Transfer Pricing

Identify a multinational corporation (MNC); its corporate home office may be in any country, as long as you are able to post a link to an annual report in your initial post to the discussion. Using Pfeiffer et al. (2011), and Lin, and Chang (2010) as starting resources discuss the following

1. Discuss the benefits and potential problems that the three methods of transfer pricing (negotiated prices, market prices, and full cost plus profit margin would present to the MNC you have chosen.
2. Discuss specifically the role of minimization of tax burden, maximization of whole company profit, and minimization of customs duties plays out for the MNC you selected, and the host countries they produce parts or develop services in.

HERE IS ONE OF THE ARTICLES IN ITS ENTIRETY

1 Introduction

Although globalization opens worldwide trade markets bringing business opportunities never before seen, this phenomenon also opens the door to numerous competitors of various industries ([18] Lin and Kuo, 2007). In the globalized business operations of multinational enterprises (MNEs), foreign direct investment brings various benefits, including expansion of trade, job opportunities, technology transfer, and flow of international market information, industrial upgrading, technical R&D, economic growth, and increased taxes, which in turn upgrade the recipient country's overall economic power. There are still some strategies that MNEs will use to maintain growing and promising organizational performance and economics efficiency, such as innovation management ([43] Wong and Chin, 2007), differentiation and cost leadership ([29] Prajogo, 2007), information systems and technology ([26] Ojiako and Maguire, 2008), and revenue and costs ([12] Heather, 2002; [1] Allen, 2005; [3] Bojnec and Latruffe, 2008). Meanwhile, many countries have applied measures, such as tax incentives, financial incentives, and administrative incentives, to attract more investment.

Past studies have identified many of the factors that influence outward investments of MNEs and the role of institutions of MNEs in international business ([9] Dunning and Lundan, 2008). One important consideration is the tax environment of the investment locations ([13] Ho, 2008; [50] Dunning, 1993). Therefore, whether a country's tax environment is conducive to investment has become an important factor of consideration in the selection of investment locations of MNEs. The differences between the tax system and the tax rate of the home country and host country may affect the overall business performance of MNEs ([15] Klassen and Shackelford, 1998). In addition, tax incentives are no longer just a pre-tax benefit deduction item, applied after the generation of profits, but an important business cost. Even if an enterprise is not profitable, tax costs may still exist. Therefore, if relevant tax costs are not taken into consideration, the enterprise may result in false profits, which should be taken seriously by all MNEs.

MNEs are confronted with diverse tax environments, including tax burdens, tax rates, processing costs, tax deductions and exemptions, tax jurisdictions, and tax agreements ([41] Tremblay and Suarez, 2009). When MNEs are deciding whether to invest at home or abroad, the level of tariffs, tax laws, and regulations of other countries are taken into consideration in order to achieve the goal of global tax minimization and profit maximization by taking advantage of the low or even tax-free policies of the host country ([2] Bartelsman and Beetsma, 2003; [28] Phusavat, 2007; [5] Chan, 2007). [8] Clausing (2003) indicate that, tax systems could prompt enterprises to engage in transfer pricing manipulation and income transfer activities by applying different strategies, including transfer pricing manipulation, to enhance their competitiveness ([50] Dunning, 1993). [24] O'Brien and Oates (2007) also indicated that an increasing number of opportunities and incentives have emerged, prompting MNEs to become engaged in transfer pricing manipulation strategies.

The management of MNEs agree that, with higher host country tariff rates, they are more likely to adopt low quotes in transfer pricing manipulation strategies in order to maintain the profits of the subsidiaries in the host country. If the income tax rates of the host country are higher, management is more likely to adopt high quotes in transfer pricing manipulation strategies in order to retain profits in the host country, achieved by reducing operational performances of subsidiaries ([20] Lin et al. , 2010). When conducting investments in an international environment, enterprises should be aware of the market changes and properly use the international transfer pricing manipulation to increase the efficiency of resource allocation, management performance, and increase the interests of internalization. Thus, it can contribute to achieving the goals of survival and growth for MNEs and allow enterprises to obtain maximized long-term interests. Hence, issues relating to transfer pricing manipulation strategies are particularly important to MNEs and are worthy of further discussion.

