Tax induced transfer pricing under universal adoption of the destination-based cash-flow tax

Abstract

The view that the transfer pricing problem vanishes under universal destination-based cash flow taxation (DBCFT) is based on how firms behave in perfectly competitive markets. We show that the neutralizing effect DBCFT has on transfer price incentives fails once multinational firms are multi-market oligopolists. Under imperfect competition, a multinational will delegate output decisions to its affiliates. The transfer price then takes on a strategic role because it influences competitors’ actions. Even if all countries adopt DBCFT, transfer prices will not equal arm’s length prices, and the global efficiency implications attributed to DBCFT are lost.

Keywords: Destination-based cash-flow tax, transfer pricing, managerial delegation

JEL Classification: F23, G32, H21, H25, H26