Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2014/21: Abusive Transfer Pricing and Economic Activity

Søren Bo Nielsen (), Dirk Schindler () and Guttorm Schjelderup ()
Additional contact information
Søren Bo Nielsen: Dept. of Economics, Copenhagen Business School, Postal: Copenhagen Business School, Department of Economics, Porcelænshaven 16 A, 1st floor, DK-2000 Frederiksberg, Denmark
Dirk Schindler: Dept. of Accounting, Auditing and Law, Norwegian School of Economics, Postal: NHH , Department of Accounting, Auditing and Law, Helleveien 30, N-5045 Bergen, Norway
Guttorm Schjelderup: Dept. of Business and Management Science, Norwegian School of Economics, Postal: NHH , Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: This paper investigates how concealment costs of transfer pricing and the probability of detection affect transfer pricing and firm behavior. We find that transfer pricing in intermediate production factors does not affect real activity of a multinational firm if the firm’s concealment effort as well as the probability of being audited by tax authorities are conditioned on the amount of shifted profits. If tax authorities rely on the standard OECD arm’s-length principle instead by reacting to a deviation of the transfer price from the market price, the multinational will for tax reasons adjust its production structure. A policy implication of the paper is that it should be preferable to condition audits on the amount of income shifted rather than on the distortion of the transfer price proper. Another policy finding is that improving the quality of tax law might be superior to higher detection effort. The former reduces profit shifting and concealment effort, whereas the latter leads to more wasteful use of resources on concealment and has an ambiguous effect on profits shifted.

Keywords: Transfer Pricing; Firm Behavior; Tax Law

JEL-codes: H20

20 pages, May 30, 2014

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