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JOURNAL OF INTERNATIONAL ACCOUNTING RESEARCH American Accounting Association

Vol. 14, No. 1 DOI: 10.2308/jiar-51019


2015
pp. 2557

Multinationality, Tax Havens, Intangible


Assets, and Transfer Pricing Aggressiveness:
An Empirical Analysis
Grantley Taylor, Grant Richardson, and Roman Lanis
ABSTRACT: This study examines the individual and joint effects of multinationality, tax
havens, and intangible assets on transfer pricing aggressiveness. Based on a hand-
collected sample of 286 publicly listed U.S. multinational firms over the 20062012
period (2,002 firm-year observations), the regression results indicate that multination-
ality, tax haven utilization, and intangible assets are significantly positively associated
with transfer pricing aggressiveness. The regression results also show that firms magnify
their international transfer pricing aggressiveness through the joint effects of intangible
assets, multinationality, and tax havens. Overall, the empirical findings demonstrate that
the utilization of tax havens and the level of intangible assets are economically important
factors that assist firms in obtaining tax benefits through transfer pricing aggressiveness.
Keywords: transfer pricing aggressiveness; multinationality; tax havens, intangible
assets.

Data Availability: All data are available from public sources identied in the paper.

I. INTRODUCTION

T
he purpose of this study is to analyze the individual and joint effects of multinationality, tax
havens, and intangible assets on transfer pricing aggressiveness1 based on a sample of
publicly listed U.S. multinational firms. The Internal Revenue Service (IRS) considers
transfer pricing to be a major means of reducing corporate tax among U.S. firms.2 In fact, the Senate
Committee on Homeland Security and Governmental Affairs (HSGA) claims that over the past

Grantley Taylor is an Associate Professor at Curtin University, Grant Richardson is a Professor at


The University of Adelaide, and Roman Lanis is an Associate Professor at the University of
Technology, Sydney.

Editors note: Accepted by Michael Welker.


Published Online: January 2015

1
In this paper, we define transfer pricing aggressiveness as the downward management of tax paid by allocating profits
(or losses) among group members located in different tax jurisdictions through the intentional manipulation of
intragroup transfer prices. Transfer pricing aggressiveness is more fully defined in the next section of the paper.
2
The implementation of reportable tax positions by the IRS from 2006 in accordance with FIN No. 48, Accounting for
Uncertainty in Income Taxes (now ASC 740-10-25, FASB 2006) requires firms to analyze and disclose their income
tax risks and uncertainties in terms of their tax positions, tax payable, or tax recovery.

25
26 Taylor, Richardson, and Lanis

decade, the application of the U.S. tax code3 concerning transfer pricing has been the primary
international tax enforcement challenge for the IRS (Ernst & Young 2011; HSGA 2012a, 2012b).
Recent media releases on aggressive transfer pricing arrangements carried out by multinational
firms such as Apple Inc., Hewlett-Packard, Microsoft Corporation, and Starbucks provide evidence
of the substantial tax benefits derived by multinational firms taking advantage of differences in tax
laws, tax rates, and regulatory conditions between jurisdictions and the non-arms length pricing of
goods, services, and funds transferred among related parties (Eden and Smith 2011; Levin 2012).
The aim of the U.S. transfer pricing rules is to ensure that related-party international transactions are
conducted on an arms length basis,4 so that profits are not artificially deflated (inflated) in high-tax
(low-tax) jurisdictions (Tax Justice Network 2013). In this study, we focus on the commerciality or
arms length nature of intragroup transactions to evaluate the extent of transfer pricing
aggressiveness among publicly listed U.S. multinational firms.
We are motivated to examine transfer pricing aggressiveness because of the IRSs extensive
audit activity over the past ten years and the establishment and training of specialist IRS teams in
the areas of economic analysis, financing, and taxation to deal with the growing threat of tax
avoidance through transfer pricing manipulation (IRS 2010, 2012). These developments signal the
importance placed on transfer pricing enforcement at the highest levels of the IRS. Indeed, the
refinement of tax rules relating to transfer pricing and the increase in resources committed by the
IRS to combat aggressive transfer pricing arrangements provide evidence of the importance of
transfer pricing compliance. The development of schemes or arrangements through the mispricing
of intragroup transactions has been the most significant tax compliance issue faced by the IRS over
the past decade (IRS 2010, 2012). An economic analysis carried out by the Government
Accountability Office (GAO) in 2008 found that 34 percent of foreign-controlled firms and 24
percent of U.S.-controlled firms reported no tax liabilities over the 19982005 period (GAO
2008a). A major explanation for the zero reported tax liabilities is the abuse of transfer pricing rules
(GAO 2008a).
Based on a hand-collected sample of 286 publicly listed U.S. multinational firms over the
20062012 period (2,002 firm-year observations), our regression results demonstrate that
multinationality, tax haven utilization, and intangible assets are significantly positively associated
with transfer pricing aggressiveness. Our regression results also show that firms magnify their
international transfer pricing aggressiveness through the joint effects of intangible assets,
multinationality, and tax havens.
This study contributes to the literature in several ways. First, it constructs a unique transfer
pricing aggressiveness index based on attributes regularly emphasized in the IRSs audit programs
and risk assessments. The construction of a transfer pricing aggressiveness index provides a
methodological contribution that extends beyond U.S. corporate transfer pricing research because
this index can be replicated in other countries around the world. Moreover, our transfer pricing
aggressiveness index could be used as an input variable to assess the degree of transfer pricinga
major area of tax risk. Past research has relied on several measures of tax aggressiveness that
collectively measure the outcomes of tax planning, which could involve income shifting, strategic
debt placement, thin capitalization, transfer pricing, tax haven utilization, and business restructuring

3
Specifically, Section 482 of the U.S. Internal Revenue Code (IRC).
4
The application of the arms length standard is challenging for two reasons. First, comparable transactions regarding
the transfer of a firms core intangible assets are difficult, if not impossible, to find. Thus, the IRS is forced to resort to
other methods that do not require direct evidence of comparable uncontrolled transactions, such as income-based
methods, that depend on an ex ante discounted cash flow analysis that, in turn, depends on evaluating the financial
projections formulated by the firm. Second, as it is possible that a firms core intangible assets may be unique,
projecting cash flows from such assets using appropriate useful lives and discount rates may be difficult and
subjective (Usmen 2012; Gravelle 2013).

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Multinationality, Tax Havens, Intangible Assets, and Transfer Pricing Aggressiveness 27

(e.g., U.S. Department of the Treasury 2007; Dyreng and Lindsey 2009; IRS 2010, 2013a, 2013b;
Gravelle 2013; Tax Justice Network 2013). However, far less research has focused on the inputs
that give rise to low effective tax rates (ETRs) and large book-tax gaps (Shackelford, Slemrod, and
Sallee 2011). We attempt to pinpoint the effect of one such tax aggressiveness input variable
transfer pricing aggressivenessin this study. Indeed, our transfer pricing aggressiveness index
could be used as both a dependent variable (such as in the present study) or as an independent
variable in future research. Second, this study contributes to extant research on the transfer pricing
practices of multinational firms by providing empirical evidence of the associations between
multinationality, tax havens, intangible assets, and transfer pricing aggressiveness. Third, it also
examines the interactive effects among the three factors to determine whether these variables are
used concurrently to magnify transfer pricing aggressiveness. To the best of our knowledge, these
issues have not been addressed empirically in the U.S. literature.
The rest of this paper is organized as follows. Section II provides the definition of transfer
pricing aggressiveness used in this study. Section III examines the literature and develops the
hypotheses. Section IV describes the research design. Section V presents the main empirical results
and Section VI reports the sensitivity analyses. Finally, Section VII concludes the paper.

II. DEFINITION OF TRANSFER PRICING AGGRESSIVENESS


Countries establish laws and practices to ensure that the prices used in transactions between
related parties (i.e., transfer prices) are appropriate and result in the correct allocation of profits
across jurisdictions (Joint Committee on Taxation 2010). Transfer pricing aggressiveness in the
international context refers to the downward management of tax paid by allocating profits (or
losses) among group members located in different tax jurisdictions through the intentional
manipulation of intragroup transfer prices. Tax benefits arise for the group as a whole as a result of
the mispricing of goods, services, loans, interest, and royalties among related parties. It thus
includes transfer pricing activities that typically fall in the gray area of tax compliance, and
activities that are clearly illegal (Hanlon and Heitzman 2010). Hanlon and Heitzman (2010) allude
to transfer pricing aggressiveness as incorporating tax saving strategies that may involve
noncommercial arrangements, such as the establishment of group entities in variably taxed
jurisdictions, for the purpose of taking advantage of differences in tax rules relating to income and
deductions. Eden and Smith (2011) define transfer pricing manipulation as the tax benefit that
results when multinational firms successfully arbitrage economic, financial, and legislative
differences between countries. Profits may be artificially inflated in low-tax jurisdictions and
deflated in high-tax jurisdictions through aggressive transfer pricing that does not reflect an arms
length basis of related-party transactions (Levin 2012).
Transfer pricing aggressiveness is inferred from the lack of assurances with respect to the
commerciality or arms length nature of related-party transactions between firms (Joint Committee
on Taxation 2010). Specifically, lack of assurances may exist with the setting of intercompany
prices of goods or services, the character of transferred funds (i.e., royalty, dividend, or interest
distributions), and the overall transfer pricing arrangement or method used (Levin 2012). The
commercial basis of related-party transactions is used by the IRS and other agencies such as the
U.S. Department of the Treasury to ascertain if the manipulation of prices of goods and services, or
the terms and conditions that underpin transfer pricing transactions and arrangements, have taken
place.
Later in the paper, we develop a unique transfer pricing index to capture and measure the non-
arms length nature of transactions or arrangements between group affiliates (as identified from
mandated disclosures of related-party transactions within 10-K annual reports) as a basis for
assessing the propensity of firms to engage in aggressive transfer pricing activities. The items that

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28 Taylor, Richardson, and Lanis

comprise this index measure the occurrence of transactions that are either non-arms length in
nature or transactions or arrangements for which the firm has been unable to substantiate a
commercial basis for their occurrence. The IRS, in the first instance, relies on disclosures of the
commercial terms and conditions of related-party transactions within annual reports to evaluate
transfer pricing aggression and risk (see, e.g., IRS 2014).

