Knocking on tax haven’s door: Multinational firms and transfer pricing

Ronald Davies, Julien Martin, Mathieu Parenti, Farid Toubal

05 January 2015



It is well known that tax differences across countries provide multinationals with an arbitrage opportunity allowing them to minimise tax payments (de Mooij et al. 2014). While there are many ways in which firms can shift profits to low-tax locations, the use of internal, or transfer, prices is seen as one of the most significant (OECD 2012). This is achieved by having an affiliate in a low-tax location charge high transfer prices for what it sells to an affiliate in a high-tax jurisdiction – in essence, inflating revenues where taxes are low and costs where taxes are high. This runs afoul of tax authorities when the transfer price deviates from a notional arm’s length price, that is, the price that would be charged by two unrelated parties. Note that such behaviour need not be illegal; indeed transfer pricing regulations are typically vague enough for the multinational to make a strong case for a wide range of arm’s length prices which should be used to judge whether or not its transfer pricing is abusive. Either way, however, the end result remains the same – profits are shifted towards low-tax locations.

Challenges in the measurement of transfer pricing

Despite the clear incentive to shift profits through transfer pricing and the widespread concern over its implications, direct and systematic evidence of this practice remains scarce. This is due to a general lack of data on the prices used within a multinational and the prices for comparable arm’s length transactions. Thus, key questions such as the extent of transfer pricing in terms of monetary value, the number of firms and countries involved remain largely unanswered.

With this in mind, in a recent paper, we built a unique dataset which overcomes this problem. In particular, these data contain prices at the firm-product-destination level for both intra-firm and arm’s length exports. This is important for two key reasons. First, it allows us to control for other determinants of prices across firms, such as the relative productivity of multinationals as compared to exporters. Second, we can control for destination country characteristics, such as income and trade costs, which may be correlated with tax variables yet potentially impact intra-firm and arm’s length prices in different ways. Third, the richness of the data allows us to consider not only the effect of foreign corporate taxes on pricing behaviour, but also the role of tax havens and how this behaviour varies with firm and product characteristics.

As noted above, the lack of data demarcating intra-firm and arm’s length exports is a major barrier to studying transfer pricing, with many papers assuming that all exports by a multinational to a country with an affiliate are done intra-firm. However, our data indicate that this is not the case – over one-third of the value of multinational exports to countries hosting affiliates are done at arm’s length. Two papers which avoid this pitfall are Clausing (2003) and Bernard et al. (2006) who utilise intra-firm export prices for US firms. However, the US’s worldwide tax system makes it difficult to interpret the results. By using 1999 French data, where a territorial tax system is in place, we avoid this complication. Furthermore, Clausing (2003) does not have firm-level information, whereas Bernard et al. (2006) do not control for destination characteristics – two features which we find significantly impact pricing behaviour and which do so differently for intra-firm and arm’s length prices.

A few large multinational firms in low-tax jurisdictions

Controlling for all these differences, we can directly ask whether the differences between intra-firm prices vary with the tax environment of the destination. In short, we find that they do, with lower prices being charged for exports to low-tax destinations – a move which shifts profits to low-tax countries. We find in particular that this behaviour is driven by very low-tax countries. As Figure 1 illustrates, after controlling for firm and non-tax destination characteristics, there is a systematic difference between internal and arm’s length prices only for countries in the lowest-tax deciles, indicating a very non-linear relationship between tax rates and transfer prices. A key implication is that, except for the lowest-tax countries, profit shifting is unlikely to change should a given destination marginally alter its tax rate.

Figure 1. Non-linear effect of corporate tax rate on transfer pricing

Source: Authors’ computation.

Furthermore, we find that while such behaviour tends to occur in low-tax countries overall, it is most prevalent in tax havens (including Hong Kong, Ireland, Luxembourg, Singapore, and Switzerland in our data). Although the precise tax advantages likely vary across tax havens (for instance, Ireland’s ‘double Irish’ regime or Switzerland’s well-known investor information protection), our estimates clearly indicate that transfer pricing is greatest when low tax rates are combined with other firm-friendly tax policies. 

In addition, we find not only that transfer pricing is concentrated in a small number of countries, but also in a small number of large multinational firms. More specifically, 90% of intra-firm exports to tax havens come from 450 firms. Back-of-the-envelope calculations suggest that if these firms had set the same prices for their exports to the ten tax havens the same as for unrelated transactions, French corporate tax revenues from manufacturing would have increased by 1%. Given that these estimates are for 1999 alone, the cumulative tax losses from such transfer pricing should be quite large. Moreover, since our data is only for manufacturing, and not services, this tax loss is likely just the tip of the iceberg. Indeed, the lack of comparable arm’s length prices when attempting to curb transfer pricing is even more of a problem for the tax authorities in services than in manufacturing.

Concluding remarks

Our analysis suggests that the extent of profit shifting via transfer pricing may be reduced by focusing on a small number of large firms in a small number of tax havens. Given the ambitious agenda set as part of the OECD’s Base Erosion and Profit Shifting project, recognising the granular nature of transfer pricing may be critical to achieving a meaningful reform of the international tax system.


Bernard, A B, J B Jensen, and P K Schott (2006), “Transfer Pricing by U.S.-Based Multinational Firms”, NBER Working Paper 12493.

Clausing, K A (2003), “Tax-motivated transfer pricing and US intrafirm trade prices”, Journal of Public Economics 87(9–10): 2207–2223.

Davies, R B, J Martin, M Parenti, and F Toubal (2014), “Knocking on Tax Haven Doors: Multinational firms and transfer pricing”, CESIfo Working Paper 5132.

de Mooij, R, M Keen, and V Perry (2014), “Taking a bite out of Apple? Fixing international corporate taxation”,, 14 September. 

OECD (2012), Dealing Effectively with the Challenges of Transfer Pricing



Topics:  Taxation

Tags:  multinationals, transfer pricing, tax, taxation, tax havens, tax avoidance, profit shifting

Professor of Economics, University College Dublin

Assistant Professor in the Department of Economics, Université du Québec à Montréal

Assistant Professor of Economics, Université Catholique de Louvain

Professor of Economics, Ecole Normale Supérieur of Cachan; Associate Professor, Paris School of Economics; Scientific Advisor, CEPII