draining development.pdf - Khazar University

Transfer Price Manipulation 213withholding tax. Note that if the MNE receives a full foreign tax creditagainst the home country tax for the withholding tax, the form bywhich the MNE moves the funds out becomes irrelevant since the taxis fully credited.• Tax holidays can also be a motivation for TPM, particularly if the holidayis conditional on the profits earned by the foreign affiliate. In Chinain the 1980s, the government offered a tax holiday for foreign firms aslong as they did not show a profit. Not surprisingly, the foreign affiliatesdid not show profits until after the law was changed (see below).• Some forms of intrafirm transfers are more fungible than others andtherefore more susceptible to TPM. Management fees are particularlynotorious because the MNE parent charges each affiliate for the costs ofservices provided by the parent to the affiliates, and these charges aredifficult to measure. Many host country tax authorities have specificrules limiting the deductibility of the management fees charged by anMNE parent to its foreign subsidiaries because governments see thesedeductions as a method to eviscerate the host country’s national taxbase. Governments also levy withholding taxes, in addition to CITs, ifforeign affiliates repatriate income to their parent firms. The withholdingtaxes on management fees are often in the range of 30–35 percent.• Some forms of intrafirm transfers are easier to misprice simplybecause there is no open market for the product. (The product isnever exchanged between arm’s-length parties; an example is highlysophisticated new technologies.) So, arm’s-length comparables areimpossible to find. Payments for intangible assets are particularly susceptibleto TPM because there are often no outside transfers availableto determine an arm’s-length comparable.Trade taxes and transfer price manipulationTrade taxes provide a second external motivation for manipulating transferprices. For evidence on tariff-induced motivations for TPM, see Eden(1998), Vincent (2004), Goetzl (2005), and Eden and Rodriguez (2004).Some examples of TPM motivated by trade tax include the following:• If customs duties are levied on an ad valorem (percentage) basis, theMNE can reduce the duties paid if it underinvoices imports. Specific orper-unit customs duties cannot be avoided by over- or underinvoicing.