Transfer Pricing or Formula Apportionment? Tax-Induced Distortions of Multinationals' Investment and Production Decisions

Martini JT, Niemann R, Simons D (2012)
Contemporary Accounting Research 29(4): 1060-1086.

Journal Article | Published | English

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Abstract
Within multinational corporate groups (MNCs) the international coordination of decisions and the allocation of taxable income among different legal entities is vital. Transfer pricing (TP) is a device of both coordination and international tax planning. For instance, by adequately selecting the transfer price all MNC members are willing to purchase an intermediate product internally instead of procuring from the market. By manipulating TP the MNC tries to shift revenues to low-tax countries and expenses to high-tax countries. As a solution to the inherent problems of such earnings management, this paper proposes formula apportionment (FA), in which a common tax base is calculated and divided among the host countries on the basis of predefined factors. We analyze the impact of different combinations of tax allocation and managerial accounting regimes on investment and production decisions of an MNC. In contrast with traditional views of TP and FA, we show that TP affects the production decision, so that a frequently cited advantage of TP does not hold true. However, the effects of TP are robust with respect to the internal decision-making structure. With respect to FA, we extend the results of the public finance literature by demonstrating that the MNC's decisions, and thereby tax revenue, crucially depend on the MNC's organizational structure and that there exist settings in which FA does not induce distortions. Therefore, it is ambiguous whether MNCs favor the introduction of FA.
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Martini JT, Niemann R, Simons D. Transfer Pricing or Formula Apportionment? Tax-Induced Distortions of Multinationals' Investment and Production Decisions. Contemporary Accounting Research. 2012;29(4):1060-1086.
Martini, J. T., Niemann, R., & Simons, D. (2012). Transfer Pricing or Formula Apportionment? Tax-Induced Distortions of Multinationals' Investment and Production Decisions. Contemporary Accounting Research, 29(4), 1060-1086.
Martini, J. T., Niemann, R., and Simons, D. (2012). Transfer Pricing or Formula Apportionment? Tax-Induced Distortions of Multinationals' Investment and Production Decisions. Contemporary Accounting Research 29, 1060-1086.
Martini, J.T., Niemann, R., & Simons, D., 2012. Transfer Pricing or Formula Apportionment? Tax-Induced Distortions of Multinationals' Investment and Production Decisions. Contemporary Accounting Research, 29(4), p 1060-1086.
J.T. Martini, R. Niemann, and D. Simons, “Transfer Pricing or Formula Apportionment? Tax-Induced Distortions of Multinationals' Investment and Production Decisions”, Contemporary Accounting Research, vol. 29, 2012, pp. 1060-1086.
Martini, J.T., Niemann, R., Simons, D.: Transfer Pricing or Formula Apportionment? Tax-Induced Distortions of Multinationals' Investment and Production Decisions. Contemporary Accounting Research. 29, 1060-1086 (2012).
Martini, Jan Thomas, Niemann, Rainer, and Simons, Dirk. “Transfer Pricing or Formula Apportionment? Tax-Induced Distortions of Multinationals' Investment and Production Decisions”. Contemporary Accounting Research 29.4 (2012): 1060-1086.
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