Transfer Pricing and Debt Shifting in Multinationals

There is a growing concern that governments lose substantial corporate tax revenue due to transfer pricing and debt shifting strategies. Existing literature studies debt shifting and transfer pricing separately. In practice, however, the choice of debt-to-asset ratios in affiliates and the transfer price of internal debt are interrelated management decisions that are also mutually affected by government regulation. This paper models these strategies as intertwined. We find that the tax sensitivity of the corporate tax base depends on whether debt shifting and transfer pricing are cost complements or substitutes. A second result is that stricter regulation of debt shifting and transfer pricing may have the effect of fostering such activities.