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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. CHOI, Jay Pil & FURUSAWA, Taiji, 2018. "Transfer Pricing and the Arm's Length Principle under Imperfect Competition," Discussion paper series HIAS-E-73, Hitotsubashi Institute for Advanced Study, Hitotsubashi University.
    2. 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.
    3. MUKUNOKI Hiroshi & OKOSHI Hirofumi, 2021. "Wake Not a Sleeping Lion: Free Trade Agreements and Decision Rights in Multinationals," Discussion papers 21036, Research Institute of Economy, Trade and Industry (RIETI).
    4. Hiroshi Mukunoki & Hirofumi Okoshi, 2021. "Tariff elimination versus tax avoidance: free trade agreements and transfer pricing," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 28(5), pages 1188-1210, October.
    5. OKOSHI Hirofumi, 2021. "Innovation for Tax Avoidance: Product Differentiation and the Arm's Length Principle," Discussion papers 21038, Research Institute of Economy, Trade and Industry (RIETI).
    6. 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.
    7. Alexander Georgievich Gurinovich & Marina Afanasyevna Lapina & Alexey Evgenievich Ivanov, 2020. "Ways of Restricting the Rights of Taxpayers Under Agreements for the Avoidance of Double Taxation in National Legislation," SAGE Open, , vol. 10(4), pages 21582440209, October.

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    More about this item

    Keywords

    Transfer pricing; Intra-firm trade; Production location choice; Arm's length principle;
    All these keywords.

    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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