When do firms use one set of books in an international tax compliance game?

Rebecca Reineke, Katrin Weiskirchner-Merten, Stefan Wielenberg

Publication: Working/Discussion PaperWU Working Paper

Abstract

This study examines how a strategic tax auditor affects a multinational firm’s transfer pricing in a tax compliance game. Our model uses a divisionalized firm, in both a low-taxand a high-tax country, that decides to implement a transfer-pricing regime with either one or two sets of books. After observing its unit costs, the firm reports a compliant or non-compliant tax transfer price. In a regime with one set of books, the single transferprice coordinates the quantity decision and determines the tax payments. In a regime with two sets, different transfer prices serve those tasks. In contrast to previous studies, our analysis incorporates a strategic tax auditor, who observes the tax transfer price and decides whether to audit the firm. Real-world regulations suggest larger penalties for detected non-compliance under a two-sets-of-books transfer-pricing regime. Our analysis identifies the mixed strategy equilibria and examines how variations in the tax regulation—the tax rate difference and the penalty difference—affect the firm’s tax aggressiveness. We show that a firm acts less tax aggressively with a higher tax rate difference. Additionally, the model predicts that the firm either increases or decreases the probability of keeping one set of books for a smaller penalty difference.
Original languageEnglish
Place of PublicationVienna
PublisherWU Vienna University of Economics and Business
Publication statusPublished - 11 Mar 2020

Publication series

NameWU International Taxation Research Paper Series
No.2017-08

WU Working Paper Series

  • WU International Taxation Research Paper Series

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