For transfer pricing manipulation purposes, comparable companies are chosen based on the similarity of the functions performed and the risks assumed by the companies analyzed in this study ([30] Riisberg et al. , 2009). International enterprises conduct overseas investments based on many factors and face greater difficulties in investment environments and risks than doing business at home. Tax issues play a key role and are considered as one of the major factors affecting the operational costs of MNEs. With the increasing importance of MNEs in modern economic activities, transactions engaging in transfer pricing manipulation to obtain the optimal global tax allocation are not simply issues of tax but have become a major topic of economic systems. For this reason, the senior management of MNEs must have greater knowledge than those of local enterprises regarding how to legally carry out transfer pricing manipulation's financial decision planning in the international tax arena. However, there is little literature on international taxation that addresses the theories and practices of transfer pricing manipulation. Most studies have focused on the comparisons and suggestions of taxation systems and transfer pricing manipulation policies of individual countries, the relationship between taxation systems and transfer pricing manipulation, or comparisons of environments and organizational characteristics of different countries ([20] Lin et al. , 2010), and few studies have conducted model analysis of the MNEs' transfer pricing manipulation financial strategies. Only further exploration in developing optimal transfer pricing manipulation strategies for MNEs can achieve the operational goals of enterprises for tax minimization and profit maximization on the premises of effectively avoiding tax risks.

This paper is organized as follows. Section 2 presents literature. Next, Section 4 describes the empirical results and analysis. Finally, Section 5 discusses the results and presents conclusions. Moreover, the data section is in the Appendix.

2 Literature review

2.1 Motives for transfer pricing manipulation

In order to achieve the maximum after-tax profits, MNEs often apply internal transfer price adjustments between parent companies and subsidiaries, or among the subsidiaries, in order to reduce their overall income tax payable. For example, when exporting products to subsidiaries in countries with high income tax, the transfer pricing manipulation is set at a higher level ([39] Styron, 2007) in order to reduce the surplus of the local subsidiaries and the tax payable. On the contrary, when exporting products to countries with low income tax, the transfer price is set at a lower level, in order to transfer the profits to the local subsidiaries, thus increasing the overall after-tax profits. The vertical integration of a multinational enterprise through transfer pricing manipulation would gain higher profits than two conventional trading companies of similar business operations ([14] Istrate et al. , 2009; [11] Granfield, 1993).

[19] Lin (2006) indicated that the main purposes and functions of applying transfer pricing strategies by MNEs are as follows:

Enhanced market competitiveness . The fundamental method for MNEs to improve a new product's competitiveness in a foreign market is to set lower transfer prices of products purchased from within the enterprises, as well as affiliates, in order for the subsidiaries to be competitively in price in local markets.

Flexible transfer of internal funds . MNEs can transfer funds from a local subsidiary of a host country through high transfer in and low transfer-out prices to facilitate their global fund management. For example, when the currency of the host country may depreciate, or in order to avoid the over erosion of local assets by inflation, MNEs may take advantage of transfer pricing manipulation adjustment to reduce financial risks.

Alleviate tax burdens :

- Reduce tariff costs. MNEs may apply low-transfer pricing manipulation policies to reduce the tariff costs of the importing subsidiaries of the internal transactions. As the value-added proportion of products in the area is the calculation basis of tariffs, the tariff costs may be eliminated if the subsidiaries of MNEs, from outside the area, sell goods with lower transfer prices to subsidiaries in the area.

- Reduce income tax. To achieve the highest after-tax profits, MNEs often take advantage of the adjustments of parent-subsidiary, or subsidiary-subsidiary, transfer pricing manipulation strategies to reduce the overall income tax payable. For example, set a transfer price higher when exporting products from subsidiaries located in countries with high income tax, which reduces the profits and tax payable of the local subsidiaries, accordingly. On the contrary, set a transfer price lower when exporting goods to countries with low income tax, which transfers profits to local subsidiaries with low local tax rates in order to further increase the overall after-tax total profit of the enterprise.

