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Duopolistic Competition, Taxes, and the Arm's-Length Principle

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  • Korn, Evelyn
  • Lengsfeld, Stephan

Abstract

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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File URL: http://diskussionspapiere.wiwi.uni-hannover.de/pdf_bib/dp-378.pdf
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Bibliographic Info

Paper provided by Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät in its series Hannover Economic Papers (HEP) with number dp-378.

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Length: 22 pages
Date of creation: Oct 2007
Date of revision:
Handle: RePEc:han:dpaper:dp-378

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Related research

Keywords: transfer prices; taxes; arm's-length principle; one set of books; duopolistic competition; enforcement.;

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Cited by:
  1. Ana B. Lemus, 2011. "Strategic incentives for kepping one set of books under the Arm's Length Principle," Economics Working Papers we1135, Universidad Carlos III, Departamento de Economía.

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