A Model of Transfer Pricing Conflicts between Revenue Canada and the Internal Revenue Service
29 Pages Posted: 24 Oct 1997
Abstract
Although both Canada and the United States use the ?arm?s length standard? when evaluating transfer prices for tax purposes, they disagree over which transfer pricing methods are acceptable. Both countries accept methods based on comparable transactions and gross margins of comparable products. The U.S. also accepts, and may in practice prefer, methods based on net profits of comparable firms. Canada resists using the comparable profit method. This paper examines the effects of the various transfer pricing methods on the allocation of taxable income in a model in which organization structure affects the level of relationship-specific investments made by vertically integrated groups and comparable independent firms. Analysis of the model shows that the five transfer pricing methods considered are not equivalent. The comparable profit method allocates less income to Canada in cases involving U.S. parents and Canadian subsidiaries, and in cases in which more reliable gross margin data is available for U.S. firms than for Canadian firms.
JEL Classification: K34, H24, L29
Suggested Citation: Suggested Citation
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