Transfer Pricing by Multinational Firms: New Evidence from Foreign Firm Ownerships

Cristea, Anca D. and Nguyen, Daniel X. (2013): Transfer Pricing by Multinational Firms: New Evidence from Foreign Firm Ownerships.

Abstract

Using a firm-level panel dataset covering the universe of Danish exports between 1999 and 2006, we find robust evidence for profit shifting by multinational corporations (MNC) through transfer pricing. Our triple difference estimation method corrects for a downward bias in previous studies. The bias results from MNCs adjusting their arm's length prices to obscure the extent of their transfer price manipulations. Our identification strategy exploits the movement in export prices to a destination in response to: (1) the establishment of a foreign affiliate by an exporter to that destination, and (2) a change in the foreign corporate tax rates. Once owning an affiliate in a country with a corporate tax rate lower than in the home country, Danish multinationals reduce the unit values of their exports there between 5.7 to 9.1 percent, on average. This reduction corresponds to $141 million in underreported export revenues in year 2006, which translates into a loss in tax income equal to 3.24 percent of Danish MNCs' tax returns.

• Item Type: MPRA Paper
• Language: English
• Keywords: corporate tax, transfer pricing, arm's length principle, triple difference, foreign ownership
• Subjects: D - Microeconomics > D2 - Production and Organizations > D23 - Organizational Behavior ; Transaction Costs ; Property Rights; F - International Economics > F2 - International Factor Movements and International Business > F23 - Multinational Firms ; International Business; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H25 - Business Taxes and Subsidies

References

Antras, Pol. 2003. "Firms, Contracts, and Trade Structure." Quarterly Journal of Economics 118 (4): 1375-1418.

Baldenius, Tim, Nahum D. Melumad, and Stefan Reichelstein. 2004. "Integrating Managerial and Tax Objectives in Transfer Pricing." The Accounting Review 79 (3): 591-615.

Bartelsman, Eric J. and Roel M.W.J. Beetsma. 2003. "Why Pay More? Corporate Tax Avoidance Through Transfer Pricing in OECD Countries." Journal of Public Economics 87: 2225-2252.

Bauer, Christian J. and Dominika Langenmayr. 2013. "Sorting Into Outsourcing: Are Profits Taxed at a Gorilla's Arm's Length?" Journal of International Economics , forthcoming.

Bernard, Andrew, Bradford Jensen, and Peter Schott. 2006. "Transfer Pricing by U.S.-based Multinational Firms." NBER, Working Paper 12493.

Blonigen, Bruce A. and Jeremy Piger. 2012. "Determinants of Foreign Direct Investment." University of Oregon, mimeo.

Cameron, David. 2013. "Prime Minister David Cameron's Speech to the World Economic Forum in Davos." Jan. 24, 2013, http://www.number10.gov.uk/news/prime-minister-david-camerons- speech-to-the-world-economic-forum-in-davos.

Clausing, Kimberly A. 2003. "Tax-motivated Transfer Pricing and US Intrafirm Trade Prices." Journal of Public Economics 87: 2207-2223.

Cristea, Anca D. 2012. "Multinational Production with Costly Communication: The Role of Foreign Skilled Labor." University of Oregon, mimeo.

Deloitte. 2014. "International Tax: Denmark Highlights 2014." Http://www2.deloitte.com/content/dam/Deloitte/global/Documents/Tax/dttl-tax-denmarkhighlights-2014.pdf.

Desai, Mihir, Fritz Foley, and James R. Hines. 2006. "The Demand for Tax Haven Operations." Journal of Public Economics 90 (3):513 - 531.

Devereux, Michael. 2006. "The Impact of Taxation on the Location of Capital, Firms and Profit: A Survey of Empirical Evidence." Oxford University Centre for Business Taxation, Working Paper No. 07/02.

di Giovanni, Julian. 2005. "What Drives Capital Flows? The Case of Cross-Border M&A Activity and Financial Deepening." Journal of International Economics 65 (1): 127-149.

Dixit, Avinash K. and Joseph E. Stiglitz. 1977. "Monopolistic competition and optimum product diversity." The American Economic Review: 297-308.

