The effects of tariffs, partial ownership, and regulated transfer pricing on production decisions

Scope and method of study. The purpose of this study was to determine the effects of tariffs, partial ownership, taxes and regulated transfer pricing methods on the transfer price and resource allocation decisions of a firm. The method used in this study was analytical research. The model was based on the theory of profit maximization in a partial equilibrium framework. In the analysis of tariffs, first tariffs alone were introduced, then tariffs and taxes, and finally tariffs, taxes, and regulations by use of the resale price and cost plus methods of transfer pricing. In the analysis of partial ownership, first a benchmark resource allocation and optimal transfer price were found, then taxes were introduced and last taxes and regulations were analyzed through the comparable uncontrolled price, resale price, and cost plus methods of transfer pricing.;Findings and conclusions. Without regulations, tariffs alone do not cause any resource allocation distortions and the optimal transfer price is zero. With tariffs and taxes, the optimal transfer price is zero. With tariffs and taxes, the optimal transfer price depends on the relationship between the tax benefits in the foreign country and the tax benefits in the domestic country inflated by one plus the tariff. However, regardless of the relationship between the tax benefits and tariffs, the multinational has an incentive to distort resource allocations by underproducing the intermediate product thus decreasing tariffs. With tariffs, taxes and regulated methods when using the resale price method, as the gross profit percentage of the similar product increases, the tariff effect disappears. Under the cost plus method, the tariff causes imports to remain at a level lower than under taxes only. Under both methods the similar product could be either over- or underproduced. Finally a tariff was found that a government could set to avoid the distortions causes by regulations.;The introduction of partial ownership causes the transfer price to be important because of the existence of co-owners. The combination of taxes and co-ownership allows the multinational to earn more after-tax profits when the tax benefits in the domestic country are less than or equal to the tax benefits in the foreign country multiplied by the ownership percentage. To obtain the additional after-tax profits, the multinational should choose an ownership percentage greater than the ratio of the domestic tax benefits to the foreign tax benefits. The domestic government gains tax revenue by requiring use of the market price thorough regulations when the tax benefits in the domestic country are less than or equal to the tax benefits in the foreign country multiplied by the ownership percentage. When the resale price method is used, imports initially increase to a level higher than under no taxes or taxes without regulations, but as the gross profit percentage of the similar product increases, imports decrease to a level lower than under taxes or taxes without regulations. When the cost plus method is used, imports initially remain at the same level as under taxes but no regulations but then increase as the gross profit percentage of the similar product increases.