Transfer Pricing in Vertically Integrated Industries

36 Pages Posted: 12 May 2004 Last revised: 5 Jan 2011

See all articles by Thomas A. Gresik

Thomas A. Gresik

University of Notre Dame - Department of Economics and Econometrics

Petter Osmundsen

University of Stavanger; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: June 1, 2008

Abstract

Tax officials judge whether a multinational's transfer price is consistent with the arm's-length standard, the price at which two independent firms would carry out a similar transaction, by using data from comparable but independent transactions. In vertically integrated industries, the only source of comparable data may be from controlled (non-independent) transactions. Conventional wisdom asserts that standard arm's-length methods cannot perform well in such markets because the comparability rules encourage the integrated firms to collude tacitly on transfer prices in a way that amplifies tax-differential incentives. In this paper, we show that strategic linkages between vertically integrated firms operating in the same final good market moderate, and can possibly reverse, tax-differential incentives if the correct comparison method is used.The Cost-Plus method turns out to be the most effective in limiting the equilibrium amount of profit-shifting out of the high-tax country and it yields the highest tax revenues for the high-tax country. These benefits are shown to strengthen when the firms have private cost information.

Keywords: Tranfer pricing, vertical integration, incentive comparability

JEL Classification: F23, H26, H73

Suggested Citation

Gresik, Thomas A. and Osmundsen, Petter, Transfer Pricing in Vertically Integrated Industries (June 1, 2008). International Tax and Public Finance, Vol. 15, 2008. Available at SSRN: https://ssrn.com/abstract=545324

Thomas A. Gresik (Contact Author)

University of Notre Dame - Department of Economics and Econometrics ( email )

P.O. Box 399
Notre Dame, IN 46556-0399
United States

Petter Osmundsen

University of Stavanger ( email )

4036 Stavanger
Norway

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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