Joint transfer pricing decision on tangible and intangible assets for multinational firms

TL;DR

This paper analyzes how multinational firms optimize transfer pricing for tangible and intangible assets, considering tax differences, markups, and royalties under different operational structures to maximize after-tax profits.

Contribution

It introduces a comparative analysis of markup and royalty-based transfer pricing strategies under two operational structures, highlighting their effects on profit optimization.

Findings

Tax differences always increase profits under the commissionaire structure.

Non-monotonic profit behavior observed under the limited-risk structure.

Markups benefit profits more at small order quantities, royalties at larger quantities.

Abstract

While conventional multinational firms (MNFs) often avoid taxes by transferring their profits to low-tax regions through markup on tangible asset costs, high-tech MNFs may avoid taxes by transferring royalty fees to intangible assets (i.e., royalty-based transfer prices). This study investigates the effects of tax differences, markups, and royalties on decision-making. We also compare the different effects of markups and royalties on the improvement of MNFs' after-tax profit under two main business structures: the commissionaire operational structure (C) with complete information, and the limited-risk operational structure (R) in the principal-agent setting. We find that the tax difference always improves MNFs' profits under the C structure, whereas non-monotonic behavior exists under the R structure. More interestingly, when the order quantity is relatively small, the markup improves MNFs' profits faster than the royalty; conversely, the royalty improves MNFs' profits faster than the markup.