Numerous (high-tax) countries presume that multinational firms use their transfer-pricing policies to shift profits into countries with lower tax rates. To avoid the corresponding loss in tax revenues, tax authorities develop constantly tightening rules to curb transfer-price distortions. Affected firms include the decision of compliance to these rules into their strategic considerations. In a scenario with arm's-length regulation in two countries, we analyze the transfer-pricing policy of a firm that uses the same transfer price for tax and managerial incentive purposes. Thus, the transfer-pricing policy is driven by three issues: interaction with competitors, minimization of tax burden, and avoidance of punishments. The model shows that tighter transfer-pricing rules may help firms to mitigate competition and to increase their profits and that non-compliance to the arm's-length principle is part of their equilibrium strategy.
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Find related papers by JEL classification: H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure M40 - Business Administration and Business Economics; Marketing; Accounting - - Accounting - - - General
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