Transfer pricing or formula apportionment? Tax-induced distortions of multinationals' investment and production decisions
Multinational groups (MNGs) produce a major part of global output. Further, a substantial fraction of international transactions happens to be internal, i.e., intermediate products and services are traded between group members. Thus, the problem of co-ordinating economic decisions like investment or production within such large entities has been widely recog-nized in the theoretical and empirical literature. The findings suggest that transfer prices are a widespread device for splitting up complex decision situations and allocating the responsibility for the resulting subproblems to several decision makers. Apart from its co-ordination function transfer pricing is also used for tax purposes. Legally independent group members realize intra-group sales and contribute to a single product. Taxable group profits are often allocated among the participating companies by means of transfer prices. In this case, from the group's perspective, transfer pricing is a device of international tax planning. Of course, national tax authorities have been aware of potential misuse. In Europe, the problem has become especially severe since the mid-European countries joined the EU. Due to the emerging large tax rate differentials, tax revenues of high-tax legislations eroded. For mitigating this problem formula apportionment (FA) is discussed intensively. Under FA, a common tax base is calculated and divided among the host countries in accordance with given apportionment factors. As a consequence, earnings management fails to re-allocate profits to low-tax legislations and tax base erosion seems to be stopped. However, FA could even be more harmful than transfer pricing because under FA income shifting would require changing economic decisions instead of just taking advantage of accounting options. In addition to the erosion of tax revenues, capital investments and employment could decrease in high-tax legislations. The goal of our paper is to analyze the impact of different international tax allocation regimes on the MNG's investment and production decisions. In our theoretical model, we derive optimal decisions under transfer pricing and FA. A prominent result of our analysis is that FA offsets the advantages of decision decentralization as it reverses the separation of responsibility areas. It is not clear whether FA is desirable from a fiscal or an entrepreneurial perspective. We show that the effects of FA compared to transfer pricing depend strongly on the parameter setting under consideration. One of the most important determinants is the internal decision procedure within the MNG.
|Date of creation:||2007|
|Contact details of provider:|| Web page: http://www.arqus.info/|
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Osband, Kent & Reichelstein, Stefan, 1985. "Information-eliciting compensation schemes," Journal of Public Economics, Elsevier, vol. 27(1), pages 107-115, June.
- Stefan Reichelstein, 1982.
"Incentives in Government Contracts,"
522S, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Groves, Theodore, 1973. "Incentives in Teams," Econometrica, Econometric Society, vol. 41(4), pages 617-631, July.
- 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, 03.
- Marcel Gérard, 2005. "Multijurisdictional Firms and Governments’ Strategies under Alternative Tax Designs," CESifo Working Paper Series 1527, CESifo Group Munich.
- Marcel Gérard & Joann Weiner, 2003. "Cross-Border Loss Offset and Formulary Apportionment: How do they affect multijurisdictional firm investment spending and interjurisdictional tax competition ?," CESifo Working Paper Series 1004, CESifo Group Munich.
- Anand, Bharat N. & Sansing, Richard, 2000. "The Weighting Game: Formula Apportionment as an Instrument of Public Policy," National Tax Journal, National Tax Association, vol. 53(2), pages 183-200, June.
- Rüdiger Pethig & Andreas Wagener, 2003.
"Profit Tax Competition and Formula Apportionment,"
CESifo Working Paper Series
1011, CESifo Group Munich.
- Mintz, Jack & Weiner, Joann Martens, 2003. "Exploring Formula Allocation for the European Union," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 10(6), pages 695-711, November.
- Martin L. Weitzman, 1976.
"The New Soviet Incentive Model,"
Bell Journal of Economics,
The RAND Corporation, vol. 7(1), pages 251-257, Spring.
- Søren Bo Nielsen & Pascalis Raimondos-Møller & Guttorm Schjelderup, 2001.
"Formula Apportionment and Transfer Pricing under Oligopolistic Competition,"
CESifo Working Paper Series
491, CESifo Group Munich.
