Knocking on Tax Haven’s Door: Multinational Firms and Transfer Pricing

Abstract

HighlightsThis paper directly estimates the deviation in prices between those done within a multinational and those done at arm's length while controlling for firm and destination characteristics.We find significant transfer pricing behavior, with prices diverging by 11%.Transfer pricing is due primarily to tax havens, not simply low-tax countries.During our sample, transfer pricing resulted in a 1% reduction in French corporate tax revenue. AbstractThis paper analyzes the transfer pricing of multinational firms. We propose a simple framework in which intra-firm prices may systematically deviate from arm's length prices for two motives: i) pricing to market, and ii) tax avoidance. Multinational firms may decide not to avoid taxes if the risk to be sanctioned is high compared to the tax gap. Using detailed French firm-level data on arm's length and intra-firm export prices, we find that both mechanisms are at work. The sensitivity of intra-firm prices to foreign taxes is reinforced once we control for pricing-to-market determinants. Most importantly, we find almost no evidence of tax avoidance if we disregard exports to tax havens. Back-of-theenvelope calculations suggest that tax avoidance through transfer pricing amounts to about 1% of the total corporate taxes collected by tax authorities in France. The lion's share of this loss is driven by the exports of 450 firms to ten tax havens. As such, it may be possible to achieve significant revenue increases with minimal cost by targeting enforcement.

Trade Liberalization and Corporate Income Tax Avoidance

“…Our results are different from that in Davies et al () who find that the effects of tax haven on multinational firms' tax avoidance are stronger for those with more exports. It could be because their sample only includes exporters but our sample includes exporters and nonexporters.…”

The economics of advance pricing agreements

“…Except for interest rates (if the traded asset is an intra…rm loan) and commodity prices, comparables are often imperfect or outright missing. The arm's length reference price therefore has to be constructedand it is obvious that the involved parties may have diverging opinions on how 6 Related evidence is found by using …rm-level data on intra-…rm and arm's length transactions in U.S. data by Bernard, Jensen, and Schott (2006) and in French data by Davies, Martin, Parenti, and Toubal (2014). Clausing (2000) uses information on …rm trade balances as it depends on host tax rates while Bartelsman and Beetsma (2003) examines the allocation of pro…ts as it depends on taxes.…”

“…10 An APA can be unilateral, bi-or multilateral, according to the number of tax authorities participating in the negotiations ( § 4.129, § 4.130 OECD TP Guidelines). 11 As part of this request, the MNE is allowed to propose a transfer pricing method and to participate in the negotiations. In doing so the MNE has to motivate the elected transfer pricing method ( § 4.133, § 4.134 OECD TP Guidelines) and submit all necessary and relevant information on the speci…c intracompany transactions ( § 4.123 OECD TP Guidelines).…”

Transfer Pricing as Tax Avoidance Under Different Legislative Schemes

“…In general, these studies' findings are in line with taxmotivated transfer pricing at work. Empirical evidence is provided by Bartelsman and Beetsma (2003) for the value added in different manufacturing sectors for a sample of OECD countries, by Overesch (2006) for German MNEs' balance sheet positions which reflect intra-firm transaction values, by Swenson (2001) for US import prices, by Clausing (2003) and Bernard et al (2008) for intra-firm trade prices of US MNEs, and by Davies et al (2014) for intra-firm export prices for a sample of French firms.…”