Clemens Löffler, Senior Researcher at FHWien der WKW, investigated the relationship between different national taxation regimes, intra-company transfer pricing systems and the location choices of multinational corporations together with Michael Kopel from the University of Graz.
The results of the study suggest that a comprehensive organizational design that considers a corporation’s tax strategy as well as its location strategy can make the complete re-location of production to low-tax countries unattractive. Instead, the focus is on the relocation of the “right” production units from the company’s point of view.
Minimizing taxes as a matter of practice
The article, published in the International Journal of Production Economics, analyzes a decision model that examines the impact of different national corporate tax rates on multinational companies’ location choices and the design of intracompany service allocation (transfer pricing). It is a widespread practice that companies relocate their production facilities to countries with low tax rates in order to save taxes.
Previous studies have shown this with the example of Nike or Nokia, which moved their entire production abroad. Other corporations such as Toyota or Intel follow a location policy in which only part of the production is relocated to low-tax foreign countries, while the remaining production is kept in the home region. The motivation of companies to relocate the entire production or only parts of it can often not be explained by a mere comparison of tax advantages.
The article shows that a complex network of internal transactions and transfer prices in combination with an optimized location policy helps corporations to minimize their tax payments. A tax-optimal organizational design is not always achieved by relocating more production sites to low-wage countries, but rather by relocating the right ones from the group’s perspective. Excessive relocation makes it more difficult to coordinate the individual business units and leads to conflicting objectives, which have a negative impact on the group’s earnings and tax savings.
National taxes and international guidelines fall short
Even if national and international transfer pricing guidelines (e.g. of the OECD) are intended to prevent tax evasion to low-tax countries, in practice there are a large number of ways for manufacturing groups to optimize their location policy in terms of tax minimization.
The analysis shows that relocating complete production to low-tax countries tends to make sense when the differences in national tax rates and the permitted markups on transnational transfer prices are low. In this case, tax advantages are achieved through the sheer volume of transactions. On the other hand, large differences in national tax rates and high markups on transnational transfer prices tend to lead to relocating only selected production sites to transfer profits to low-tax countries. This is because, according to Clemens Löffler, “if the quality of the tax savings is right for the corporations, the quantity is no longer so decisive.” Given the broad menu of applicable international transfer pricing models, companies can choose the variant that suits them best. For this reason, tax regulations should not be based on individual transactions, but should cover the tax and location strategy of a corporate group as a whole.