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Transfer pricing rules, OECD guidelines, and market distortions

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  • Kristian Behrens

    ()
    (Université du Québec à Montréal (UQAM), Canada; CORE, Université catholique de Louvain, Belgium; CIRPÉE, Canada; and CEPR, London)

  • Susana Peralta

    ()
    (Universidade Nova de Lisboa, Portugal; CORE, Université catholique de Louvain, Belgium, and CEPR)

  • Pierre M. Picard

    ()
    (CREA, Université du Luxembourg, Luxembourg; and CORE, Université catholique de Louvain, Belgium)

Abstract

We study the impact of transfer pricing rules on sales prices, firms' organizational structure, and consumers' utility within a two-country monopolistic competition model featuring source-based profit taxes that differ across countries. Firms can either become multinationals, i.e., they serve the foreign market through a fully controlled a¢ liate; or they can become exporters, i.e., they serve the foreign market by contracting with an independent distributor. Compared to the benchmark cases, where tax authorities are either unable to audit firms or where they are able to audit them perfectly, the use of the OECD's Comparable Uncontrolled Price (CUP) or Cost-Plus (CP) rule distorts firms' output and pricing decisions. The reason is that the comparable arm's length transactions between exporters and distributors, which serve as benchmarks, are not efficient. We show that implementing the CUP or CP rules is detrimental to consumers in the low tax country, yet benefits consumers in the high tax country.

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Bibliographic Info

Paper provided by Center for Research in Economic Analysis, University of Luxembourg in its series CREA Discussion Paper Series with number 10-20.

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Date of creation: 2010
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Handle: RePEc:luc:wpaper:10-20

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Keywords: transfer pricing; OECD guidelines; multinationals and exporters; organizational choice; arm's length principle;

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Cited by:
  1. Choe, Chongwoo & Matsushima, Noriaki, 2011. "The Arm's Length Principle and Tacit Collusion," MPRA Paper 37295, University Library of Munich, Germany, revised 12 Mar 2012.

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