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Do Transfer Pricing Rules distort R&D Investment Decisions?

Bornemann, Tobias (2018) Do Transfer Pricing Rules distort R&D Investment Decisions? WU International Taxation Research Paper Series, 2018-02. WU Vienna University of Economics and Business, Universität Wien, Vienna.

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Abstract

This study analyzes the impact of transfer pricing on multinational enterprises' R&D investment decisions. Specifically, I examine the effects of two commonly used contract designs to exchange and develop intangible assets across group affiliates: licensing and cost sharing agreements. Whilst serving as a tool to allocate taxable income between group affiliates, the economic implications of licensing and cost sharing agreements differ. Whereas licensing agreements provide for a sharing rule on the intangible's profits, cost sharing agreements on the other hand provide a sharing rule on R&D development costs. This difference matters when firms simultaneously use internal transfer prices to allocate taxable income and provide local management with sufficient investment incentives. Using a multiple-agent, moral hazard investment framework I model a multinational firm with comparable group affiliates in two countries that delegates the R&D investment decision to a local risk and effort averse affiliate manager. The results suggest that the optimal contract not only depends on available tax benefits, but also on R&D investment and manager specific characteristics. A licensing agreement provides management with larger incentives to invest in R&D mitigating agency concerns associated with R&D. On the other hand, using a cost sharing agreement the firm can cater different risk preferences among managers potentially increasing investment. The arm's length principle however may distort an efficient allocation of R&D costs when using a cost sharing agreement.

Item Type: Paper
Additional Information: Financial support by the Austrian Science Fund FWF): W1235-G16 is gratefully acknowledged. Editors: Eva Eberhartinger, Michael Lang, Rupert Sausgruber and Martin Zagler (Vienna University of Economics and Business), and Erich Kirchler (University of Vienna)
Keywords: transfer pricing, R&D investment, taxes
Classification Codes: JEL H21, H25
Divisions: Departments > Finance, Accounting and Statistics
Depositing User: Mohammad Al Hessan
Date Deposited: 15 Feb 2018 13:26
Last Modified: 05 May 2018 19:50
URI: http://epub.wu.ac.at/id/eprint/6057

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