Transfer pricing regulation and taxation of royalty payments

Abstract

The digital economy is characterized by the use of intellectual property such as software, patents, and trademarks. The pricing of such intangibles is widely used to shift profits to low‐tax countries. We analyze the implications of different OECD methods to regulate transfer pricing and the role of a source tax on royalty payments for abusive transfer pricing. First, we show that under the traditional transfer pricing methods mispricing of royalty payments does not affect investment behavior. In contrast, the Transactional Profit Split Method that is promoted by the OECD for evaluating firms in the digital economy triggers higher investment in order to facilitate higher profit shifting. Second, royalty taxation is effective in reducing (such) abusive profit shifting, but always reduces investment. Third, a royalty tax rate below the corporate tax rate leads to overinvestment in a tax system with allowance for corporate equity (ACE).

Factor model for assessing the state of the digital economy

“…Macroeconomic Analysis and Factors of Economic Growth Juranek S., Schindler D., Schjelderup G. (2018). Transfer pricing regulation and taxation of royalty payments.…”

Transfer Pricing and Location Choice of Intangibles Spillover and Tax Avoidance through Profit Shifting

“…We are interested in the implications of the location choice and an MNC's maintenance investments. Therefore, in line with prior work of Juranek et al (2018), we neglect the initial invention and innovation of the intangible. According to the findings of Karkinsky and Riedel (2012) and Schwab and Todtenhaupt (2017), neglecting the development of an intangible is not restrictive.…”

“…Juranek et al (2018) investigate how different transfer pricing methods and the possibly differing arm's length ranges influence profit shifting with intangibles.10Electronic copy available at: https://ssrn.com/abstract=3314732…”

Do Transfer Pricing Rules Distort R&D Investment Decisions?

“…This in turn shifts more profits towards the lower taxed subsidiary using the CPM method. In a recent study Juranek, Schindler, and Schjelderup (2017) analyze various transfer pricing regulations to set royalties at arm's length. The authors find that mispricing of royalty payments does not affect investment behavior.…”