III. THEORY AND HYPOTHESES DEVELOPMENT


Multinationality, tax haven utilization, and intangible assets are argued to represent the main
determinants of transfer pricing aggressiveness, together with the joint effects of these variables on
transfer pricing aggressiveness. In this section, we review the literature and develop our hypotheses.

Multinationality
U.S. multinational firms can defer domestic taxation on the earnings of foreign subsidiaries
until the earnings are repatriated back to the U.S. (Blouin and Krull 2009; Graham, Hanlon, and
Shevlin 2011). By declaring foreign source earnings as permanently reinvested in foreign
jurisdictions, U.S. multinational firms can avoid recognizing the income tax expense related to their
foreign earnings. Because transfer prices play a significant role in determining the distribution of
income between group members, transfer pricing affects the tax provision of multinational firms
through its impact on unrepatriated earnings (Gravelle 2013).
Jacobs (1996) early research on transfer pricing aggressiveness found that firms with
operations located across variably taxed jurisdictions have greater opportunities and resources to
shift income (e.g., interest, dividend, and royalty income) to low-tax jurisdictions and to source or
allocate tax deductible expenses (e.g., interest on debt) in or to high-tax jurisdictions. Jacobs
(1996) results support the work of Grubert and Mutti (1991) who also found that U.S. multinational
firms report more income in low-tax jurisdictions than in high-tax jurisdictions. The net effect of
such arrangements is lower group ETRs (GAO 2008a). Over the past decade, further research on
the financial and tax arbitrage benefits available to multinational firms has confirmed that such firms
have the opportunity to shift funds, goods, and services among variably taxed jurisdictions,
resulting in preferential tax outcomes and additional tax benefits that may not be available to purely
domestic U.S. firms (Rego 2003; Mills and Newberry 2004; Hanlon, Mills, and Slemrod 2007;
Dyreng and Lindsey 2009).
More recent research by Clausing (2009) and Klassen and Laplante (2012a) documents the
existence of income shifting and speculates that multinational firms shift income between group
subsidiaries located in variably taxed jurisdictions through transfer pricing, strategic debt location,
and preferential cost allocation. Income shifting can be achieved by manipulating the transfer prices
of goods and services, thus allowing more income to be assigned to low-tax jurisdictions. By
reducing the price of goods and services sold by parent and affiliate firms in high-tax jurisdictions
and increasing the price of purchases, income can be shifted to low-tax jurisdictions (Gravelle
2013).
U.S. multinational firms, especially in the high technology and pharmaceutical industries,
are able to shift profits offshore through a variety of arrangements that lead to the transfer of
valuable intangibles to related foreign affiliates for non-arms length consideration (HSGA
2006). Debt could be sourced in high-tax jurisdictions to achieve greater tax deductions on
interest expenses and loan fees in that locality, with the loan amounts then transferred for use in
other jurisdictions (Adams 2009; Klassen and Laplante 2012a; Gravelle 2013). Similarly, R&D
expenditure may be assigned to high-tax jurisdictions with the tax benefits accruing to the
corporate group as a whole. Klassen and Laplante (2012b) provided evidence showing that U.S.
multinational firms have engaged in more aggressive tax-motivated income shifting over time,

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Multinationality, Tax Havens, Intangible Assets, and Transfer Pricing Aggressiveness 29

with firms that have either low or high average foreign tax rates engaging in shifting income
both into and out of the U.S.5
The aforementioned studies emphasize the ability and capacity of U.S. multinational firms to
make use of tax rate differentials and increased opportunities to engage in tax-motivated income
shifting. Thus, aggressive transfer pricing activity, as a component of income shifting, can
potentially have a significant effect on firm profitability and hence the amount of corporate taxes
payable by a firm. To formally test the effect of multinationality on transfer pricing aggressiveness,
we develop the following hypothesis:
H1: All else being equal, multinationality is positively associated with transfer pricing
aggressiveness.

Tax Haven Utilization


Transfer pricing aggressiveness may also be facilitated if members of the corporate group are
residents of countries with tax haven status that offer beneficial financial, legal, and taxation
regimes (OECD 2006; Dharmapala 2008; Dharmapala and Hines 2009).6 Harris, Morck, Slemrod,
and Yeung (1993) found that the tax liabilities of U.S. multinational firms with tax haven
subsidiaries are much lower than those U.S. firms without them. They claimed that their results
were indicative of aggressive transfer pricing among U.S. multinational firms with tax haven
subsidiaries (Harris et al. 1993).7 Furthermore, Dyreng and Lindsey (2009) found that U.S.
multinational firms that disclose material operations in at least one tax haven country have an
average worldwide tax rate on pretax worldwide income that is around 1.5 percentage points lower
than firms without operations in at least one tax haven country. While tax havens may have
legitimate business purposes relating to financing, investing, and other capital management
purposes (Dyreng and Lindsey 2009), the IRS, the GAO, and the HSGA all emphasize that tax
havens play a major role in reducing corporate tax liabilities (Homeland Security and Governmental
Affairs 2006; U.S. Department of the Treasury 2007; GAO 2008a, 2008b).
As an example of the link between transfer pricing aggressiveness and tax haven utilization,
assume a firm domiciled in Australia (AUS Inc.) produces pharmaceutical products for sale on the
world market. AUS Inc. sells its pharmaceuticals to a tax haven incorporated subsidiary (subject to
zero taxes) located in the Cayman Islands (Cayman Inc.) at an artificially low price, resulting in a
low profit margin for AUS Inc. (subject to a statutory corporate tax rate of 30 percent) on this
product. Cayman Inc. then resells the pharmaceutical product to a subsidiary of AUS Inc. domiciled
in the U.S. (U.S. Inc.) at a high price that is set close to the final retail price. The profit margin on
the pharmaceutical product by U.S. Inc. is low, generating a minimal taxable income. Cayman Inc.
has purchased the pharmaceutical product at a low price from AUS Inc. and sold that product to
U.S. Inc. (subject to a statutory corporate tax rate of 35 percent) at a comparatively high price,
resulting in a high profit margin. However, because it is subject to a zero tax rate, there is no

5
Cecchini, Leitch, and Strobel (2013) argued that multinational firms can take advantage of complex international
market imperfections to effectively achieve financial and taxation arbitrage via effective transfer pricing strategies.
6
Tax havens may impose no or only nominal amounts of corporate tax, have laws or administrative practices that
prevent the effective exchange of information between tax authorities, and lack transparency in their financial and tax
arrangements (e.g., regulatory, legal, and administrative provisions) and access to financial records (OECD 2006;
Dyreng and Lindsey 2009; Gravelle 2013).
7
The case of Microsoft Corporation provides an interesting example of this association. Specifically, Microsoft
licensed its software for use in Europe, the Middle East, and Africa through an Irish subsidiary. Microsoft received
royalty payments that were tax deductible in high-tax jurisdictions and subject to a low rate of tax in Ireland. This
practice allowed Microsoft to save at least $500 million in corporate taxes each year (Mutti and Grubert 2009).

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30 Taylor, Richardson, and Lanis

corporate tax payable on that margin. The overall result is that group taxes are aggressively avoided
by transfer pricing manipulation through tax havens.
Overall, tax havens assist in reducing the amount of corporate taxes payable through transfer
pricing by permitting the reallocation of taxable income (e.g., royalties, dividends, and service fees)
to low-tax jurisdictions or by the reallocation of deductible expenditure (e.g., interest, bad debts,
advertising, and R&D expenses) to high-tax jurisdictions (Desai, Foley, and Hines 2006; Desai,
Dyck, and Zingales 2007).8 To formally test the effect of tax haven utilization on transfer pricing
aggressiveness, we develop the following hypothesis:
H2: All else being equal, tax haven utilization is positively associated with transfer pricing
aggressiveness.

