Tax motivated vertical FDI and transfer pricing

Joel Sandonis and Binur Yermukanova

Economic Modelling, 2024, vol. 139, issue C

Abstract: We examine a domestic downstream producer that acquires a foreign input supplier with the aim of manipulating the transfer price and shifting profits from a high-tax to a low-tax country. The multinational enterprise faces a trade-off: insourcing the input at a high transfer price reduces the corporate tax burden but at the cost of increasing the input cost of its downstream division, which reduces domestic sales and profits. The optimal transfer price balances this trade-off. Regulation under the arm’s length principle is shown to reduce the transfer price, which reduces distortion in the domestic production and expands the region in which vertical FDI benefits consumers and social welfare in the home country. We also show that promoting downstream competition could help align private and social incentives, reinforcing the positive effects of regulation.

Keywords: Multinational enterprise; Vertical foreign direct investment; Corporate tax; Transfer price; Arm’s length principle (search for similar items in EconPapers)
JEL-codes: F12 F23 H26 L13 L22 L51 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S026499932400169X
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:139:y:2024:i:c:s026499932400169x

DOI: 10.1016/j.econmod.2024.106813

Access Statistics for this article

Economic Modelling is currently edited by S. Hall and P. Pauly

More articles in Economic Modelling from Elsevier
Bibliographic data for series maintained by Catherine Liu ().