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Do tax information exchange agreements curb transfer pricing-induced tax avoidance?

Markus Diller and Johannes Lorenz

No B-29-17, Passauer Diskussionspapiere, Betriebswirtschaftliche Reihe from University of Passau, Faculty of Business and Economics

Abstract: We propose a game theoretical model where a multinational company with divisions in two countries and the respective tax authorities interact with each other. Prior to an audit the functional profile of the divisions is unknown to the tax authorities. In equilibrium, tax avoidance emerges in both countries. It turns out that the audit pressure is highest for firms with a hybrid functional profile, dampening their production and reducing their after-tax profit. We find that introducing a bilateral Tax Information Exchange Agreement reduces tax avoidance by aggressive transfer pricing in the high-tax ("domestic") country and precludes tax avoidance in the lowtax ("foreign") country. The volume of production increases. The foreign tax authority discontinues its audit activities, while the domestic tax authority audits less often at least if the foreign division is a toll manufacturer ("routine function"). While the expected net tax revenues increase in the foreign country, they may decrease in the domestic country.

Keywords: transfer pricing; tax evasion; cooperation (search for similar items in EconPapers)
JEL-codes: H26 F23 K34 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-acc, nep-gth, nep-iue, nep-law and nep-pbe
Date: 2017
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