The Distorting Arm's Length Principle

Devereux, Michael and Keuschnigg, Christian (2009) The Distorting Arm's Length Principle. Centre for Business Taxation WP 09/10.

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Abstract

To prevent profit shifting by manipulation of transfer prices, tax authorities typically apply the arm’s length principle in corporate taxation and use comparable market prices to ‘correctly’ assess the value of intracompany trade and royalty income of multinationals. We develop a model of heterogeneous firms subject to financing frictions and offshoring of intermediate inputs. We find that arm’s length prices systematically differ from independent party prices. Application of the principle thus distorts multinational activity by reducing debt capacity and investment of foreign affiliates, and by distorting organizational choice between direct investment and outsourcing. Although it raises tax revenue and welfare in the headquarter country, welfare losses are larger in the subsidiary location, leading to a first order loss in world welfare.

Item Type: Other Working Paper
Keywords: Corporate tax, transfer prices, arm’s length principle, outsourcing, foreign direct investment, corporate finance
Centre: Oxford University Centre for Business Taxation > CBT Working Papers
Date Deposited: 23 May 2012 15:55
Last Modified: 15 Oct 2015 02:18
URI: http://eureka.sbs.ox.ac.uk/id/eprint/3300

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