Knocking on Tax Haven’s Door: Multinational Firms and Transfer Pricing

This paper analyzes the transfer pricing of multinational firms. We propose a simple
framework in which intra-firm prices may systematically deviate from arm’s length
prices for two motives: i) pricing to market, and ii) tax avoidance. Multinational firms
may decide not to avoid taxes if the risk to be sanctioned is high compared to the
tax gap. Using detailed French firm-level data on arm’s length and intra-firm export
prices, we find that both mechanisms are at work. The sensitivity of intra-firm prices
to foreign taxes is reinforced once we control for pricing-to-market determinants. Most
importantly, we find almost no evidence of tax avoidance if we disregard exports to tax
havens. Back-of-the-envelope calculations suggest that tax avoidance through transfer
pricing amounts to about 1% of the total corporate taxes collected by tax authorities
in France. The lion’s share of this loss is driven by the exports of 450 firms to ten
tax havens. As such, it may be possible to achieve significant revenue increases with
minimal cost by targeting enforcement.