Transfer pricing as tax avoidance under different legislative schemes

This paper investigates transfer pricing as tax avoidance before and after reforms of anti-avoidance legislation. The reforms introduced and tightened obligatory documentation requirements for transfer prices to enforce that multinational enterprises (MNEs) set internal transfer prices at an arm's-length. Linking data from the Microdatabase Statistics on International Trade in Services that comprehends prices of MNEs' international service transactions to the Microdatabase Direct Investment, I create a unique, novel data set to obtain information on whether MNEs' transaction partners are affiliated companies or not. The results provide empirical evidence for tax-motivated transfer pricing during the entire first decade of the 2000s. Interestingly, MNEs target different types of service transactions for profit shifting via transfer pricing depending on the at the time applicable anti-shifting legislation. The findings show transfer pricing legislation to be effective in case of service transactions with observable market values. In contrast, the results clearly reveal the short-comings of transfer pricing legislation in case of intellectual property (IP) where an effective enforcement of the arm's-length principle is very limited as market values are unobservable. Here, the findings suggest the need for a change in tax policy in order to effectively prevent base erosion in case of IP-related transfer pricing.