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Multinational Transfer Pricing, Tax Arbitrage and the Arm's Length Principle

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  • CHONGWOO CHOE
  • CHARLES E. HYDE

Abstract

This paper studies the multinational firm's choice of transfer prices when the firm uses separate transfer prices for tax and managerial incentive purposes, and when there is penalty for non-compliance with the arm's length principle. The optimal incentive transfer price is shown to be a weighted average of marginal cost and the optimal tax transfer price plus an adjustment by a fraction of the marginal penalty for non-arm's length pricing. Insofar as the tax rates are different in different jurisdictions, the firm optimally trades off the benefits of tax arbitrage against the penalty for non-arm's length pricing. Copyright © 2007 The Economic Society of Australia.

Suggested Citation

  • Chongwoo Choe & Charles E. Hyde, 2007. "Multinational Transfer Pricing, Tax Arbitrage and the Arm's Length Principle," The Economic Record, The Economic Society of Australia, vol. 83(263), pages 398-404, December.
  • Handle: RePEc:bla:ecorec:v:83:y:2007:i:263:p:398-404
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    References listed on IDEAS

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    1. Shaffer, Sherrill, 1990. "Regulatory Compliance with Nonlinear Penalties," Journal of Regulatory Economics, Springer, pages 99-103.
    2. Alan de Brauw, 2006. "The Kyoto Protocol, market power, and enforcement," Applied Economics, Taylor & Francis Journals, vol. 38(18), pages 2169-2178.
    3. Charles E. Hyde & Chongwoo Choe, 2005. "Keeping Two Sets of Books: The Relationship Between Tax and Incentive Transfer Prices," Journal of Economics & Management Strategy, Wiley Blackwell, pages 165-186.
    4. Stranlund, John K & Chavez, Carlos A, 2000. "Effective Enforcement of a Transferable Emissions Permit System with a Self-Reporting Requirement," Journal of Regulatory Economics, Springer, pages 113-131.
    5. Carmen Arguedas & Hamid Hamoudi, 2004. "Controlling Pollution with Relaxed Regulations," Journal of Regulatory Economics, Springer, pages 85-104.
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    Cited by:

    1. Kristian Behrens & Susana Peralt & Pierre M. Picard, 2014. "Transfer Pricing Rules, OECD Guidelines, and Market Distortions," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 16(4), pages 650-680, August.
    2. Choe, Chongwoo & Matsushima, Noriaki, 2013. "The arm's length principle and tacit collusion," International Journal of Industrial Organization, Elsevier, pages 119-130.

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