Intangible Assets
Over the past decade, the Large Business and International Division of the IRS has identified
the transfer of intangible assets (e.g., intellectual property) between group affiliates as a Tier-1 risk
and compliance issue (IRS 2013a). The increased cross-border trade in intangible assets, especially
core or high-value business assets that could be difficult to value, together with the realization that
traditional transfer pricing audit practices may be ineffective, has led the U.S. Department of the
Treasury and the IRS to allocate significant resources to this area (Markham 2005; U.S. Department
of the Treasury 2007; IRS 2013a). To assist the IRS in dealing with transfer pricing risks, it now
requires firms to disclose information regarding the nature and migration of intangible assets among
group affiliates through a Schedule UTP, Uncertain Tax Position Statement 9 and also as part of an
overall package of transfer pricing documentation required by firms willing to establish formal
transfer pricing agreements with the IRS (IRS 2013a).
Past research has found that the risk of transfer pricing aggressiveness is increased by the
variability in the interpretation of transfer pricing valuations and methods and firms difficulty in
defining precisely the economic substance of transactions under which intangible property transfers
have taken place (e.g., Grubert 2003; Grubert and Mutti 2007; Gravelle 2010). The application of
appropriate arms length prices using comparable transactions is fairly straightforward for the vast
majority of cross-border transactions, which typically involve the transfer of common goods or
services. However, IRS enforcement difficulties arise when U.S. firms shift high-value intangible
assets offshore, because the sale and purchase prices of these assets are not readily comparable due
to their unique nature and the lack of an active market for them.10 The lack of well-established
markets and subjective valuations of core intangible assets provides management with the
opportunity to develop and exploit various tax benefits by transferring these assets between variably
taxed jurisdictions (Shackelford et al. 2011; Dyreng, Hanlon, and Maydew 2008). To formally test
the effect of intangible assets on transfer pricing aggressiveness, we develop the following
hypothesis:

8
Tax havens can be very important in reducing corporate taxes and have come under careful scrutiny by the IRS and
other taxing authorities (Gravelle 2013). Subsidiaries incorporated in tax havens may have legitimate commercial
purposes for choosing to incorporate subsidiaries there. There may be a number of reasons why firms utilize tax
havens, ranging from legitimate financial or legal activities to the reduction of the global tax liabilities of the firm and
concealment of the flow of funds among group affiliates (Drucker 2011; Womack and Drucker 2011).
9
Since the 2010 tax year, firms have been required to lodge a Schedule UTP with their tax returns. Schedule UTPs
require information about tax positions that affect the U.S. federal income tax liabilities of certain firms that issue or
are included in audited financial statements and have assets that equal or exceed $50 million.
10
Comparability with regard to related-party transactions requires that the differences between alternative transactions
are not material, which in practice may be difficult to achieve with certainty (Gravelle 2013).

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Multinationality, Tax Havens, Intangible Assets, and Transfer Pricing Aggressiveness 31

H3: All else being equal, intangible assets are positively associated with transfer pricing
aggressiveness.

Interaction Effects of Intangible Assets, Multinationality, and Tax Havens


Past research suggests that firms are able to magnify their aggressive transfer pricing activities
through the collective use of intangible assets, multinational operations, and tax haven incorporated
subsidiaries (e.g., Jacob 1996; Conover and Nichols 2000; U.S. Department of the Treasury 2007;
Wilson 2009). The U.S. Department of the Treasury (2007) claims that multinational firms are able
to exploit differences in tax rates and tax rules to reduce their group tax liabilities, which can be
achieved by shifting high-value intangible assets to favorable tax jurisdictions such as tax havens.
Grubert (2003) found that the profit differential between group affiliates domiciled in low-tax and
high-tax jurisdictions of U.S. multinational firms was largely attributable to the transfer of
intellectual property and other intangible assets.
Klassen and Laplante (2012a) emphasized that U.S. multinational firms shift income across
international borders in response to tax incentives and that transfer pricing is an important tool that
firms can use to shift income. Research by Dyreng and Markle (2013) estimated that U.S.
multinational firms with tax haven incorporated subsidiaries transferred an average of $28 million
more out of the U.S. than did firms without tax haven operations, and attributed the incremental
amount to tax-motivated shifting. Gravelle (2013) claimed that many high-value intangible assets
(e.g., patents, trademarks, and intellectual property) do not have readily comparable market prices,
so it is difficult to establish arms length prices for these types of assets. Thus, if intangible assets
developed in the U.S. are licensed to an affiliate in a low- or no-tax jurisdiction such as a tax haven,
then income will be shifted if the associated royalty or other payment is lower than the true value of
those intangible assets (Gravelle 2013).11
We extend the research on transfer pricing economics and taxation (e.g., Jacob 1996; Conover
and Nichols 2000; U.S. Department of the Treasury 2007; Wilson 2009) by considering empirically
whether the associations between multinationality, tax haven utilization, and transfer pricing
aggressiveness are magnified by intangible assets. We thus develop the following hypothesis:
H4a: All else being equal, the positive association between multinationality and transfer
pricing aggressiveness is magnified by intangible assets.
H4b: All else being equal, the positive association between tax haven utilization and transfer
pricing aggressiveness is magnified by intangible assets.

IV. RESEARCH DESIGN

Sample Selection and Data Source


Our initial sample comprised of the S&P 500 U.S. publicly listed firms for the 20062012
period. However, the sample was reduced to 286 firms after excluding financial and insurance firms
(47) and firms with no significant overseas subsidiaries, based on Exhibit 21 subsidiary listings
(167). The full sample consists of 2,002 firm-year observations over the seven-year period.
Financial institutions, insurance firms, and utilities were excluded because of the significant
differences in the application of accounting policies and the derivation of accounting estimates,

11
Google Inc. has successfully used the Dutch Sandwich method to transfer intangible assets among group entities,
some of which are domiciled in no-tax (tax haven) jurisdictions (e.g., Bermuda) or low-tax jurisdictions (e.g., Ireland)
to significantly reduce group tax liabilities (Drucker 2011; Womack and Drucker 2011).

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32 Taylor, Richardson, and Lanis

together with the different regulatory constraints faced by these firms. All transfer pricing data were
hand collected from the 10-K annual reports of the sample firms. Finally, financial data were
obtained from Compustat.
The sample period was chosen because it was around 2005 that the IRS realized the extent to
which U.S. multinational firms were avoiding taxes through aggressive transfer pricing activity
(IRS 2013a, 2013b). The sample period also coincides with the IRSs creation of specialized teams
to deal with transfer pricing noncompliance and an increase in the disclosure of transfer pricing
risks, transfer pricing audits, and associated related-party transactions in 10-K annual reports. These
activities may have contributed to the quantum of uncertain tax benefits (UTBs)12 required to be
disclosed in accordance with the provisions of FIN No. 48. Information about tax haven
incorporated subsidiaries was collected from Schedule 21 of the 10-K annual report.

Dependent Variable
Our dependent variable is represented by transfer pricing aggressiveness (TPRICE). We
developed a TPRICE index that comprises eight dichotomous items (see below). The sum-score
approach has been used successfully in other research, especially in relation to the construction of
corporate governance indices (e.g., Cremers and Nair 2005; Karamanou and Vafeas 2005; Brown
and Caylor 2006; Bebchuk, Cohen, and Ferrell 2009) and the development of accounting disclosure
indices (e.g., Adhikari and Tondkar 1992; Salter and Niswander 1995; Marston and Shrives 1991;
Zarzeski 1996).
The key issue relating to transfer pricing aggressiveness is the lack of compliance with the
arms length principle in establishing transfer prices. It is not unreasonable to assume that transfer
pricing aggressiveness is reflected in the noncommercial or non-arms length nature of transferred
goods, services, and loan amounts and the nature of intragroup dealings and documentation relating
to these dealings. A lack of documentation and objectivity in relation to intragroup dealings is likely
to suggest that a firm engages in aggressive transfer pricing practices or poor transfer pricing risk
management. Hence, the dichotomous items representing TPRICE collectively measure the
occurrence of transactions that are either non-arms length in nature or transactions or arrangements
for which a firm has been unable to substantiate a commercial basis for their occurrence. These key
attributes have been at the forefront of discussions among the Pacific Association of Tax
Administrators (PATA) (IRS 2013a).13 The higher the score attained for TPRICE, the greater the
degree of transfer pricing aggressiveness.
The items that comprise the TPRICE index were selected based on the general criterion that
they must involve intra-entity transactions that are not commercially justified or are not of a
commercial or arms length nature, in line with IRS regulations dealing with aggressive transfer
pricing activity. The IRS enforcement power in this area arises from Section 482 of the IRC14 (IRS
2013b). In accordance with Section 482 and the supporting regulations, firms are required to
prepare contemporaneous documentation of the selection and application of transfer pricing
methods that provide the most reliable arms length result. Thus, when a U.S. firm sells or licenses

12
This represents the estimated dollar amount of tax benefits recorded in a firms income tax filing that does not meet
the general probability recognition criterion according to FIN No. 48, Accounting for Uncertainty in Income Taxes
(FASB 2006) requirements and is recorded as an UTB or liability in the financial statements.
13
The PATA member countries include Australia, Canada, Japan, and the U.S.
14
U.S. Treasury Regulations relating to Section 482 of the IRC provide that in determining the true taxable income of a
controlled taxpayer, the standard to be applied in every case is that of a taxpayer dealing at arms length with an
uncontrolled taxpayer. A controlled transaction meets the arms length standard if the results of the transaction are
consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same
transaction under the same circumstances (IRS 2013b).

