Duopolistic Competition, Taxes, and the Arm's-Length Principle

Evelyn Korn and Stephan Lengsfeld

Hannover Economic Papers (HEP) from Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät

Abstract: Numerous (high-tax) countries presume that multinational firms use their transfer-pricing policies to shift profits into countries with lower tax rates. To avoid the corresponding loss in tax revenues, tax authorities develop constantly tightening rules to curb transfer-price distortions. Affected firms include the decision of compliance to these rules into their strategic considerations. In a scenario with arm's-length regulation in two countries, we analyze the transfer-pricing policy of a firm that uses the same transfer price for tax and managerial incentive purposes. Thus, the transfer-pricing policy is driven by three issues: interaction with competitors, minimization of tax burden, and avoidance of punishments. The model shows that tighter transfer-pricing rules may help firms to mitigate competition and to increase their profits and that non-compliance to the arm's-length principle is part of their equilibrium strategy.

Keywords: transfer prices; taxes; arm's-length principle; one set of books; duopolistic competition; enforcement. (search for similar items in EconPapers)
JEL-codes: H25 L22 M40 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2007-10
New Economics Papers: this item is included in nep-acc, nep-com, nep-ind and nep-mic
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Citations: View citations in EconPapers (4)

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