<scp>Keeping Two Sets of Books: The Relationship Between Tax and Incentive Transfer Prices</scp>

TLDR

Multinational enterprises use tax and incentive transfer prices, which are independent under the apportionment approach for taxable income assessment. The study examines the case where the incentive transfer price is negotiated rather than dictated by the parent. The authors analyze this scenario by comparing negotiated versus dictated incentive transfer prices. Under the separate entity approach, the tax and incentive transfer prices are interdependent, both decreasing with higher noncompliance penalties, while the tax price falls and the incentive price rises with higher marginal production costs, and these results hold across various market structures and tax environments.

Abstract

Multinational enterprises use two types of transfer prices: the tax transfer price to achieve optimal tax outcomes and the incentive transfer price to provide appropriate incentives to offshore managers. The two optimal transfer prices are independent if taxable income is assessed using the formula apportionment approach. Under the separate entity approach, however, they are interdependent: they both decrease as the penalty for noncompliance with the arm's length principle increases; and the tax transfer price decreases and the incentive transfer price increases as the marginal cost of production increases. We also examine the case where the incentive transfer price is negotiated rather than dictated by the parent. The results are robust to different market structures and tax environments.