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Multinationality, Tax Havens, Intangible Assets, and Transfer Pricing Aggressiveness 33

the use of an asset to an offshore affiliate, it is required to report a sale price or a royalty rate based
on the price or royalty that would be expected if the transaction had occurred between a U.S. firm
and an unrelated party.
SFAS No. 57, Related Party Disclosures (FASB 1982)15 requires disclosure of related-party
transactions (see paragraph 2ad) and balances in the notes to the financial statements of the group.
This means that intragroup transactions between such entities (i.e., between the parent and
subsidiaries), which by definition constitute a group, are disclosed. On consolidation, however,
such transactions are eliminated and would, therefore not be disclosed in the actual consolidated
financial statements.
A basic principle of Section 482 of the IRC is that in most cases, determining whether the
pricing of a transaction between affiliates meets the appropriate arms length standard involves
comparing the results of the transaction reported by a firm with the results realized by unrelated
firms engaged in comparable transactions under comparable circumstances. Thus, TPRICE captures
several major types of non-arms length transactions that require disclosure pursuant to SFAS No.
57 in a firms annual reports that are indicative of transfer pricing aggressiveness.
Based on IRS transfer pricing audit checklists (IRS 2012), eight types of transactions or
arrangements involving noncommercial related-party behavior were examined in firms annual
reports. These are listed as follows:16
(1) the existence of interest free loans between related entities;
(2) the existence of debt forgiveness between related entities;
(3) the existence of impaired loans between related entities;
(4) the provision of nonmonetary consideration (e.g., services or nonliquid assets) without
commercial justification between related entities;
(5) the absence of formal documentation held by a firm to support the selection and
application of the most appropriate arms length methodologies or the absence of formal
documentation relating to transfer pricing between related entities;
(6) the disposal of capital assets to related entities without commercial justification;
(7) the absence of arms length justification for transactions between related entities; and
(8) the transfer of losses between related entities without commercial justification.
The IRS and OECD refer to these eight items as key indicators of aggressive transfer pricing
activity (OECD 2012; IRS 2013a). For instance, the large-business guidelines for the IRS (2013b)
require auditors of the IRS to obtain evidence of interfirm agreements between a U.S. firm and its
offshore subsidiaries, especially in relation to non-arms length transactions, the transfer of
intangibles, and licensing agreements and corporate restructuring events designed to shift income to
offshore subsidiaries. The OECD (2012) also finds that interest free loans, reliance on related
parties domiciled in low-tax jurisdictions for key financing or insurance purposes for the group, and
uncertainties about valuing core intangible assets are potential signs of transfer pricing risks.
Intragroup transactions that are deemed to lack commercial justification include, for example,
those where there was a transfer of assets, loans advanced to or repaid by related parties, or the
provision of services between related parties, often in different tax jurisdictions, where at least one

15
Specifically, FAS No. 57 provides an example of a non-arms length arrangement in paragraph 13: Related-party
transactions may be controlled by one of the parties so that those transactions may be affected significantly by
considerations other than those in arms length transactions with unrelated parties. For example, the terms under
which a subsidiary leases equipment to another subsidiary of a common parent may be imposed by the common
parent and might vary significantly from one lease to another because of circumstances entirely unrelated to market
prices for similar leases (FASB 1982).
16
These eight items were extracted from the financial statement notes in the 10-K annual report; specifically, the
sections dealing with borrowings, receivables, payables, and related-party transactions.

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34 Taylor, Richardson, and Lanis

of the following elements is present: (1) no rationale for undertaking material transactions has been
disclosed, so there is an expectation that the underlying commercial reason for the transfer will be
provided; (2) there was no statement in the report describing that the terms of the transaction were
based on arms length pricing; and (3) there was no indication that expert advice was obtained in
relation to material transactions. The non-arms length nature of intragroup transactions is
considered to be a key factor indicative of transfer pricing risk (IRS 2012).
A description of each of the items that comprise TPRICE and examples of items coded as 1 are
provided in Appendix A. Evidence for the existence (or otherwise) of each item was obtained from
both narrative and accounting data in the notes to the financial statements17 and the corporate
governance section of the annual report.
The IRS (2012, 2013b) emphasizes the importance of compliance with the arms length principle
in determining transfer prices and the establishment of documentation to provide evidence that a
firms transactions comply with the arms length principle. In particular, the IRS stipulates that such
documentation assists the IRS and the U.S. Department of the Treasury in controlling intragroup
transactions and in minimizing the risks related to reviews or audits arising from transfer pricing
uncertainties. The IRS considers the eight aforementioned items to be high risk because they result in
the transfer of a firms benefits to related entities without commercial justification. The IRS (2013b)
requires firms to provide information about the existence and nature of noncommercial intragroup
arrangements, including the underlying strategy of those transactions as part of an overall package of
documentation required by firms willing to establish transfer pricing agreements with the IRS.
Pursuant to FIN48,18 firms are required to disclose the nature and source of transactions or
arrangements that gave rise to or are expected to give rise to UTPs. As transfer pricing compliance,
and adherence to the arms length principal in particular, is expected to lead to significant tax
uncertainties, disclosure of documentation in support of those tax positions is expected to be
included in the annual report. The propensity to disclose supportive transfer pricing documentation
has become more important following the implementation of the Schedule UTP (or Form 1120).19
The implementation of Schedule UTP from the 2010 tax year requires consistency in the reporting
of UTPs across financial statements and tax filings lodged with the IRS. The reason for this
requirement is that Schedule UTP requires a firm that discloses UTBs in its financial statements to
provide additional information in its tax return about the nature of each tax position (IRS 2013c).
To avoid a transfer pricing penalty under Section 482 of the IRC, a firm must have sufficient
documentation to establish that its selection and application of transfer pricing methods provide
evidence in support of an arms length result. Finally, firms are also required to disclose the nature
of tax uncertainties in the tax footnotes of 10-K annual reports under FIN48 and also to quantify
any UTB that is unlikely to be sustained following audit examination.20

17
In particular, the sections dealing with financial income and expensestrade and other receivables, investments in
controlled entities and associated entities, trade and other payables, interest bearing liabilities, related-party
transactions, asset disposals, and tax losseswere used to obtain evidence for each of the TPRICE items.
18
Accounting Standards Codification 740-10 (ASC 740-10), formerly referred to as Financial Accounting Standards
Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (hereafter, FIN48), specifies a
comprehensive model of how firms should determine and disclose in their financial statements UTPs that they have
taken or expect to take on their tax returns.
19
Schedule UTP became effective on December 15, 2010 for firms with assets equal to or exceeding $50 million. A
Schedule UTP must be lodged with a firms tax return from the 2010 tax year onward under Treasury Regulation
Section 1.6012-2(a)(4) and (5).
20
The IRS states that it uses information contained in the tax footnotes of annual reports, especially with regard to
disclosures under FIN48, as a roadmap to assess a firms tax compliance risks (Mills, Robinson, and Sansing 2010;
Ciconte 2013; IRS 2014). One of the key tax risks affecting FIN48 UTB estimates is transfer pricing (IRS 2012, 2014).
Firms are aware that the IRS uses their FIN48 disclosures and other relevant disclosures in their annual reports as a
source document to assist them with their risk reviews and forms the basis for the commencement of audits (IRS 2014).

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SFAS No. 5 (ASC 450), Contingencies (FASB 2010) may also apply if tax contingencies
develop that are dependent on, for instance, the IRS being satisfied with a firms arms length
methods, terms and pricing following a review of a firms documentation. The disclosure of
documentation on transfer pricing policies and procedures about the arms length basis of
intragroup transactions may also arise through loss contingencies relating to litigation. For instance,
litigation by the IRS or other taxing authorities may provide the incentive for a firm to participate in
a formal agreement with the IRS (e.g., Advanced Pricing Agreement or APA), which requires the
existence of formal documentation on transfer pricing methods (J. Schiff, A. Schiff, and Rozen
2012).
The eight transfer pricing aggressiveness items represented in the sample were scored as
either 1 if a firm engaged in activities indicative of transfer pricing aggressiveness and was unable
to substantiate the arms length or commercial basis of transactions, or 0 if there was no evidence
of activities suggestive of transfer pricing aggressiveness. To ensure objective and reliable
scoring of the eight transfer pricing aggressiveness items, a checklist and a set of decision rules
were initially developed by the main author (see Appendix B). The scoring was then performed
by one of the other authors and a research assistant within three months of the data collection. The
scoring was later crosschecked by the main author to determine the error rate in each individuals
scoring. The main author randomly selected a subsample of 30 firms (around 10 percent of the
sample firms) to achieve this task. Minor differences in the scoring of transfer pricing items were
detected during the crosschecking, but the total number of differences was found to be
insignificant and they were adjusted accordingly. Overall, the results of the crosschecking
indicate the reliability of the TPRICE index. Finally, our measure of transfer pricing
aggressiveness activity was computed as the sum of the individual number of transfer pricing
aggressiveness items disclosed in a firms annual report (each scored as 1), scaled by the number
of items applicable to that firm.21 This computation resulted in a TPRICE index ranging from 0
100 percent for each sample firm. In the majority of firms (92 percent), all eight items were
applicable. However, a minority (8 percent) of firms did not disclose the existence of intragroup
loans and hence ITEM1 (the existence of interest free loans) and ITEM2 (intragroup loan
impairment) of TPRICE were not considered applicable. TPRICE was then computed using six
applicable items in this instance.
Table 1 presents the descriptive statistics for the eight transfer pricing aggressiveness items that
comprise the TPRICE index. The most important items relate to ITEM5 and ITEM7. Specifically,
ITEM5 (mean of 0.939) indicates that about 93.9 percent of the sample firms did not disclose the
existence of formal documentation to support the selection and application of the most appropriate
arms length methodologies, or did not provide formal documentation relating to transfer pricing
between related entities. ITEM7 (mean of 0.932) shows that around 93.2 percent of the sample firms
failed to disclose information relating to the arms length justification of transactions between
related entities. The other items were ITEM1, concerning the existence of interest free loans
between related parties (mean of 0.017), ITEM2 about the existence of debt forgiveness between
related parties (mean of 0.052), ITEM3 regarding the existence of impaired loans between related
parties (mean of 0.035), ITEM4 concerning the provision of nonmonetary consideration (e.g.,
services or nonliquid assets) without commercial justification between related entities (mean of
0.046), ITEM6 regarding the disposal of capital assets to related entities without commercial

21
Each item was treated equally in the scoring of our TPRICE index. Past research has shown that weighted and
unweighted scores generally provide similar results (e.g., Marston and Shrives 1991). Moreover, the focus of our
study is not on one particular user group per se, so the weighting of transfer pricing items was not appropriate. Cook
(1989) for example, claimed that one class of user would attach different weights to an item than another class of user.
Finally, the development of weighted indices also involves subjective judgment (Marston and Shrives 1991).

