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Keeping Two Sets of Books: The Relationship Between Tax and Incentive Transfer Prices


  • Charles E. Hyde
  • Chongwoo Choe


Multinational enterprises use two types of transfer prices: the tax transfer price to achieve optimal tax outcomes and the incentive transfer price to provide appropriate incentives to offshore managers. The two optimal transfer prices are independent if taxable income is assessed using the formula apportionment approach. Under the separate entity approach, however, they are interdependent: they both decrease as the penalty for noncompliance with the arm's length principle increases; and the tax transfer price decreases and the incentive transfer price increases as the marginal cost of production increases. We also examine the case where the incentive transfer price is negotiated rather than dictated by the parent. The results are robust to different market structures and tax environments. Copyright Blackwell Publishing 2005.

Suggested Citation

  • 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, vol. 14(1), pages 165-186, March.
  • Handle: RePEc:bla:jemstr:v:14:y:2005:i:1:p:165-186

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    References listed on IDEAS

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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. Michael P. Devereux & Christian Keuschnigg, 2009. "The Distorting Arm’s Length Principle," Working Papers 0910, Oxford University Centre for Business Taxation.
    3. Keuschnigg, Christian & Devereux, Michael P., 2013. "The arm's length principle and distortions to multinational firm organization," Journal of International Economics, Elsevier, vol. 89(2), pages 432-440.
    4. Cools, Martine & Emmanuel, Clive & Jorissen, Ann, 2008. "Management control in the transfer pricing tax compliant multinational enterprise," Accounting, Organizations and Society, Elsevier, vol. 33(6), pages 603-628, August.
    5. repec:ces:ifodic:v:12:y:2015:i:4:p:19149986 is not listed on IDEAS
    6. Søren Bo Nielsen, 2014. "Transfer Pricing: Roles and Regimes," CESifo Working Paper Series 4694, CESifo Group Munich.
    7. Andrew B. Bernard & J. Bradford Jensen & Peter K. Schott, 2006. "Transfer Pricing by U.S.-Based Multinational Firms," NBER Working Papers 12493, National Bureau of Economic Research, Inc.
    8. Lemus Torres, Ana Belén, 2011. "Strategic incentives for kepping one set of books under the Arm's Length Principle," UC3M Working papers. Economics we1135, Universidad Carlos III de Madrid. Departamento de Economía.
    9. Choe, Chongwoo & Matsushima, Noriaki, 2013. "The arm's length principle and tacit collusion," International Journal of Industrial Organization, Elsevier, vol. 31(1), pages 119-130.
    10. Bodo Knoll & Nadine Riedel, 2015. "Transfer Pricing Laws," ifo DICE Report, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 12(4), pages 22-26, 01.
    11. Jan Thomas Martini & Rainer Niemann & Dirk Simons, 2007. "Transfer Pricing or Formula Apportionment? Tax-Induced Distortions of Multinationals’ Investment and Production Decisions," CESifo Working Paper Series 2020, CESifo Group Munich.
    12. Søren Bo Nielsen & Pascalis Raimondos-Møller & Guttorm Schjelderup, 2008. "Taxes and Decision Rights in Multinationals," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 10(2), pages 245-258, April.
    13. Moreno Ruiz, Diego & Lemus Torres, Ana Belén, 2011. "The non-neutrality of the arm's length principle with imperfect competition," UC3M Working papers. Economics we1134, Universidad Carlos III de Madrid. Departamento de Economía.
    14. Jie Ma & Pascalis Raimondos-Møller, 2015. "Competition for FDI and Profit Shifting," CESifo Working Paper Series 5153, CESifo Group Munich.
    15. Martini, Jan Thomas & Niemann, Rainer & Simons, Dirk, 2007. "Transfer pricing or formula apportionment? Tax-induced distortions of multinationals' investment and production decisions," arqus Discussion Papers in Quantitative Tax Research 27, arqus - Arbeitskreis Quantitative Steuerlehre.
    16. repec:otg:wpaper:1403 is not listed on IDEAS
    17. Chongvilaivan, Aekapol & Hur, Jung & Riyanto, Yohanes E., 2013. "Labor union bargaining and firm organizational structure," Labour Economics, Elsevier, vol. 24(C), pages 116-124.
    18. 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.

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