After the Tax Breaks Fade: What Executives Need to Know About Transfer Pricing

Abstract

Transfer pricing policies have traditionally been driven by a desire to limit taxes by shifting profits from high- to low-tax jurisdictions. Though such practices will no doubt continue, recent changes in public policy, most notably the influence of the OECD's Base Erosion and Profit Shifting initiative, have rendered tax savings more difficult to achieve. But also working in this direction is the tax treaty agreed to by 136 countries in October 2021 mandating a minimum 15% corporate tax rate. The treaty was pushed largely as a reaction against abusive transfer pricing practices.

But another economic consequence of transfer pricing, one that is often ignored in practice, appears to be as important than ever—namely, the agency costs associated with conflicts of interests and incentives between corporate managers and owners. Apart from tax effects, when companies get transfer pricing wrong—that is, when the prices are too high or too low relative to opportunity cost—value-maximizing cooperation across business units tends to be discouraged, resulting in excessive reliance on outsourcing. This article discusses the steps companies can take to limit such agency conflicts and the associated costs.