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Multinational Transfer Pricing, Tax Arbitrage, and the Arm's Length Principle


Chongwoo Choe


Monash University - Department of Economics

Charles E. Hyde


Independent

September 22, 2004


Abstract:     
This paper studies the multinational firm's choice of transfer prices when the firm uses separate transfer prices for tax and managerial incentive purposes, and when there is penalty for noncompliance with the arm's length principle. The optimal incentive transfer price is shown to be the weighted average of marginal cost and the optimal tax transfer price plus an adjustment by a fraction of the marginal penalty for non-arm's length pricing. Insofar as the tax rates are different in different jurisdictions, the firm optimally trades off the benefits of tax arbitrage against the penalty for non-arm's length pricing. Such a tradeoff leads the optimal tax transfer price to deviate from the arm's length price. In the special, but unlikely, case where the tax rates are the same and the arm's length price is equal to marginal cost, the optimal incentive price is equal to marginal cost.

Number of Pages in PDF File: 13

Keywords: Multinational transfer pricing, arm's length principle

JEL Classification: H26, H73, H87, M40, M46

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Date posted: October 7, 2004  

Suggested Citation

Choe, Chongwoo and Hyde, Charles E., Multinational Transfer Pricing, Tax Arbitrage, and the Arm's Length Principle (September 22, 2004). Available at SSRN: http://ssrn.com/abstract=600881 or http://dx.doi.org/10.2139/ssrn.600881

Contact Information

Chongwoo Choe (Contact Author)
Monash University - Department of Economics ( email )
Department of Economics
PO Box 197
Caulfield East, Victoria 3145
Australia
+61 2 9903 1125 (Phone)
+61 2 9903 1128 (Fax)

Monash University Business and Economics Logo

Charles E. Hyde
Independent
No Address Available
United States
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