U.S. Income Tax Transfer-Pricing Rules and Resource Allocation: The Case of Decentralized Multinational Firms

A study examines how transfer pricing, in the presence of differential taxation, affects the resource allocation and profitability of a decentralized multinational enterprise (MNE) that uses the same transfer price for tax and performance evaluation purposes. An analytical model is derived in which...

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Bibliographic Details
Published in:The Accounting review 1991-01, Vol.66 (1), p.141-157
Main Authors: Halperin, Robert M, Srinidhi, Bin
Format: Article
Language:English
Subjects:
Decentralized
Income tax
Mathematical models
Multinational corporations
Multinational enterprises
Pricing
Resource allocation
Tax rates
Transfer pricing
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Summary:A study examines how transfer pricing, in the presence of differential taxation, affects the resource allocation and profitability of a decentralized multinational enterprise (MNE) that uses the same transfer price for tax and performance evaluation purposes. An analytical model is derived in which a foreign manufacturing division transfers a single product to a US distribution division, which then sells it in the marketplace as part of a final product. When differential tax rates exist but there are no transfer-pricing rules imposed by the taxing authorities, it is shown that the MNE's optimal resource allocation is the same as in the absence of taxes; however, firmwide profits are not maximized. When the resale-price method of computing transfer prices is used, the results differ, depending on the manufacturing division's bargaining power. When transfer prices are computed in accordance with the cost-plus method, it is shown that production of the final product first decreases, then increases. Numerical examples demonstrate these results.
ISSN:0001-4826
1558-7967