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Production Location of Multinational Firms under Transfer Pricing: The Impact of the Arm's Length Principle

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  • Hayato Kato

    (Faculty of Economics, Keio University)

  • Hirofumi Okoshi

    (Graduate School of Economics, Hitotsubashi University)

Abstract

In what situation does a vertically-integrated multinational enterprise (MNE) establish an upstream affiliate in a different country from its downstream affiliate? When MNEs separate the location of two affiliates, they can shift prots between affiliates by manipulating intra-firm prices. The location choice of the MNE depends on the difference in corporate taxes between the parent and the host countries. This paper shows that if the international tax difference is small, the upstream affiliate is located in the same country as the downstream affiliate. It also investigates the impact of the arm's length principle (ALP) on the location choice, which requires that the intra-firm price of inputs should be set equal to that of similar inputs for the independent downstream firms. The imposition of the ALP may change the location choice of MNEs. This location change brings smaller tax revenues to the host country, but generally greater revenues globally.

Suggested Citation

  • Hayato Kato & Hirofumi Okoshi, 2017. "Production Location of Multinational Firms under Transfer Pricing: The Impact of the Arm's Length Principle," Keio-IES Discussion Paper Series 2017-016, Institute for Economics Studies, Keio University.
  • Handle: RePEc:keo:dpaper:2017-016
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    Cited by:

    1. Jay Pil Choi & Taiji Furusawa & Jota Ishikawa, 2018. "Transfer Pricing and the Arm's Length Principle under Imperfect Competition," CESifo Working Paper Series 7303, CESifo Group Munich.
    2. Mukunoki, Hiroshi & Okoshi, Hirofumi, 2020. "Tariff Elimination versus Tax Avoidance: Free Trade Agreements and Transfer Pricing," Discussion Papers in Economics 71608, University of Munich, Department of Economics.
    3. MUKUNOKI Hiroshi & OKOSHI Hirofumi, 2019. "Tariff Elimination versus Tax Avoidance: Free Trade Agreements and Transfer Pricing," Discussion papers 19099, Research Institute of Economy, Trade and Industry (RIETI).
    4. Hayato Kato & Hirofumi Okoshi, 2019. "Production location of multinational firms under transfer pricing: the impact of the arm’s length principle," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 26(4), pages 835-871, August.
    5. Kato, Hayato & Okoshi, Hiofumi, 2019. "Economic Integration and Agglomeration of Multinational Production with Transfer Pricing," Discussion Papers in Economics 62013, University of Munich, Department of Economics.

    More about this item

    Keywords

    Transfer pricing; Intra-firm trade; Production location choice; Arm's length principle;

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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