- S¯ren Bo Nielsen & Pascalis Raimondos-M¯ller & Guttorm Schjelderup, 2003. "Formula Apportionment and Transfer Pricing under Oligopolistic Competition," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 5(2), pages 419-437, 04.
- Søren Bo Nielsen & Pascalis Raimondos-Møller & Guttorm Schjelderup, "undated". "Formula Apportionment and Transfer Pricing under Oligopolistic Competition," EPRU Working Paper Series 01-05, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
- Nielsen, Søren Bo & Raimondos-Møller, Pascalis & Schjederup, Guttorm, 2000. "Formula Apportionment And Transfer Pricing Under Oligopolistic Competition," Working Papers 18-2000, Copenhagen Business School, Department of Economics.
- Spengel, Christoph & Schäfer, Anne, 2003. "The Impact of ICT on Profit Allocation within Multinational Groups: Arm's Length Pricing or Formula Apportionment?," ZEW Discussion Papers 03-53, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
- Simmons, Beth A., 2001. "The International Politics of Harmonization: The Case of Capital Market Regulation," International Organization, Cambridge University Press, vol. 55(03), pages 589-620, June.
- Klassen, Kenneth J. & Shackelford, Douglas A., 1998. "State and provincial corporate tax planning: income shifting and sales apportionment factor management," Journal of Accounting and Economics, Elsevier, vol. 25(3), pages 385-406, June.
- Austan Goolsbee & Edward L Maydew, 1998.
"Coveting Thy Neighbor's Manuafacturing: The Dilemma of State Income Apportionment,"
NBER Working Papers
6614, National Bureau of Economic Research, Inc.
- Goolsbee, Austan & Maydew, Edward L., 2000. "Coveting thy neighbor's manufacturing: the dilemma of state income apportionment," Journal of Public Economics, Elsevier, vol. 75(1), pages 125-143, January.
- repec:ntj:journl:v:53:y:2000:i:n._2:p:183-200 is not listed on IDEAS
- Michael Devereux, 2004. "Debating Proposed Reforms of the Taxation of Corporate Income in the European Union," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 11(1), pages 71-89, January.
- Theodore Groves & Martin Loeb, 1979. "Incentives in a Divisionalized Firm," Management Science, INFORMS, vol. 25(3), pages 221-230, March.
- Tim Baldenius & Stefan Reichelstein, 2006. "External and Internal Pricing in Multidivisional Firms," Journal of Accounting Research, Wiley Blackwell, vol. 44(1), pages 1-28, 03.
- Gordon, Roger H & Wilson, John Douglas, 1986. "An Examination of Multijurisdictional Corporate Income Taxation under Formula Apportionment," Econometrica, Econometric Society, vol. 54(6), pages 1357-1373, November.
- Douglas Shackelford & Joel Slemrod, 1998. "The Revenue Consequences of Using Formula Apportionment to Calculate U.S. and Foreign-Source Income: A Firm-Level Analysis," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 5(1), pages 41-59, February.
- Fox, William F. & Murray, Matthew N. & Luna, LeAnn, 2005. "How Should a Subnational Corporate Income Tax on Multistate Businesses Be Structured?," National Tax Journal, National Tax Association, vol. 58(1), pages 139-159, March.
- Samuelson, Larry, 1982. "The multinational firm with arm's length transfer price limits," Journal of International Economics, Elsevier, vol. 13(3-4), pages 365-374, November.
- Dietmar Wellisch, 2004. "Taxation under Formula Apportionment - Tax Competition, Tax Incidence, and the Choice of Apportionment Factors," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 60(1), pages 1-24, April.
- Elitzur, Ramy & Mintz, Jack, 1996. "Transfer pricing rules and corporate tax competition," Journal of Public Economics, Elsevier, vol. 60(3), pages 401-422, June.
- Musgrave, Peggy B, 1972. "International Tax Base Division and the Multinational Corporation," Public Finance = Finances publiques, , vol. 27(4), pages 394-413.
When requesting a correction, please mention this item's handle: RePEc:zbw:arqudp:27. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (ZBW - German National Library of Economics)
If references are entirely missing, you can add them using this form.