This seems to be the conclusion of a 1986 study on transfer pricing by multinationals operating in Bangladesh by StDbHK


									       WEB: CH. 12, Salvatore’s International Economics, 9th Ed.

             3. Transfer Pricing by Multinational Corporations

When an enterprise operates across national borders, additional profit opportunities and
risks arise because of different rates of corporate taxes in different countries, currency
fluctuations, import-export tariffs and subsidies, and so on. For example, by artificially
overpricing intermediate products shipped to a semiautonomous division of the firm in a
higher-tax nation and underpricing products shipped from the division in the high-tax
nation, a multinational corporation can minimize its tax bill and increase its profits.
Governments of high-tax countries seek to minimize the loss of tax and customs revenues
resulting from transfer pricing by generally applying an “arm’s length” test. “Arm’s-
length” is defined as the price an unrelated party would pay for the products under the
same circumstances. This test, however, provides general guidance only and is vague on
many issues. As a result, multinational corporations retain a great deal of leeway in
setting transfer prices so as to minimize their overall taxes and maximize profits. This is
especially true in developing countries since they generally have less effective legal
controls on the transfer pricing practices of multinational corporations than developed
countries. This seems to be the conclusion of a 1986 study on transfer pricing by
multinationals operating in Bangladesh.
   The authors of the study began by pointing out that multinational enterprises have
many important advantages over local competitors. These include: economies of scale
in production, high research and development expenditures by the parent company,
sophisticated and efficient marketing techniques, access to sources of finance on a
worldwide basis, superior marketing skills, and so on. Because of these important
economic advantages, the authors expected that semiautonomous divisions of
multinational corporations would have higher profit rates than local competitors. They
found the reverse to be the case, however. The average net profit as a percentage of total
sales of the division of multinational corporations was 3.4 percent as compared to 5.4
percent for their local competitors over the period 1975 to 1979 of the study. The authors
then examined the price of intermediate products imported by semiautonomous divisions
of multinational pharmaceutical corporations and the price of the same products imported
by their local competitors and found that, on the average, the former were 194 percent
higher than the latter. Since this difference was not due to differences in transportation
costs, the authors concluded that multinational pharmaceutical firms operating in
Bangladesh used transfer pricing to transfer large profits abroad.
     The U.S. Internal Revenue Service, bolstered by new auditing powers, is
investigating many American subsidiaries of foreign firms, especially Japanese ones, on
the suspicion that they have underpaid U.S. corporate income taxes by as much as $12
billion. Indirect evidence of this is given by the fact that the ratio of income tax payments
to total receipts of foreign-controlled U.S. corporations was less than half that of U.S.
corporations. Even more incredible is the fact that of the nearly 37,000 foreign-owned
companies filing returns in 1986, more than half reported no taxable income! Then
starting in 1991, the IRS adopted an “advance pricing agreement” with an increasing
number of multinational corporations on the range of prices at which to value the various
products that these multinationals import to the United States, so as to avoid transfer
price disputes. But such disputes continue. In 2000 DailmerChrysler had to pay an extra
$46 million in taxes to Japan because of transfer pricing, and in the same year Nissan also
had to pay extra taxes to the United Kingdom for the same reason. By far the largest
transfer transfer pricing case is the one going to trial in the United States in 2006 against
the pharmaceutical group GlaxoSmithKline seeking to recoup $4.6 billion in unpaid taxes
and $2.5 billion in penalty interest.

Source: OECD, Transfer Pricing and Multinational Enterprises (Paris: OECD, 1979); M. Z.
Rahman and R. W. Scapens, “Transfer Pricing by Multinationals: Some Evidence from
Bangladesh,” Journal of Business and Financial Accounting, Autumn 1986, pp. 383-391; “I.R.S.
Investigating Foreign Companies for Tax Cheating,” The New York Times, February 10, 1990, p.
1; “Big Japan Concern Reaches an Accord on Paying U.S. Tax,” The New York Times, November
11, 1992, p. 1; “Why Do Foreign Companies Report such Low Profits on Their U.S. Operations?”
The Wall Street Journal, November 2, 1994, p. A1; “DaimlerChrysler Japan Forced to Pay More
Tax,” Financial Times, October 10, 2000, p. 22; “Nissan’s U.K. Arm Hit by Tax Charges,”
Financial Times, November 8, 2000, p. 27; and “Treasury Cracks Down on Companies Shifting
Profits to Low-Tax Jurisdictions,” Financial Times, August 25, 2005, p. 1.


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