The arm's length principle and distortions to multinational firm organization

Christian Keuschnigg and Michael Devereux

Journal of International Economics, 2013, vol. 89, issue 2, 432-440

Abstract: To prevent profit shifting by manipulation of transfer prices, tax authorities typically apply the arm's length principle in corporate taxation and use comparable market prices to ‘correctly’ assess the value of intracompany trade and royalty income of multinationals. We develop a model of firms subject to financing frictions and offshoring of intermediate inputs. We find that arm's length prices systematically differ from prices set by independent agents. Application of the principle distorts multinational activity by reducing debt capacity and investment of foreign affiliates. Although it raises tax revenue and welfare in the headquarter country, welfare losses may be larger in the subsidiary location, leading to a loss in world welfare.

Keywords: Corporate tax; Transfer prices; Arm's length principle; Corporate finance (search for similar items in EconPapers)
JEL-codes: D23 F23 H25 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (37)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:inecon:v:89:y:2013:i:2:p:432-440

DOI: 10.1016/j.jinteco.2012.08.007

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