Transfer Pricing Rules and Business Relocations by Multinational Enterprises

In this paper, we investigate the optimal choice of transfer pricing regulations from a normative point of view. In this context we put special emphasis on the treatment of business relocations. Two inefficiencies may arise: First, firms may structure a transaction as multinational enterprise (MNE) for tax reasons even though it would be welfare enhancing to carry out the transaction between unrelated parties due to the differences in transaction costs. Second, firms may not undertake a transaction, because under given regulations, it may not pay off even though such a transaction would be welfare enhancing. We show that the simple rule "related parties have to use the market price of unrelated parties as the intercompany transfer price as long as no party is worse off" implements the first best solution. Surprisingly, this shows that one does not have to account for efficiency differences of a MNE compared to unrelated parties.