Doernberg, Richard L. 2012. International Taxation in a Nutshell. St. Paul, MN: West Academic Publishing, 9 ed.

Eden, Lorraine. 1998. Taxing Multinationals: Transfer Pricing and Corporate Income Taxation in North America. University of Toronto Press.

Egger, Peter, Wolfgang Eggert, Christian Kreuschnigg, and Hannes Winner. 2010. "Corporate Taxation, Debt Financing and Foreign Plant Ownership." European Economic Review 54: 96-107.

Egger, Peter, Wolfgang Eggert, and Hannes Winner. 2010. "Saving Taxes through Foreign Plant Ownership." Journal of International Economics 81: 99-108.

Grossman, Gene M. and Esteban Rossi-Hansberg. 2008. \Trading Tasks: A Simple Theory of Offshoring." American Economic Review 98 (5): 1978-1997.

Grubert, Harry and John Mutti. 1991. "Taxes, Tariffs and Transfer Pricing in Multinational Corporation Decision Making." Review of Economics and Statistics 17 (2): 285-293.

Helpman, Elhanan, Marc Melitz, and Stephen Yeaple. 2004. "Export versus FDI with Heterogeneous Firms." American Economic Review 94: 300-316.

Hines, James R. 1999. "Lessons from Behavioral Responses to International Taxation." National Tax Journal 52: 304-322.

Hines, James R. and Eric M. Rice. 1994. "Fiscal Paradise: Foreign Tax Havens and American Business." Quarterly Journal of Economics 109: 149-182.

Hirshleifer, Jack. 1956. "On the Economics of Transfer Pricing." The Journal of Business 29 (3): 172-184.

Huizinga, Harry, Luc Laeven, and Gaetan Nicodeme. 2008. "Capital Structure and International Debt Shifting." Journal of Financial Economics 88: 80-118.

Irarrazabal, Alfonso, Andreas Moxnes, and Luca David Opromolla. 2013. "The Margins of Multinational Production and the Role of Intrafirm Trade." Journal of Political Economy 121 (1): 74-126.

Kaufmann, Daniel, Aart Kraay, and Massimo Mastruzzi. 2004. "Governance Matters III: Governance Indicators for 1996 - 2002." The World Bank Economic Review 18 (2):253 -287.

Keller, Wolfgang and Stephen R. Yeaple. 2013. "The Gravity of Knowledge." American Economic Review 103 (4): 1414-44.

Keuschnigg, Christian and Michael Devereux. 2013. "The Arm's Length Principle and Distortions to Multinational Firm Organization." Journal of International Economics 89 (2): 432-440.

Kleinert, Jorn and Farid Toubal. 2013. "Production versus Distribution Oriented FDI." Review of World Economics, forthcoming.

Krautheim, Sebastian. 2012. "Heterogeneous Firms, Exporter Networks and the Effect of Distance on International Trade." Journal of International Economics 87 (1): 27-35.

Lanz, Rainer and Sebastien Miroudot. 2011. "Intra-Firm Trade: Patterns, Determinants and Policy Implications." OECD Trade Policy Working Papers, No. 114.

Melitz, Marc. 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity." Econometrica 71 (6): 1695-1725.

OECD. 2013. "Addressing Base Erosion and Profit Shifting." OECD Publishing. http://dx.doi.org/10.1787/9789264192744-en.

Raimondos-Moller, Pascalis and Kimberley Scharf. 2002. "Transfer Pricing Rules and Competing Governments." Oxford Economic Papers 54 (2): 230-246.

Rauch, James E. 1999. "Networks versus markets in international trade." Journal of International Economics 48 (1): 7-35.

Rosenthal, Edward C. 2008. "A Game-theoretic Approach to Transfer Pricing in a Vertically Integrated Supply Chain." International Journal of Production Economics 115 (2): 542-552.

Swenson, Deborah L. 2001. "Tax Reforms and Evidence of Transfer Pricing." National Tax Journal 54 (1): 7-25.

Yeaple, Stephen R. 2009. "Firm Heterogeneity and the Structure of U.S. Multinational Activity." Journal of International Economics 78 (2): 206-215.