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36 Taylor, Richardson, and Lanis

TABLE 1
Descriptive StatisticsTPRICE Index Items
Std.
Item Description Mean Dev. 25th Pctl. 75th Pctl.
ITEM1 The existence of interest free loans between related 0.017 0.131 0.000 0.000
entities.
ITEM2 The existence of debt forgiveness between related entities. 0.052 0.222 0.000 0.000
ITEM3 The existence of impaired loans between related entities. 0.035 0.185 0.000 0.000
ITEM4 The provision of nonmonetary consideration (e.g., 0.046 0.211 0.000 0.000
services or nonliquid assets) without commercial
justification between related entities.
ITEM5 The absence of formal documentation held by a firm to 0.939 0.240 1.000 1.000
support the selection and application of the most
appropriate arms length methodologies or the absence
of formal documentation relating to transfer pricing
between related entities.
ITEM6 The disposal of capital assets to related entities without 0.056 0.231 0.000 0.000
commercial justification.
ITEM7 The absence of arms length justification for transactions 0.932 0.252 1.000 1.000
between related entities.
ITEM8 The transfer of losses between related entities without 0.076 0.266 0.000 0.000
commercial justification.
n 2,002 for all variables.

justification (mean of 0.056), and ITEM8 about the transfer of losses between related entities
without commercial justification (mean of 0.076).
To assess the validity of our TPRICE index, we compare (correlate) that variable with
several measures of tax aggressiveness from the extant literature (e.g., Dyreng et al. 2008;
Manzon and Plesko 2002; S. Chen, X. Chen, Cheng, and Shevlin 2010; Lisowsky 2010;
McGuire, Omer, and Wang 2012; Lisowsky, Robinson, and Schmidt 2013), which are denoted
by ETRs, the book-tax gap, and UTBs. Specifically, we use two measures of ETRs (Dyreng et al.
2008): the accounting effective tax rate (ACCETR) and the cash effective tax rate (CASHETR).
ACCETR is computed as income tax expense (comprising both current and deferred tax expense)
scaled by pretax accounting income, and CASHETR is computed as cash tax paid scaled by
pretax accounting income (Dyreng et al. 2008). We also use a measure of the book-tax gap
(Manzon and Plesko 2002), the raw book-tax gap (BTAXGAP), which is calculated as pretax
accounting income less taxable income, scaled by total assets. Taxable income is computed as
income tax expense divided by the corporate statutory tax rate of 35 percent (Manzon and Plesko
2002). Finally, we use a measure of UTB (UTB), calculated as UTBs scaled by total assets
(Lisowsky 2010).
The Pearson correlation results for TPRICE and the general measures of tax aggressiveness are
reported in Table 2. The results show significant negative correlations between TPRICE and the
ETR measures (ACCETR and CASHETR) (p , 0.05 or lower) and significant positive correlations
between TPRICE and the book-tax gap and unrecognized tax benefit measures (BTAXGAP and
UTB) (p , 0.01), as expected. Overall, the significant correlations between TPRICE and the ETR,
book-tax gap and UTB measures suggest that our measure of transfer pricing aggressiveness is a
valid measure of tax aggressiveness.

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Multinationality, Tax Havens, Intangible Assets, and Transfer Pricing Aggressiveness 37

TABLE 2
Correlation Results
TPRICE Index and Tax Aggressiveness Measures
Variable TPRICE ACCETR CASHETR BTAXGAP UTB
TPRICE
ACCETR 0.053**
CASHETR 0.081*** 0.494***
BTAXGAP 0.113*** 0.131*** 0.092***
UTB 0.102*** 0.184*** 0.104*** 0.155***

*, **, *** Indicate significance at the 0.10, 0.05, 0.01 levels, respectively.
The p-values are based on two-tailed tests.
n 2,002 for all variables.

Variable Definitions:
TPRICE the transfer pricing aggressiveness index ranging of 01;
ACCETR income tax expense (comprising both current and deferred tax expense) scaled by pretax accounting income;
CASHETR cash tax paid scaled by pretax accounting income;
BTAXGAP pretax accounting income less taxable income, scaled by total assets (where taxable income is computed as
income tax expense divided by the corporate statutory tax rate of 35 percent); and
UTB UTBs scaled by total assets.

Independent Variables
Our independent variables are denoted by multinationality (MULTI), tax haven utilization
(THAV), and intangible assets (INTANG).
MULTI is measured as the total number of foreign incorporated subsidiaries scaled by the total
number of subsidiaries, following Rego (2003) and Mills and Newberry (2004). Information on the
country of incorporation is obtained from Exhibit 21 attached to 10-K annual reports. Exhibit 21 has
previously been used to obtain information on country of incorporation and a list of the significant
entities that comprise the corporate group (e.g., Harris et al. 1993; Rego 2003; Mills and Newberry
2004). MULTI is expected to have a positive sign. THAV is measured as a dummy variable that equals
1 if the firm has at least one subsidiary company incorporated in an OECD (2006) listed tax haven22
and, 0 otherwise, consistent with Desai et al. (2006) and Dharmapala and Hines (2009). We expect
THAV to have a positive sign. Finally, INTANG is measured as intangible assets scaled by total assets,
as used by Chen et al. (2010). INTANG is expected to have a positive sign.

Control Variables
Our control variables are represented by firm size (SIZE), profitability (PROFIT), leverage
(LEV), industry sector effects (INDSEC), and year effects (YEAR).
As large firms have both the resources and incentives to apply efficient tax planning across
group entities, it is likely that such firms with multiple foreign subsidiaries have the opportunity to

22
The OECD catalogues 33 tax havens: Anguilla, Antigua and Barbuda, Bahamas, Bahrain, Bermuda, Belize, British
Virgin Islands, Cayman Islands, Cook Islands, Cyprus, Dominica, Gibraltar, Grenada, Guernsey, Isle of Man, Jersey,
Liberia, Malta, Marshall Islands, Mauritius, Montserrat, Nauru, The Netherlands Antilles, New Caledonia, Panama,
Samoa, San Marino, Seychelles, St. Lucia, St. Kitts and Nevis, St. Vincent and the Grenadines, Turks and Caicos
Islands, and Vanuatu (OECD 2006).

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38 Taylor, Richardson, and Lanis

reduce corporate taxes by locating their operations in low-tax jurisdictions, by shifting income from
high-tax jurisdictions to low-tax jurisdictions and by exploiting variations in the tax rules of
different countries (Slemrod 2001; Rego 2003). Past research has found that large firms have more
opportunities to engage in transfer pricing manipulation due to differences in tax rates and
profitability between U.S. and foreign group entities (e.g., Benvignati 1985; Jacob 1996; Conover
and Nichols 2000). SIZE is measured as the natural logarithm of total assets, following Stickney and
McGee (1982). We expect SIZE to have a positive sign.
More profitable firms have greater incentives to engage in aggressive transfer pricing schemes
or arrangements to significantly avoid corporate taxes (Jacob 1996). For instance, Apple, Google,
and Microsoft have been able to favorably locate profits in low-tax jurisdictions and increase tax
deductible expenditure (e.g., royalty payments) in high-tax jurisdictions to significantly reduce their
taxable profits (Mutti and Grubert 2009; Womack and Drucker 2011; Duhigg and Kocieniewski
2012). PROFIT is measured as pretax income scaled by total assets, as per Gupta and Newberry
(1997). PROFIT is expected to have a positive sign.
Highly leveraged firms are likely to exploit the tax deductibility of interest payments and loan
fees to shift debt among variably taxed jurisdictions (Hines 1996; Newberry and Dhaliwal 2001;
Rego 2003). Additionally, thinly capitalized firms may seek to transfer debt or loans among group
subsidiaries through the recharacterization of those amounts, thereby avoiding the payment of
corporate taxes on transferred amounts.23 Finally, evidence from tax avoidance research suggests
that firms with high debt-to-equity ratios tend to be more tax aggressive than more highly
capitalized firms (e.g., Bernard, Jensen, and Schott 2006; Dyreng et al. 2008; Blouin, Huizinga,
Laeven, and Nicodeme 2013). LEV is measured as long-term debt scaled by total assets, as per
Gupta and Newberry (1997). We expect LEV to have a positive sign.
It is also possible for transfer pricing aggressiveness to fluctuate across different industry
sectors (Stewart 1977; Oyelere and Emmanuel 1998; Bernard et al. 2006). Hence, we include eight
industry sector (INDSEC) dummy variables as control variables based on two-digit General
Industry Classification Standard (GICS) codes: basic materials, consumer goods, consumer
services, healthcare, industrials, oil and gas, pharmaceuticals, and technologies.24 No predictions
are made for the signs of the INDSEC dummies.
Finally, year (YEAR) dummy variables are included as control variables to control for
differences in transfer pricing activities that could exist over the 20062012 sample period.25 No
predictions are made for the signs of the YEAR dummies.

