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Duopolistic Competition, Taxes, and the Arm's-Length Principle

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  • Korn, Evelyn
  • Lengsfeld, Stephan

Abstract

Numerous (high-tax) countries presume that multinational firms use their transfer-pricing policies to shift profits into countries with lower tax rates. To avoid the corresponding loss in tax revenues, tax authorities develop constantly tightening rules to curb transfer-price distortions. Affected firms include the decision of compliance to these rules into their strategic considerations. In a scenario with arm's-length regulation in two countries, we analyze the transfer-pricing policy of a firm that uses the same transfer price for tax and managerial incentive purposes. Thus, the transfer-pricing policy is driven by three issues: interaction with competitors, minimization of tax burden, and avoidance of punishments. The model shows that tighter transfer-pricing rules may help firms to mitigate competition and to increase their profits and that non-compliance to the arm's-length principle is part of their equilibrium strategy.

Suggested Citation

  • Korn, Evelyn & Lengsfeld, Stephan, 2007. "Duopolistic Competition, Taxes, and the Arm's-Length Principle," Hannover Economic Papers (HEP) dp-378, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  • Handle: RePEc:han:dpaper:dp-378
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    File URL: http://diskussionspapiere.wiwi.uni-hannover.de/pdf_bib/dp-378.pdf
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    Cited by:

    1. 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.
    2. repec:wsi:gjexxx:v:02:y:2013:i:01:n:s2251361213500031 is not listed on IDEAS

    More about this item

    Keywords

    transfer prices; taxes; arm's-length principle; one set of books; duopolistic competition; enforcement.;

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • M40 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - General

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