Who benefits from greater transparency in the harmonization of transfer prices – and who doesn’t

In an increasingly interconnected global economy, transfer pricing has become a critical issue for multinational enterprises, tax authorities, and policy makers. A recent TRR 266 “Accounting for Transparency” research paper sheds light on the complex dynamics of transfer pricing harmonization and challenges some common beliefs about who benefits from harmonization.

This study examines how harmonizing tax transfer pricing by increasing the consistency of transfer pricing standards and improving global tax transparency for tax authorities affects firms and tax revenues. Although transfer pricing harmonization is seen as a promising tool to combat unwanted tax avoidance, its effects and side effects are largely unresearched. This study shows that, despite the ambitious plans of the OECD/G20 Inclusive Framework on BEPS (Base Erosion and Profit Shifting) to create a globally uniform tax system to effectively combat tax avoidance and prevent double taxation, these inconsistencies may not disappear in the short term. Moreover, many of the implications of transfer pricing harmonization are still unclear. Who benefits from harmonization? How does it affect firms? Why do not all countries agree on uniform regulations and improved global tax transparency (e.g. through tax information exchange)?

What are transfer prices and their challenges?

There is no market price for cross-border intercompany transactions. A price is needed, however, to calculate the company’s tax burden in the respective countries. Tax transfer prices are intended to serve as a proxy for the missing market prices.

The arm’s-length principle states that tax transfer prices should resemble prices that unrelated parties (which deal “at arm’s length”) would agree upon. Although most countries apply the arm’s-length principle, there are several methods for calculating arm’s-length prices, which ultimately lead to different outcomes. Often, different jurisdictions mandate taxpayers to use diverging methods. Furthermore, the specific design of the calculation methods often differs across countries. Thus, different countries, again and again, expect different tax transfer prices for the same transaction.

An online survey conducted as part of the study shows that MNCs, anticipating this inconsistency across countries, indeed occasionally report different tax transfer prices, that is, report inconsistently. Consequently, double taxation may arise. These inconsistencies might also enable companies to engage in more tax avoidance.

By contrast, enhanced global tax transparency is expected to help tax authorities challenge excessive tax avoidance in transfer pricing.

Consequently—and, especially, to curb multinational tax avoidance—lately, intergovernmental forums like the OECD/G20 Inclusive Framework on BEPS have promoted consistent and uniform transfer pricing standards. As a step towards this aim, the OECD has proposed a harmonized transfer pricing documentation in its BEPS Action 13 called “Transfer Pricing Documentation and Country-by-Country Reporting”. Transparency about transfer pricing is a key concern of OECD Action Point 13, which can be achieved by enhanced transfer pricing documentation and exchange of information.

It seems intuitive that consistent transfer pricing rules and high global tax transparency should be advantageous for everybody, as they eliminate double taxation and double non-taxation. However, the changed institutional setting also might affect a multinational’s production decision and the involved tax authorities’ audit decisions. Therefore, the overall effects on tax avoidance, countries’ tax revenue, and the company’s profit are unclear.

The impact of harmonization

The study by Markus Diller (University of Passau), Johannes Lorenz (University of Oldenburg), Georg Schneider (University of Graz) and Caren Sureth-Sloane (Paderborn University) answers a fundamental question: What are the effects of harmonizing transfer pricing standards and improving global tax transparency on MNEs, tax revenues and overall economic welfare? This question is particularly relevant given the recent initiatives of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) to promote uniform transfer pricing standards and improve transparency.

A game theory approach

To investigate this question, the researchers developed a game-theoretic model with a multinational and two tax authorities. The model assumes that production takes place in a low-tax country, while sales take place in a high-tax country. By analyzing the equilibrium between the multinational and the tax authorities, the study shows how improved information exchange and increased consistency of standards affect production decisions, tax avoidance, tax revenues, and global welfare.

Surprising insights

The research provides several surprising and important findings:

1. Persistent tax avoidance: The equilibrium always implies some level of tax avoidance in both countries, regardless of efforts to harmonize transfer prices.
2. Impact on production volume: Multinational’s production decisions depend on global tax transparency, inconsistency of transfer pricing standards and individual arm’s length prices.
3. Preferences of high-tax countries: Surprisingly, net tax revenues in the high-tax country may be maximized at a medium level of global tax transparency rather than at full transparency.
4. Diverging country interests: The study identifies scenarios in which high-tax countries prefer medium over high transparency levels, while low-tax countries benefit most from full transparency. This finding challenges the common assumption that high-tax countries suffer most from transfer-price-induced tax avoidance and would therefore benefit the most from more transparency.
5. Optimization of global welfare: In most scenarios, a high degree of consistency in transfer pricing standards combined with a high degree of global tax transparency maximizes global welfare.

Academic contributions and implications

By developing a comprehensive model that considers the strategic interactions between multinationals and tax authorities, the study provides novel insights into the complex dynamics of transfer pricing harmonization.

The findings have important implications for policymakers and firms:

1. Policy design: policy makers should consider the potential unintended consequences of harmonization efforts, especially the diverging interests of high- and low-tax countries.
2. Business strategy: Multinationals need to anticipate how changes in transparency and consistency of transfer pricing standards might affect their optimal production and reporting decisions.
3. Global coordination: The study highlights the challenges in achieving a uniform application of transfer pricing rules across countries.

Conclusion: A differentiated view of harmonization

These results provide new insights into why high-tax importing countries, in particular, may have incentives to act in ways that do not maximize the global welfare. For this and other reasons, a lack of global tax transparency and inconsistent transfer pricing standards are likely to remain a phenomenon in international taxation. In the context of the envisioned new global tax system, it is also unclear whether the inherent mechanisms for tax audits, dispute avoidance and dispute resolution will actually lead to a uniform application of the rules in all countries.

The results of this study thus illustrate that inconsistencies in transfer pricing practice could remain, despite ambitious international initiatives.

Furthermore, the study highlights the complexity of aligning the interests of different countries and stakeholders in the global tax landscape. As policymakers continue to grapple with these challenges, further research will be crucial to understanding the full implications of transfer pricing harmonization and developing effective, equitable solutions for the global economy.

This research not only advances our understanding of the dynamics of transfer pricing but also provides valuable insights for designing future international tax reforms and business strategies in an increasingly interconnected world.

To cite this blog: Diller, M., Lorenz, J., Schneider, G., Sureth-Sloane, C. (March 2025). Who benefits from greater transparency in the harmonization of transfer prices – and who doesn’t, TRR 255 Accounting for Transparency Blog. https://www.accounting-for-transparency.de/harmonization-of-transfer-prices/