Journal of Accounting and Management Information Systems (JAMIS)

Determinants of non-compliance with arm’s length rules. An empirical study of foreign controlled subsidiaries in the Netherlands

19/2007 ,   p28..41


Keywords:   Tax compliance, transfer pricing, multinational enterprises

Transfer pricing is the number one international tax concern of multinational enterprises (MNEs), according to latest three Ernst & Young LLP biennial surveys. Tax authorities around the globe also view transfer pricing as a top audit issue, scrutinizing MNEs pricing for intra-company transactions to make sure that arm's length standard is followed. While the use of cross-border transfer pricing as income-shifting mechanism has been researched extensively over the last fifteen years, very few studies have focused on issues like the impact of regulation credibility and enforcement on tax planning behaviour or on the relationship between tax and non-tax determinants of MNEs behaviour. This research investigates what factors explain the cross-sectional variation in tax compliance behaviour documented in prior research (Negrea, 2006). Using a sample of foreign-controlled subsidiaries incorporated in the Netherlands and applying the Comparable Profit Method to define subsidiary's specific degree of compliance with arm's length regulation, the study finds this indicator to be significantly dependent on the strength of tax incentives to manipulate transfer price: subsidiaries which belong to parents from high tax EU countries adopt riskier positions from a tax compliance perspective. Also, the evidence in this study reinforces theoretical predictions (Scholes-Wolfson, 1992) that non-tax factors, like incentive contracting needs within large corporation, can offset tax minimization incentives. Several others countervailing factors affect the propensity to deviate from arm's length performance: enforcement credibility, political costs, and startup effects.