Regression Procedure
Given that our dependent variable (TPRICE) is fractional and is bounded between zero and
one, we make use of the generalized linear model (GLM) framework of McCullagh and Nelder
(1989) in our study. More specifically, Papke and Wooldridge (1996) suggest that a GLM with a
binomial distribution and a logit link function (i.e., the logit transformation of the dependent
variable), which they term fractional logit regression (Papke and Wooldridge 2008; Wooldridge
2010), is appropriate for a fractional dependent variable that is bounded between zero and one (i.e.,
TPRICE). In fact, a fractional logit regression analysis provides more accurate estimates of
predicted values than can be obtained from an ordinary least squares (OLS) regression analysis in

23
For instance, since 2008, Hewlett Packard has used billions of dollars of intercompany offshore loans to effectively
repatriate untaxed foreign profits back to the U.S. (Levin 2012).
24
Basic materials is the omitted sector in our regression models.
25
2006 is the omitted year in our regression models.

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Multinationality, Tax Havens, Intangible Assets, and Transfer Pricing Aggressiveness 39

these circumstances (Papke and Wooldridge 1996). Therefore, we employ fractional logit
regression analysis in our study.26

Regression Models
To examine the association between multinationality, tax havens, intangible assets, and transfer
pricing aggressiveness, we estimate the following regression model:
TPRICEit a0it b1 MULTIit b2 THAVit b3 INTANGit b4 SIZEit b5 PROFITit
b6 LEVit b7-13 INDSECit b14-19 YEARit eit ; 1
where i firms 1286; t the 20062012 financial years; TPRICE the transfer pricing
aggressiveness index ranging from 0100 percent; MULTI the total number of foreign
incorporated subsidiaries scaled by the total number of subsidiaries; THAV a dummy variable that
equals 1 if the firm has at least one subsidiary company incorporated in an OECD (2006) listed tax
haven, and 0 otherwise; INTANG intangible assets scaled by total assets; SIZE the natural
logarithm of total assets; PROFIT pretax income scaled by total assets; LEV long-term debt
scaled by total assets; INDSEC an industry sector dummy variable that equals 1 if the firm is
represented in the specific GICS code category, and 0 otherwise; YEAR a year dummy variable
that equals 1 if the year falls within the specific year category, and 0 otherwise; and e the error
term.
Our extended regression model, incorporating the interaction effects of intangible assets,
multinationality and tax havens, is estimated as follows:
TPRICEit a0it b1 MULTIit b2 THAVit b3 INTANGit b4 INTANGMULTIit
b5 INTANGTHAVit b6 SIZEit b7 PROFITit b8 LEVit b9-15 INDSECit
b16-21 YEARit eit ;
2
where INTANG  MULTI an interaction term computed by multiplying INTANG by MULTI; and
INTANG  THAV an interaction term computed by multiplying INTANG by THAV.

V. EMPIRICAL RESULTS

Descriptive Statistics
Table 3 (Panel A) reports the descriptive statistics for our dependent variable (TPRICE),
independent variables (MULTI, THAV, and INTANG), and control variables (SIZE, PROFIT,
and LEV). Specifically, the dependent variable TPRICE shows that the sample firms have a
transfer pricing aggressiveness score of around 26.9 percent. Further, TPRICE has a range from
0 to 87.5 percent (i.e., seven out of the eight transfer pricing aggressiveness items are
exhibited).
Table 3 (Panel B) presents the descriptive statistics for the transfer pricing index by
industry (GICS) classification. While our sample includes a greater number of firm-years
represented in industries such as technology, industrials, and consumer goods, they are
relatively evenly distributed across all industries, indicating no significant industry bias. Finally,
the means for TPRICE are fairly evenly spread across industry classifications, with Oil and Gas

26
We also considered using Tobit regression analysis (e.g., Tobin 1958; Amemiya 1973) in our study. However, this is
not an appropriate strategy, as the observed data for TPRICE are not censored: values outside the 01 range are not
feasible for fractional data that contain zeros or ones (Baum 2008).

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40 Taylor, Richardson, and Lanis

TABLE 3
Descriptive Statistics

Panel A: Variable Summary


Variable Mean Std. Dev. Minimum Median Maximum
TPRICE 0.269 0.094 0 0.250 0.875
MULTI 0.633 0.264 0.000 0.710 0.952
THAV 0.782 0.413 0.000 1.000 1.000
INTANG 0.103 0.145 0.000 0.050 0.566
SIZE 22.159 1.658 18.350 21.961 27.405
PROFIT 0.081 0.167 0.345 0.082 0.321
LEV 0.521 0.202 0.000 0.517 1.003

Panel B: TPRICE by Industry Classification


Industry
(Two-Digit SIC Codes) n Mean Std. Dev. Minimum Median Maximum
Basic materials 190 0.280 0.010 0.000 0.250 0.875
Consumer goods 343 0.276 0.005 0.125 0.250 0.750
Consumer services 166 0.233 0.006 0.125 0.250 0.375
Healthcare 98 0.271 0.006 0.250 0.250 0.500
Industrials 413 0.269 0.004 0.000 0.250 0.500
Oil and gas 98 0.340 0.016 0.125 0.250 0.750
Pharmaceuticals 70 0.297 0.012 0.250 0.250 0.500
Technology 624 0.256 0.256 0.125 0.250 0.625

n 2,002 for all variables.

Variable Definitions:
TPRICE the transfer pricing aggressiveness index ranging of 01;
MULTI the total number of foreign incorporated subsidiaries scaled by the total number of subsidiaries;
THAV a dummy variable that equals 1 if the firm has at least one subsidiary company incorporated in an OECD (2006)
listed tax haven, and 0 otherwise;
INTANG intangible assets scaled by total assets;
SIZE the natural logarithm of total assets;
PROFIT pretax income scaled by total assets; and
LEV long-term debt scaled by total assets.

having the highest mean of 34.0 percent and consumer services having the lowest mean of 23.3
percent.

Correlation Results
The Pearson correlation results are reported in Table 4. We find significant correlations
between TPRICE and MULTI, THAV, INTANG, SIZE, PROFIT, and LEV (p , 0.05 or lower).
Table 4 also shows that collinearity between the explanatory variables is generally moderate. In
particular, the highest correlation coefficient is between LEV and SIZE (0.192; p , 0.01). Finally,
we compute the variance inflation factors (VIFs) when estimating our regression models to test for
signs of multicollinearity between the explanatory variables. Our (untabulated) results confirm that
the VIF does not exceed 5 for any of our explanatory variables, so multicollinearity is not a problem
(e.g., Kutner, Nachtsheim, and Neter 2004).

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Multinationality, Tax Havens, Intangible Assets, and Transfer Pricing Aggressiveness 41

TABLE 4
Correlation Results
Variable TPRICE MULTI THAV INTANG SIZE PROFIT LEV
TPRICE
MULTI 0.058**
THAV 0.075*** 0.175***
INTANG 0.153*** 0.016 0.014
SIZE 0.139*** 0.035 0.174*** 0.017
PROFIT 0.161*** 0.067*** 0.019 0.013 0.165***
LEV 0.144*** 0.125*** 0.061** 0.005 0.192*** 0.060**

*, **, *** Indicate significance at the 0.10, 0.05, 0.01 levels, respectively.
The p-values are one-tailed for directional hypotheses and two-tailed otherwise.
n 2,002 for all variables.

Variable Definitions:
TPRICE the transfer pricing aggressiveness index ranging of 01;
MULTI the total number of foreign incorporated subsidiaries scaled by the total number of subsidiaries;
THAV a dummy variable that equals 1 if the firm has at least one subsidiary company incorporated in an OECD (2006)
listed tax haven, and 0 otherwise;
INTANG intangible assets scaled by total assets;
SIZE the natural logarithm of total assets;
PROFIT pretax income scaled by total assets; and
LEV long-term debt scaled by total assets.

Regression Results
Table 5 presents our fractional logit regression results (coefficient estimates with t-statistics in
parentheses). Note that in all of the regression models, we compute fully robust sandwich standard
errors, as recommended by Papke and Wooldridge (2008) and Wooldridge (2010). The reported p-
values are one-tailed for directional hypotheses and two-tailed otherwise. Finally, the regression
coefficients for industry sectors and years are not reported for the sake of brevity.
Table 5 (FLOGIT1) presents the results of our base regression model, which shows that the
regression coefficient for MULTI is positively and significantly associated with transfer pricing
aggressiveness (p , 0.01). H1 is thus supported: the greater the proportion of foreign controlled
subsidiaries, the greater the level of transfer pricing aggressiveness. The regression coefficient for
THAV is positively and significantly associated with transfer pricing aggressiveness (p , 0.05),
which supports H2: OECD (2006) listed tax havens are used to shift profits aggressively. The
regression coefficient for INTANG is positively and significantly associated with transfer pricing
aggressiveness (p , 0.01); thus, H3 is supported: intangible assets are used to facilitate the
aggressive transfer of profits internationally. Finally, for the control variables, we observe that the
regression coefficients for SIZE, PROFIT, and LEV are positively and significantly associated with
transfer pricing aggressiveness (p , 0.10 or lower), as expected.
We also report the results of our extended regression model in Table 5 (FLOGIT2), which
includes the interaction effects of intangible assets, multinationality, and tax havens. The regression
coefficients for INTANG  MULTI and INTANG  THAV are both positively and significantly
associated with transfer pricing aggressiveness (p , 0.05), so H4a and H4b are supported by the
results. Our results thus provide empirical support for the claim that firms are able to magnify
transfer pricing aggressiveness by means of intragroup transfers of intangible assets among foreign
controlled firms (e.g., Jacob 1996; Conover and Nichols 2000; U.S. Department of the Treasury

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42 Taylor, Richardson, and Lanis

TABLE 5
Regression Results
FLOGIT1 FLOGIT2
Pred. Coeff. Coeff.
Variable Sign (t-stat.) (t-stat.)
Intercept ? 0.897*** 0.868***
(4.81) (4.47)
MULTI 0.151*** 0.119**
(3.52) (2.13)
THAV 0.050** 0.065**
(2.02) (2.22)
INTANG 0.138*** 0.127***
(2.32) (2.37)
INTANG  MULTI 0.302**
(2.21)
INTANG  THAV 0.139**
(1.99)
SIZE 0.010* 0.010*
(1.29) (1.37)
PROFIT 0.230*** 0.230***
(2.48) (2.46)
LEV 0.070* 0.071*
(1.32) (1.32)
INDSEC ? Yes Yes
YEAR ? Yes Yes
Log pseudo-likelihood 768.531 768.508
n 2,002 2,002

*, **, *** Indicate significance at the 0.10, 0.05, 0.01 levels, respectively.
The t-statistics are one-tailed for directional hypotheses and two-tailed otherwise.

