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A Negotiation-Based Model of Tax-Induced Transfer Pricing

Listed author(s):
  • Johannes Becker

    ()

    (University of M{\"u}nster)

  • Ronald B. Davies

    ()

    (University College Dublin; Institute for International Integration Studies, Trinity College Dublin; CES-Ifo)

We present a new model of tax induced transfer pricing as an alternative to the oft-used concealment model. Inspired by interviews with practitioners, we consider a large multinational firm which is audited by the tax authority in the high-tax location. When this country adjusts the transfer prices proposed by the firm, the low-tax location may dispute this decision and initiate negotiations. Since negotiations are costly, the high-tax location sets a transfer price that prevents the low-tax location from entering negotiations. We compare this model's predictions to those of the concealment model. The negotiation model replicates the predictions on the tax rate effects on transfer pricing, while adding new predictions. Profit shifting is expected to fall in the high-tax country's bargaining power and to rise in firm profits and domestic firm ownership in both countries. Most importantly, profit shifting occurs even if tax enforcement is perfect. We analyze the effects of an introduction of a common consolidated corporate tax base with formula apportionment and conclude that the negotiation model may change the perspective on such a policy. Specifically, strong countries with large bargaining power may find this reform unappealing.

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Paper provided by IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp451.

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Length: 35 pages
Date of creation: Jul 2014
Handle: RePEc:iis:dispap:iiisdp451
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  1. Kashif S. Mansori & Alfons J. Weichenrieder, 2001. "Tax Competition and Transfer Pricing Disputes," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 58(1), pages 1-1, December.
  2. Ronald B. Davies & Julien Martin & Mathieu Parenti & Farid Toubal, 2014. "Knocking on Tax Haven's Door: Multinational Firms and Transfer Pricing," CESifo Working Paper Series 5132, CESifo Group Munich.
  3. Haufler, Andreas & Schjelderup, Guttorm, 2000. "Corporate Tax Systems and Cross Country Profit Shifting," Oxford Economic Papers, Oxford University Press, vol. 52(2), pages 306-325, April.
  4. Hines Jr., James R., 2010. "Income misattribution under formula apportionment," European Economic Review, Elsevier, vol. 54(1), pages 108-120, January.
  5. Swenson, Deborah L., 2001. "Tax Reforms and Evidence of Transfer Pricing," National Tax Journal, National Tax Association, vol. 54(1), pages 7-26, March.
  6. Clausing, Kimberly A., 2003. "Tax-motivated transfer pricing and US intrafirm trade prices," Journal of Public Economics, Elsevier, vol. 87(9-10), pages 2207-2223, September.
  7. Markusen, James R., 1984. "Multinationals, multi-plant economies, and the gains from trade," Journal of International Economics, Elsevier, vol. 16(3-4), pages 205-226, May.
  8. Bartelsman, Eric J. & Beetsma, Roel M. W. J., 2003. "Why pay more? Corporate tax avoidance through transfer pricing in OECD countries," Journal of Public Economics, Elsevier, vol. 87(9-10), pages 2225-2252, September.
  9. Bauer, Christian J. & Langenmayr, Dominika, 2013. "Sorting into outsourcing: Are profits taxed at a gorilla's arm's length?," Journal of International Economics, Elsevier, vol. 90(2), pages 326-336.
  10. Dharmapala, Dhammika & Riedel, Nadine, 2013. "Earnings shocks and tax-motivated income-shifting: Evidence from European multinationals," Journal of Public Economics, Elsevier, vol. 97(C), pages 95-107.
  11. 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.
  12. Nielsen, Søren Bo & Raimondos-Møller, Pascalis & Schjelderup, Guttorm, 2010. "Company taxation and tax spillovers: Separate accounting versus formula apportionment," European Economic Review, Elsevier, vol. 54(1), pages 121-132, January.
  13. Ronald B. Davies, 2008. "Hunting High and Low for Vertical FDI," Review of International Economics, Wiley Blackwell, vol. 16(2), pages 250-267, 05.
  14. 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.
  15. Clemens Fuest, 2008. "The European Commission's proposal for a common consolidated corporate tax base," Oxford Review of Economic Policy, Oxford University Press, vol. 24(4), pages 720-739, winter.
  16. Dhammika Dharmapala, 2014. "What Do We Know about Base Erosion and Profit Shifting? A Review of the Empirical Literature," Fiscal Studies, Institute for Fiscal Studies, vol. 35, pages 421-448, December.
  17. Huizinga, Harry & Laeven, Luc, 2008. "International profit shifting within multinationals: A multi-country perspective," Journal of Public Economics, Elsevier, vol. 92(5-6), pages 1164-1182, June.
  18. Allingham, Michael G. & Sandmo, Agnar, 1972. "Income tax evasion: a theoretical analysis," Journal of Public Economics, Elsevier, vol. 1(3-4), pages 323-338, November.
  19. Thomas A. Gresik, 2001. "The Taxing Task of Taxing Transnationals," Journal of Economic Literature, American Economic Association, vol. 39(3), pages 800-838, September.
  20. Jack M. Mintz, 1999. "Globalization of the Corporate Income Tax: The Role of Allocation," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 56(3/4), pages 389-389, July.
  21. Swenson, Deborah L., 2001. "Tax Reforms and Evidence of Transfer Pricing," National Tax Journal, National Tax Association, vol. 54(n. 1), pages 7-26, March.
  22. Thomas Eichner & Marco Runkel, 2008. "Why the European Union Should Adopt Formula Apportionment with a Sales Factor," Scandinavian Journal of Economics, Wiley Blackwell, vol. 110(3), pages 567-589, 09.
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