Divisionalization and domestic transfer pricing for tax considerations in the multinational enterprise

Abstract

International transfer pricing within decentralized multinational enterprises (MNEs) is considerably complex when transfer prices concurrently have to satisfy taxation and managerial accounting objectives. We consider an MNE consisting of an upstream subsidiary in one country and a possibly divisionalized downstream subsidiary in another country. We find that the inherent trade-off of international transfer pricing between the upstream and the downstream subsidiary can be alleviated by divisionalizing the downstream subsidiary and implementing an appropriate domestic transfer price between the divisions of the downstream subsidiary. As a consequence, the MNE might deliberately divisionalize a subsidiary even when divisionalization diminishes the flow of information. Importantly, divisionalization can only be effective if the optimal domestic transfer price not only accounts for the costs of the internally traded good but also for tax differentials."