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ABSTRACT: While the accounting literature has extensively studied the role of transfer pricing (TP) within the management control system (MCS) of companies, MCS issues related to cross-border transfers have received far less attention. In this case study, we investigate how TP tax compliance influences responsibility accounting when one multinational enterprise (MNE) uses a single set of transfer prices for both tax compliance and management control. First, the MNE eliminated TP negotiation, leading to psychologically disagreeable and sometimes also economically harmful situations. Second, the firm administratively simplified the determination of profit margins to such an extent that it could lead to suboptimal business decisions. Third, tax compliance induced a profit-center designation for business units that were primarily responsible for costs or revenues. The firm first coped with a mixed treatment of these responsibility centers, allowing them to be profit centers for tax purposes and cost or revenue centers for MCS purposes. Later, top management became convinced of the benefits of a profit-center treatment for all purposes and started to convert the pro forma profit centers into real profit centers. Overall, this study contributes to the stream of research documenting and explaining how MCSs are designed and used under environmental pressures.
Keywords: international transfer pricing; management control system; responsibility accounting; multinational enterprise.
INTRODUCTION
In this transfer pricing (TP) paper we empirically investigate how tax compliance influences responsibility accounting in one multinational enterprise (MNE) that uses a single set of transfer prices. International tax law is a crucial determinant of cross-border TP in MNEs. It imposes the arm's length principle as the yardstick to judge the fairness and correctness of the TP system (OECD 1992, Art. 9). The tax authorities take a ''separate entity approach'' to investigate an MNE's adherence to the arm's length principle. This approach implies that MNEs need to be prepared to demonstrate that intercompany prices are in line with what would have been charged had the two companies not been related (OECD 1995). The potential penalties, the risk of encountering economic double taxation, and the significant financial and reputation consequences in case of non-compliance motivate MNEs to give high priority to TP tax compliance1 (Cools and Emmanuel 2007; The Economist 2004; Wright 2004, 2007). Under these regulatory constraints the majority of MNEs...