Variable Definitions:
MULTI the total number of foreign incorporated subsidiaries scaled by the total number of subsidiaries;
THAV a dummy variable that equals 1 if the firm has at least one subsidiary company incorporated in an OECD (2006)
listed tax haven, and 0 otherwise;
INTANG intangible assets scaled by total assets;
INTANG  MULTI an interaction term computed by multiplying INTANG by MULTI;
INTANG  THAV an interaction term computed by multiplying INTANG by THAV;
SIZE the natural logarithm of total assets;
PROFIT pretax income scaled by total assets;
LEV long-term debt scaled by total assets;
INDSEC an industry sector dummy variable that equals 1 if the firm is represented in the specific GICS code, and 0
otherwise; and
YEAR a year dummy variable that equals 1 if the year falls within the specific year category; and 0 otherwise.

2007). In fact, ownership and responsibility for intangible assets may be centralized in foreign
jurisdictions with lower corporate tax rates. The preferential location of intangible assets in higher-
tax jurisdictions could lead to a reduction in the U.S. corporate tax liabilities of these firms. This
may be reflected in the increased flow of intangible assets between variably taxed jurisdictions,
resulting in opportunities to engage in aggressive transfer pricing manipulation. The regression
coefficients for our other independent variables, MULTI, THAV, and INTANG, are also positively
and significantly associated with TPRICE (p , 0.05 or lower). Finally, for our control variables, the

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Multinationality, Tax Havens, Intangible Assets, and Transfer Pricing Aggressiveness 43

regression coefficients for SIZE, PROFIT, and LEV are positively and significantly associated with
transfer pricing aggressiveness (p , 0.10 or lower), as expected.27

VI. SENSITIVITY ANALYSES

Modified TPRICE Index


As previously mentioned, our transfer pricing index (TPRICE) comprises eight dichotomous
items, and Table 1 shows that the most important items relate to ITEM5 (mean of 0.939) and ITEM7
(mean of 0.932). Hence, a potential limitation of our research design is that these particular transfer
pricing aggressiveness items in the TPRICE index could be driving our empirical results. Therefore,
as a robustness check on our main regression results reported in Table 5, we developed a modified
TPRICE index (TPRICEMOD), which excludes both ITEM5 and ITEM7. We then recomputed our
regression models using TPRICEMOD as the dependent variable. The regression results are
presented in Table 6.
Table 6 (FLOGIT1) shows that the regression coefficients for MULTI, THAV, and INTANG are
positively and significantly associated with transfer pricing aggressiveness (p , 0.05 or lower),
which confirms the main regression results reported in Table 5. Further, Table 6 (FLOGIT2)
indicates that the regression coefficients for INTANG  MULTI and INTANG  THAV are positively
and significantly associated with transfer pricing aggressiveness (p , 0.01), which also validates
the main regression results reported in Table 5.

Matched Propensity Scores


Another potential limitation of our research design is that multinationality (MULTI), tax haven
utilization (THAV), intangible assets (INTANG), and leverage (LEV) may suffer from self-selection
bias (see, e.g., Egger, Eggert, and Winner 2010; Lennox, Lisowsky, and Pittman 2013; Finke
2014). In other words, a firms management may, based on the firms level of tax planning and
strategies and its operational or capital management requirements, select a certain level of
multinational exposure, tax havens, intangible assets, and corporate debt, which may not be
systematically associated with our transfer pricing aggressiveness measure (TPRICE).
As a robustness check on our main regression results reported in Table 5, we implement a
propensity matching analysis28 in two steps (e.g., Rosenbaum and Rubin 1983; Armstrong, Blouin,
and Larcker 2012; Lennox et al. 2013). First, we run separate OLS regressions for MULTI,
INTANG, and LEV, and a logistic regression for THAV, for each year. The explanatory variables
used in each model include SIZE, PROFIT, and INDSEC. MULTI, THAV, INTANG, and LEV are
also included as independent variables, contingent upon the specific dependent variable used. The
predicted estimates from each model are used as the propensity scores for each firm-year
observation. Second, we form one-to-one matched pairs for MULTI, THAV, INTANG, and LEV,
respectively, based on the propensity scores. In the majority of cases, the propensity scores are
matched to two decimal places in the analysis.
Consistent with the econometric procedure used by Lennox et al. (2013), we include all of the
economic variables in our regression models. Although little theoretical work has modeled the
determinants of THAV, there is some extant evidence suggesting which variables are likely to
influence the incorporation of subsidiaries in tax haven countries. For example, larger, more

27
We also conduct an OLS regression analysis to check the robustness of our main regression results (see Table 5). The
(untabulated) results are similar to those reported in Table 5.
28
One of the key advantages of using the matched propensity scoring approach is that we avoid subjectivity in the
selection of instrumental variables and the poor quality of such variables (Larcker and Rusticus 2010).

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44 Taylor, Richardson, and Lanis

TABLE 6
Regression Results
Modified TPRICE Index
FLOGIT1 FLOGIT2
Pred. Coeff. Coeff.
Variable Sign (t-stat.) (t-stat.)
Intercept ? 0.975*** 0.766***
(4.24) (4.00)
MULTI 0.159*** 0.176**
(3.80) (1.99)
THAV 0.027** 0.057***
(2.01) (3.03)
INTANG 0.152** 0.149**
(2.13) (2.23)
INTANG  MULTI 0.447***
(2.45)
INTANG  THAV 0.301***
(2.42)
SIZE 0.014* 0.036*
(1.35) (1.44)
PROFIT 0.159*** 0.160***
(3.75) (3.76)
LEV 0.032 0.033
(1.07) (1.05)
INDSEC ? Yes Yes
YEAR ? Yes Yes
Log pseudo-likelihood 687.521 686.430
n 2,002 2,002

*, **, *** Indicate significance at the 0.10, 0.05, 0.01 levels, respectively.
The t-statistics are one-tailed for directional hypotheses and two-tailed otherwise.

Variable Definitions:
MULTI the total number of foreign incorporated subsidiaries scaled by the total number of subsidiaries;
THAV a dummy variable that equals 1 if the firm has at least one subsidiary company incorporated in an OECD (2006)
listed tax haven, and 0 otherwise;
INTANG intangible assets scaled by total assets;
INTANG  MULTI an interaction term computed by multiplying INTANG by MULTI;
INTANG  THAV an interaction term computed by multiplying INTANG by THAV;
SIZE the natural logarithm of total assets;
PROFIT pretax income scaled by total assets;
LEV long-term debt scaled by total assets;
INDSEC an industry sector dummy variable that equals 1 if the firm is represented in the specific GICS code, and 0
otherwise; and
YEAR a year dummy variable that equals 1 if the year falls within the specific year category, and 0 otherwise.

profitable firms are likely to incorporate subsidiaries in tax havens due to complex multinational
financial and tax planning arrangements that may have financing or tax aggressiveness purposes.
The incorporation of tax havens may then affect the opportunities and capacity of firms to engage in
transfer pricing aggressiveness because tax haven countries are subject to nil or very low rates of
corporate taxes. Similarly, multinationality may be endogenously determined (Blonigen and Piger

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Multinationality, Tax Havens, Intangible Assets, and Transfer Pricing Aggressiveness 45

2011; Finke 2014),29 which could affect the level of transfer pricing aggressiveness through the
incorporation of multiple subsidiaries across variably taxed jurisdictions. Moreover, the derivation
of foreign-sourced profits, debt, or goods could then be transferred among group subsidiaries in tax-
effective ways (Grubert and Mutti 1991; Rego 2003; Egger et al. 2010). In fact, Egger et al. (2010)
asserted that foreign ownership of firms in Europe is endogenous and applied propensity matched
scoring to determine the differences in tax savings through profit shifting between foreign-owned
and domestic firms.30 Finke (2014) also found that the level of intangible assets is endogenous
because it may depend on factors that could also influence the level of transfer pricing
aggressiveness. For instance, firms may self-select a certain level of intangible assets based on the
industry and tax concessions applied to the research and development of intangibles, size, and
profitability. In terms of the capital structure decisions made by firms, Taylor and Richardson
(2013) found that firm size, tax haven utilization, and multinationality are significantly positively
associated with firms adopting thinly capitalized (i.e., high debt relative to asset) structures.
We establish four sets of matched pairs of firm years. Although their observable characteristics
are similar, their levels of MULTI, THAV, INTANG, and LEV are dissimilar. We are able to
effectively match 1,382; 674; 1,380; and 1,221 firm-year observations for MULTI, THAV, INTANG,
and LEV,31 respectively. After matching these variables, any difference in the outcome of interest
(i.e., TPRICE) should be attributable to the differences in MULTI, THAV, INTANG, and LEV rather
than to the differences in the other variables. We perform separate (untabulated) t-tests of the
differences in TPRICE on each of the matched samples of MULTI, THAV, INTANG, and LEV,
respectively. We find significant differences in TPRICE overall in terms of the matched samples of
MULTI, THAV, INTANG, and LEV (p , 0.10 or lower).
We report the regression results based on the matched samples in Table 7. Consistent with the
results provided in Table 5, statistically significant regression coefficients are found for MULTI,
THAV, INTANG, INTANG  MULTI, INTANG  THAV, and TPRICE for the subsamples based on
matched MULTI, THAV, INTANG, and LEV (p , 0.10 or lower). Overall, the matching analysis
shows that our regression results are attributable to systematic differences in MULTI, THAV,
INTANG, and LEV rather than to differences in the other characteristics.32

Alternative Independent Variable Measures


We also perform a robustness check based on several alternative measures of multinationality,
tax haven utilization, and intangible assets. Specifically, MULTI is measured as foreign pretax profit
scaled by total pretax profit, THAV is measured as the natural logarithm of the total number of tax
havens, and INTANG is measured as R&D expenditure33 scaled by total assets (e.g., Stickney and
McGee 1982; Jacob 1996; Gupta and Newberry 1997; Rego 2003). We report the regression results
based on the alternative independent variable measures in Table 8.

