Strategic incentives for keeping one set of books under the Arm's Length Principle Articles uri icon

publication date

  • July 2020

start page

  • 78

end page

  • 90

volume

  • 106

International Standard Serial Number (ISSN)

  • 0165-4896

Electronic International Standard Serial Number (EISSN)

  • 1879-3118

abstract

  • The OECD's recommendation that transfer prices between multinational enterprises and their sub-sidiaries be consistent with the Arm's Length Principle (ALP) for tax purposes does not restrict internalpricing policies. However, we show that under imperfect competition firms may choose to keep oneset of books (i.e., to set transfer prices consistent with the ALP), as a way of softening competitionin the external market. As a result, firms' profits are greater, and the surplus is smaller, than under vertical integration. In contrast, when firms keep two sets of books (i.e.,their transfer prices differ from those used for tax purposes), competition intensifies in both markets relative to vertical integration.

keywords

  • transfer pricing regulation; arm's length principle; imperfect competition; vertical separation