Transfer Pricing and Tax Havens for Attracting FDI

Abstract

Enterprises seek profit maximization that comprises tax optimization which, within multinationals, includes the shifting of profits from the less to the most favorable countries using transfer pricing of intra-group transactions and tax havens as the “middle man”. Because FDI is an important engine of economic growth of, at least, the less developed countries and multilateral agreements impose limitations on the allocation of direct subsidies to businesses, in our research we explore the hypothesis that countries could use the relaxation of regulation on transfer pricing as a fiscal policy instrument for attracting FDI. Using a good composed of two parts, the brand and the hardware, and consumers with concave utility on the brand, we conclude that countries can use the relaxation of regulatory acceptance of transfer pricing to attract FDI when 1) the creation and development of the brand is an important part in the total cost of the good and 2) the increase in production costs of relocating the production from the most to the less developed country is not very large. Our results seem in accordance with empirical evidence.