Transfer Prices: A Financial Perspective

Abstract

The arguments for and against transfer pricing schemes so far have focused on profitseeking approaches based on tax differentials, or on evasion of government enforced goods and fund flow restrictions. This article shifts to a value-seeking framework where transfer prices act as strategic tools that may enhance value for the multinational with a foreign affiliate by exploiting financial and/or tax arbitrage that also lead to ownership arbitrage. The results show that there is an optimal level of transfer price depending on the specific exchange rate distribution when the cost structure allows for a penalty for overcharging. Moreover, this article introduces a new form of tax arbitrage benefit of transfer prices that is based on present value of tax shields.

Uncertain tax benefits, international tax risk, and audit specialization: Evidence from US multinational firms

“…Transfer pricing aggressiveness is considered by the IRS to be an important area that has contributed toward a significant reduction in the payment of taxes by multinational firms (, 2013a;, 2013b;IRS, 2010). Recent media releases on aggressive transfer pricing arrangements carried out by US multinational firms provide evidence of the substantial tax benefits derived by these firms from taking advantage of differences in tax law, tax rates, and regulatory conditions between jurisdictions, and the non-arm's-length pricing of goods, services and funds transferred amongst related parties (Grubert, 2003;Grubert & Mutti, 1991;Levin, 2012;Usmen, 2012). Owing to the inherent difficulty in ensuring that a firm's arrangements are at arm's length, management is faced with uncertainty in deciding whether a firm's tax position can be sustained following IRS examination (Borkowski & Gaffney, 2012).…”

Determinants of tax haven utilization: evidence from Australian firms

“…Strict adherence to the arm's‐length principle in the pricing of goods and services is problematic, as there may not be an active market to compare prices outside of the firm, such as for intangible assets (Bartelsman and Beetsma, ). The divergence of transfer prices from their commercial market values may be attributed not only to tax differentials that may produce tax arbitrage, but also to market segmentation, which leads to financial arbitrage, covariance between exchange rates and foreign currency cash flows, and the specific cost structure adopted by the firm (Usmen, ). The concept of comparability is therefore central to the arm's‐length principle.…”

The determinants of thinly capitalized tax avoidance structures: Evidence from Australian firms

“…Thus, a major tax compliance problem facing firms is that they do not have adequate documentation on how they established their arm's length inter-firm transfer prices (Hamilton et al, 2001). specific cost structure adopted by the firm (Usmen, 2012). The concept of comparability is therefore central to the arm's-length principle.…”