Transfer Pricing and Location of Intangibles—Spillover and Tax Avoidance through Profit Shifting

What is it about?

This study uses an economic model to examine a multinational's choice of an intangible's location and the royalty-based transfer price for using this intangible. The multinational comprises a domestic division in a high-tax country and a foreign division in a low-tax country. Each division's activities generate spillovers on the other division's income. Unlike previous studies, we incorporate an intangible's location when the multinational trades off tax minimization and efficient activities. By locating the intangible abroad, the multinational reduces its taxes, whereas locating the intangible domestically yields better domestic division activities. For a high spillover of the domestic division, the multinational locates the intangible domestically. Empirical studies identified a "home bias" in that multinationals, by locating their intangibles domestically, forego tax savings. We explain this "home bias" through variations in spillover and show how variations in regulatory parameters such as tax rate differences affect divisions' activities and the intangible's location.

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