Do Transfer Pricing Rules Distort R&D Investment Decisions?

47 Pages Posted: 2 Feb 2018

See all articles by Tobias Bornemann

Tobias Bornemann

Vienna University of Economics and Business

Date Written: February 1, 2018


This study analyzes the impact of transfer pricing on multinational enterprises’ R&D investment decisions. Specifically, I examine the effects of two commonly used contract designs to exchange and develop intangible assets across group affiliates: licensing and cost sharing agreements. Whilst serving as a tool to allocate taxable income between group affiliates, the economic implications of licensing and cost sharing agreements differ. Whereas licensing agreements provide for a sharing rule on the intangible’s profits, cost sharing agreements on the other hand provide a sharing rule on R&D development costs. This difference matters when firms simultaneously use internal transfer prices to allocate taxable income and provide local management with sufficient investment incentives. Using a multiple-agent, moral hazard investment framework I model a multinational firm with comparable group affiliates in two countries that delegates the R&D investment decision to a local risk and effort averse affiliate manager. The results suggest that the optimal contract not only depends on available tax benefits, but also on R&D investment and manager specific characteristics. A licensing agreement provides management with larger incentives to invest in R&D mitigating agency concerns associated with R&D. On the other hand, using a cost sharing agreement the firm can cater different risk preferences among managers potentially increasing investment. The arm’s length principle however may distort an efficient allocation of R&D costs when using a cost sharing agreement.

Keywords: transfer pricing, R&D investment, taxes

JEL Classification: H21, H25

Suggested Citation

Bornemann, Tobias, Do Transfer Pricing Rules Distort R&D Investment Decisions? (February 1, 2018). WU International Taxation Research Paper Series No. 2018-02, Available at SSRN: or

Tobias Bornemann (Contact Author)

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020

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