From Bureaucracy to Cooperation? On the Evolution of Hybrid Governance in International Taxation

Abstract

This paper applies transaction cost economics to a recent trend in international corporate income taxation: Advance Pricing Agreements (APAs). An APA is a cooperative arrangement between tax authorities (of at least one jurisdiction) and the multinational corporate taxpayer. It serves to resolve, in a cooperative manner before the business has taken place, the potential transfer pricing disputes between tax authorities and multinationals. This constitutes an alternative to the traditionally adversarial process of taxing. Whereas taxation can be classified as a typical bureaucratic governance form to generate state budget, the collaborative interaction between the corporate entities (taxpayers) and the tax authorities through an APA is explained by mutual information asymmetry. By means of asymmetric information on both sides, the paper shows why APAs play an increasing role in corporate transfer pricing strategies and international taxation. Information-related factors such as compliance expose the involved parties to hazards and uncertainty regarding income allocation and taxation, if the institutional environment does not dismantle asymmetric information. The model also predicts that, if institutional change (e.g. tax system harmonization) results in one-sided asymmetric information in the hands of the taxpayer, bureaucratic governance may revert.