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Transfer Pricing and the Arm's Length Principle under Imperfect Competition

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  • CHOI, Jay Pil
  • FURUSAWA, Taiji

Abstract

This paper analyzes incentives of a multinational enterprise to manipulate an internal transfer price to take advantage of corporate-tax differences across countries under both monopoly and oligopoly. We examine “cost plus” and “comparable uncontrollable price” as two alternative implementations of the so-called arm's length principle (ALP) to mitigate this problem. Tax-induced foreign direct investment (FDI) may entail inefficient internal production. We show how the mechanisms behind such inefficient FDI differ between alternative implementation schemes of the ALP and explore implications of the ALP for welfare and dual sourcing incentives. We also develop a novel theory of vertical foreclosure as an equilibrium outcome of strategic transfer pricing.

Suggested Citation

  • CHOI, Jay Pil & FURUSAWA, Taiji, 2018. "Transfer Pricing and the Arm's Length Principle under Imperfect Competition," Discussion paper series HIAS-E-73, Hitotsubashi Institute for Advanced Study, Hitotsubashi University.
    • Handle: RePEc:hit:hiasdp:hias-e-73
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    Cited by:

    1. Hayato Kato & Hirofumi Okoshi, 2022. "Economic Integration And Agglomeration Of Multinational Production With Transfer Pricing," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 63(3), pages 1325-1355, August.
    2. Hiroshi Mukunoki & Hirofumi Okoshi, 2021. "Tariff elimination versus tax avoidance: free trade agreements and transfer pricing," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 28(5), pages 1188-1210, October.
    3. Choi, Jay Pil & Furusawa, Taiji & Ishikawa, Jota, 2020. "Transfer pricing regulation and tax competition," Journal of International Economics, Elsevier, vol. 127(C).
    4. Hayato Kato & Hirofumi Okoshi, 2019. "Production location of multinational firms under transfer pricing: the impact of the arm’s length principle," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 26(4), pages 835-871, August.
    5. MUKUNOKI Hiroshi & OKOSHI Hirofumi, 2022. "Antidumping on Tax-induced Dumping," Discussion papers 22063, Research Institute of Economy, Trade and Industry (RIETI).

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    More about this item

    Keywords

    Foreign Direct Investment; Multinational Enterprise; Corporate tax; Transfer Pricing; Arm's Length Principle; Vertical Foreclosure;
    All these keywords.

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • L12 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Monopoly; Monopolization Strategies
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • L52 - Industrial Organization - - Regulation and Industrial Policy - - - Industrial Policy; Sectoral Planning Methods

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