 (263), p.398-404
Main Authors: CHOE, CHONGWOO, HYDE, CHARLES E.
Format: Article
Language:English
Subjects:
Arbitrage
Economics
H26
H73
H87
Multinational corporations
Organizational behavior
Studies
Tax rates
Taxes
Transfer pricing
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Summary:This paper studies the multinational firm's choice of transfer prices when the firm uses separate transfer prices for tax and managerial incentive purposes, and when there is penalty for non‐compliance with the arm's length principle. The optimal incentive transfer price is shown to be a weighted average of marginal cost and the optimal tax transfer price plus an adjustment by a fraction of the marginal penalty for non‐arm's length pricing. Insofar as the tax rates are different in different jurisdictions, the firm optimally trades off the benefits of tax arbitrage against the penalty for non‐arm's length pricing.
ISSN:0013-0249
1475-4932
DOI:10.1111/j.1475-4932.2007.00429.x