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

13 Pages Posted: 7 Oct 2004  

Chongwoo Choe

Monash University - Department of Economics

Charles E. Hyde

Independent

Multiple version iconThere are 2 versions of this paper

Date Written: 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.

Keywords: Multinational transfer pricing, arm's length principle

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

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: https://ssrn.com/abstract=600881 or http://dx.doi.org/10.2139/ssrn.600881

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)

Charles E. Hyde

Independent

No Address Available

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