Transfer Pricing, Earnings Management, And Tax Avoidance

ABSTRACT

Employing a dataset from multinational companies (MNCs) in Ghana, the study takes advantage of the ongoing issues concerning international transfer pricing as a platform to examine the impact of transfer pricing (TP) abuses on tax avoidance. The study again takes advantage of the new growing area of literature on earnings management (EM) to specifically examine the effect of earnings management on tax avoidance from the perspective of both financial non-financial MNCs. The study employed panel estimation regression analysis and revealed that transfer pricing is positively related to tax avoidance for both financial and non-financial multinational firms. The result shows that multinational companies that manipulate their transfer prices based on the jurisdiction of their related entities have the chance of reducing their corporate tax liability. Similarly, the study findings also depicted that earnings management associate positively with tax avoidance for both firm categories implying that MNCs that manipulate their reported profit avoid more taxes. Furthermore, the study revealed that non-financial MNCs manipulate more earnings than the financials whiles the financials also employ more TP than non-financials. The sensitivity of TP and EM impact positively on tax avoidance for the financial firms indicating that TP strategies complement firms’ actions to manage their earnings (EM). The study further established that the sensitivity of TP and EM has a significant negative relationship with tax avoidance for the non-financial firms. This means that TP and EM are not complementary, they do not override on each other, they are independent and can explain their effect on tax avoidance. The study result further indicates that TP and EM are independent determinants of international tax avoidance. The result also depicts that the combined effect of TP and EM is less than the sum of the individual effects. This implies that when both strategies are employed, the impact of TP on tax avoidance is higher only when the value of EM is low and vice versa. Finally, the study recommends that since tax revenue plays an important role in national development and at the same time contribute to a country’s GDP, practices that result in revenue losses should be eliminated. Hence, both the practice of TP abuses and EM whether their individual or combined use should not be entertained since they result in loss of government revenue which it impacts on national development is unquantifiable.