International transfer pricing in a developing economy context : perspectives from the taxpayers and the tax authorities

Student thesis: PhD Thesis (Lingnan)

Abstract

Since the 1979 economic reforms, China has been characterized by a rapid increase in international trade and an inflow of foreign direct investment. Foreign investment enterprises (FIEs) play an increasing important role in the Chinese economy and are substantially engaged in transactions with affiliates outside China. Therefore, international transfer pricing in China has become a significant issue.

Empirical research on international transfer pricing has focused on multinational corporations (MNCs) operating in developed countries. However, it is difficult to generalize their findings to MNCs operating in developing countries as the business environment of developing countries is quite different from that of developed countries. Existing literature identifies that due to differences in the business environment between developed and developing countries, the tax factors which are important in developed countries should not be over-emphasized in developing countries. Some nontax factors such as foreign exchange control and restrictions on profit repatriation which may not be important in developed countries are nevertheless important in developing countries. However, empirical studies on international transfer pricing in developing countries are relatively scare. Furthermore, there have been no empirical studies that examine the relationships between management’s perception of the importance of environmental variables and management’s choice of international transfer pricing methods in developing countries, or which analyze the tax and nontax cost trade-off for tax evasion via international transfer pricing in developed or developing countries.

The objective of this thesis is to provide a comprehensive empirical study on international transfer pricing in China from the perspectives of both taxpayer and the tax authority. The results of this thesis indicate that the more important the management perceives the interest of local partners and the maintenance of a good relationship with host government to be, the more likely it is that the FIE will adopt a market-based transfer pricing method. On the other hand, the more important the management perceives foreign exchange controls in transfer pricing decisions to be, the more likely it is that the FIE will choose a cost-based transfer pricing method. The research results also reveal that based on a tax and non-tax cost trade-off analysis, wholly foreign-owned enterprises, cooperative joint ventures and exportoriented FIEs are more likely to be selected for transfer pricing audits in China than equity joint ventures and domestic -market oriented enterprises. Some explanations for this result are the lack of monitoring by Chinese local partners in certain FIEs and the opportunity for transfer pricing manipulations.

The results of this thesis have important policy implications for foreign investors carrying on business in China, the Chinese tax authorities as well as academic researchers. My research results should help foreign investors to have a better understanding of the tax and the nontax factors in formulating transfer pricing policies in China. The results should also help tax authorities tackle tax audit problems more effectively and in setting tax audit guidelines on related party transactions. Further, this thesis should contribute to the establishment of a more comprehensive theoretical framework of international transfer pricing in developing countries. It also empirically demonstrates the applicability of the tax and nontax cost theory in the context of international transfer pricing.
Date of Award6 Nov 2004
Original languageEnglish
Awarding Institution
  • Lingnan University
SupervisorKoon Hung CHAN (Supervisor)

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