Formula Apportionment and Transfer Pricing under Oligopolistic Competition

This paper demonstrates that under conditions of imperfect (oligopolistic) competition, a transition from separate accounting (SA) to formula apportionment (FA) does not eliminate the problem of profit shifting via transfer pricing. In particular, if affiliates of a multinational firm face oligopolistic competition, it is beneficial for the multinational to manipulate transfer prices for tax–saving as well as strategic reasons under both FA and SA. The analysis shows that a switch from SA rules to FA rules may actually strengthen profit shifting activities by multinationals.