Government control (price restrictions and quantity limits) :

- Break trade restrictions . When a host country adopts quotas, subsidies, or other non-tariff trade restrictions, MNEs are met with considerable obstacles when ensuring or expanding the local market objectives. Therefore, if the government of the host country places restrictions on quantities imported, without affecting the competitiveness of the products of the local market, then setting a higher transfer price will reduce taxes and thus make up for losses assumed from the inability to import large numbers of products. If the restriction is on imported amounts, then transfer price can be set lower to increase imports. On the contrary, the host country of the exporters within the MNEs can set restrictions on exports; thus, the export prices should be raised in order to reduce the income tax of the profit-seeking enterprise. If the restriction is on export amounts, then the transfer price should be set as low as possible in order to increase the amount of products exported. Thus, by setting transfer prices as low as is tolerable to local government would further achieve the overall maximized profits for MNEs.

- Overcome foreign exchange controls on restrictions of imports. If the market opportunities of a country are excellent, and government implemented foreign exchange controls are not conducive to local subsidiaries importing products from other countries, MNEs may reduce transfer prices to overcome such foreign exchange controls through low transfer-in prices, which reduce the local subsidiaries' expenditures of foreign exchange, when importing a large quantity of products.

- Overcome dividend export restrictions. MNEs' profits in the host country are remitted in the form of dividends and are often restricted by the government of the host country. However, MNEs may take advantage of high transfer pricing manipulation strategies to effectively shift such profits, through raising prices of internal business transactions.

2.2 Relevant factors affecting transfer pricing manipulation

[50] Dunning (1993) listed a myriad of incentives and environmental factors that encourage transfer pricing manipulation. The motivations of MNEs can be divided into external and internal motivations. To avoid international taxes and increase profits, MNEs adjust product quotes to evade unnecessary cost burdens. There are complex factors that influence transfer pricing manipulation within MNEs; therefore, prior to determining internal transfer pricing manipulation, MNEs must first establish the main purposes.

In addition, [40] Tang (2002) pointed out that there were 20 environmental factors affecting international transfer pricing manipulation, which could be further divided into external and internal motives of transfer pricing manipulation, including enterprise's overall operating profits, host country subsidiaries' interests, subsidiaries' competitiveness in the host country, and host country subsidiaries' demands for maintaining appropriate cash flows. [40] Tang (2002) and [38] Shapiro (1999) suggested that transfer pricing manipulation can reduce two major tax burdens, which are tariffs for international trades and income taxes. [45] Yancey and Cravens (1998) indicated that when facing different accumulative tax brackets across host countries, MNEs formulate transfer pricing strategies according to their own management goals.

[8] Clausing (2003) pointed out that MNEs' subsidiaries located in different countries were faced with local tax systems and legal environments, which may also affect behaviors of transfer pricing manipulation. [46] Yu (2008) suggested that many factors must be taken into account when MNEs were to conduct transfer pricing manipulation, such as positioning of funds, taxes, tariffs, foreign exchange controls, and effects on joint investments. The adoption of international financial reporting standards will affect different companies' transfer pricing manipulation policies in different ways, depending on each company's exact circumstances, function, and risks ([30] Riisberg et al. , 2009).

A central component of the funds transfer pricing manipulation system is transfer price ([7] Chittenden, 2000). Moreover, [36] Schierenbeck (2003) stated that from a controlling perspective, the funds transfer system is fair in the aspect of causality as well as performance, as business units can influence their contributions only through means of setting better rates than the market equivalent (i.e. transfer price).

Based on the literature review, it is found that most literature refers to motives, purposes, or risks relating to transfer pricing manipulation, and there is no complete, objective, and efficient transfer price making decision model analysis. Therefore, this study aims to conduct further analysis and discussion on the transfer pricing manipulation strategies of MNEs and establish a strategic pricing decision-making model on different motives for MNEs.