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The authors study the impact of transfer pricing rules on sales prices, firms' organizational structure, and consumers' utility within a two-country monopolistic competition model featuring source-based profit taxes that differ across countries. Firms can either become multinationals, i.e., they serve the foreign market through a fully controlled affiliate; or they can become exporters, i.e., they serve the foreign market by contracting with an independent distributor. Compared to the benchmark cases, where tax authorities are either unable to audit firms or where they are able to audit them perfectly, the use of the OECD's Comparable Uncontrolled Price (CUP) or Cost-Plus (CP) rule distorts firms' output and pricing decisions.
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