29
For instance, firms may self-select a certain level of multinationality based on tax planning and tax strategies
developed by the management to reduce the amount of corporate taxes payable, to attain economies of scale of
operations, for cost, labor, cultural, political, stability, or competitive reasons or for regulatory or investment purposes
(Blonigen and Piger 2011). The level of multinationality may also be closely connected to the level of intangible
assets (Finke 2014).
30
Egger et al. (2010) found that foreign-owned subsidiaries located in high-tax (low-tax) countries pay significantly less
(more) corporate taxes than domestically owned firms pay.
31
Specifically, LEV is divided into two groups (i.e., high and low), separated by the median value of LEV.
32
As an additional robustness check to address endogeneity concerns in our study, we use the lagged values of the
explanatory variables (MULTI, THAV, INTANG, SIZE, PROFIT, and LEV) and rerun our regression models. The
(untabulated) results are comparable in terms of coefficients and significance level to those presented in Table 5.
33
R&D expenditure is considered to be a better proxy measure of intellectual capital (Gravelle 2013).

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46
TABLE 7
Regression Results
Matched Propensity Scores
Matched SampleMULTI Matched SampleTHAV Matched SampleINTANG Matched SampleLEV
FLOGIT1 FLOGIT2 FLOGIT1 FLOGIT2 FLOGIT1 FLOGIT2 FLOGIT1 FLOGIT2
Pred. Coeff. Coeff. Coeff. Coeff. Coeff. Coeff. Coeff. Coeff.
Variable Sign (t-stat.) (t-stat.) (t-stat.) (t-stat.) (t-stat.) (t-stat.) (t-stat.) (t-stat.)
Intercept ? 0.726*** 0.719*** 0.725*** 0.681** 0.574*** 0.513*** 0.998*** 0.957***
(3.64) (3.60) (2.84) (2.42) (2.92) (2.56) (4.50) (4.02)
MULTI 0.135*** 0.128*** 0.148** 0.117** 0.109** 0.104** 0.203*** 0.176***
(3.14) (2.41) (2.31) (1.98) (2.28) (1.90) (3.71) (2.38)
THAV 0.013* 0.010* 0.033** 0.044* 0.036* 0.035* 0.029** 0.032**
(1.38) (1.33) (1.99) (1.40) (1.32) (1.33) (1.92) (1.80)
INTANG 0.181*** 0.177*** 0.164** 0.150** 0.121** 0.175** 0.236*** 0.277***
(2.48) (2.53) (1.86) (1.85) (1.71) (2.12) (3.20) (2.65)
INTANG  MULTI 0.077** 0.260* 0.159** 0.264**
(2.29) (1.61) (1.91) (1.82)
INTANG  THAV 0.047** 0.102 0.120** 0.195**
(2.16) (0.53) (2.12) (2.12)
SIZE 0.001 0.009 0.022** 0.023** 0.019** 0.020*** 0.002 0.001
(0.95) (0.97) (1.85) (1.88) (2.25) (2.35) (0.85) (0.11)
PROFIT 0.286** 0.287** 0.122 0.120 0.032 0.032 0.324*** 0.323***
(2.09) (2.10) (0.91) (0.90) (0.38) (0.38) (3.00) (2.98)
LEV 0.018 0.019 0.025 0.025 0.036 0.038 0.016 0.015
(0.29) (0.30) (0.35) (0.36) (0.63) (0.65) (0.24) (0.21)
INDSEC ? Yes Yes Yes Yes Yes Yes Yes Yes
YEAR ? Yes Yes Yes Yes Yes Yes Yes Yes
Log pseudo-likelihood 654.222 654.219 366.246 366.236 549.224 549.184 589.519 589.510
n 1,382 1,382 674 674 1,380 1,380 1,221 1,221

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Taylor, Richardson, and Lanis

(continued on next page)


TABLE 7 (continued)

*, **, *** Indicate significance at the 0.10, 0.05, 0.01 levels, respectively.

Variable Definitions:
MULTI the total number of foreign incorporated subsidiaries scaled by the total number of subsidiaries;
THAV a dummy variable that equals 1 if the firm has at least one subsidiary company incorporated in an OECD (2006) listed tax haven, and 0 otherwise;
INTANG intangible assets scaled by total assets;
INTANG  MULTI an interaction term computed by multiplying INTANG by MULTI;

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INTANG  THAV an interaction term computed by multiplying INTANG by THAV;
SIZE the natural logarithm of total assets;
PROFIT pretax income scaled by total assets;
LEV long-term debt scaled by total assets;
INDSEC an industry sector dummy variable that equals 1 if the firm is represented in the specific GICS code, and 0 otherwise; and
YEAR a year dummy variable that equals 1 if the year falls within the specific year category, and 0 otherwise.

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47
48 Taylor, Richardson, and Lanis

TABLE 8
Regression Results
Alternative Independent Variable Measures
FLOGIT1 FLOGIT2
Pred. Coeff. Coeff.
Variable Sign (t-stat.) (t-stat.)
Intercept ? 0.344*** 0.435***
(2.67) (2.60)
MULTI 0.042*** 0.057**
(2.43) (2.06)
THAV 0.024*** 0.032***
(4.59) (5.35)
INTANG 0.082*** 0.063***
(4.84) (3.24)
INTANG  MULTI 0.341**
(1.70)
INTANG  THAV 0.475***
(3.31)
SIZE 0.030*** 0.027***
(3.92) (3.45)
PROFIT 0.166** 0.172**
(1.80) (1.86)
LEV 0.098** 0.119**
(1.99) (2.04)
INDSEC ? Yes Yes
YEAR ? Yes Yes
Log pseudo-likelihood 771.858 771.618
n 2,002 2,002

*, **, *** Indicate significance at the 0.10, 0.05, 0.01 levels, respectively.
The t-statistics are one-tailed for directional hypotheses and two-tailed otherwise.

Variable Definitions:
MULTI foreign pretax profit scaled by total pretax profit;
THAV the natural logarithm of the total number of tax havens;
INTANG R&D expenditure scaled by total assets;
INTANG  MULTI an interaction term computed by multiplying INTANG by MULTI;
INTANG  THAV an interaction term computed by multiplying INTANG by THAV;
SIZE the natural logarithm of total assets;
PROFIT pretax income scaled by total assets;
LEV long-term debt scaled by total assets;
INDSEC an industry sector dummy variable that equals 1 if the firm is represented in the specific GICS code, and 0
otherwise; and
YEAR a year dummy variable that equals 1 if the year falls within the specific year category, and 0 otherwise.

Table 8 (FLOGIT1) presents the results of our base regression model, which shows that the
regression coefficient for MULTI is positively and significantly associated with transfer pricing
aggressiveness (p , 0.01), providing additional support for H1. Thus, the higher the ratio of foreign
pretax profit to total pretax profit, the greater the level of transfer pricing aggressiveness. Firms with
proportionately more pretax foreign-sourced profit have greater incentives to seek long-term ways
in which to avoid group taxes payable through sustained transfer pricing aggressiveness. The

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Multinationality, Tax Havens, Intangible Assets, and Transfer Pricing Aggressiveness 49

regression coefficient for THAV is positively and significantly associated with transfer pricing
aggressiveness (p , 0.01), which again supports H2. Firms that exhibit greater tax haven intensity
(i.e., groups with proportionately more tax haven incorporated subsidiaries) use their network of tax
havens to facilitate income shifting through aggressive transfer pricing. The regression coefficient
for INTANG is positively and significantly associated with transfer pricing aggressiveness (p ,
0.01), thus H3 is once more supported by the results. This finding shows that R&D expenditure
(e.g., expenditure relating to intellectual property) is used to facilitate aggressive transfer pricing
activities.
Our extended regression model results reported in Table 8 (FLOGIT2) indicate that the
regression coefficients for INTANG  MULTI and INTANG  THAV are both positively and
significantly associated with transfer pricing aggressiveness (p , 0.05 or lower), providing
additional support for H4a and H4b, respectively. Thus, firms are able to magnify transfer pricing
aggressiveness through intragroup transfers of intangible assets among foreign-controlled firms
(e.g., Jacob 1996; Conover and Nichols 2000; U.S. Department of the Treasury 2007). The
regression coefficients for our other independent variables, MULTI, THAV, and INTANG are also
positively and significantly associated with TPRICE (p , 0.05 or lower).
Overall, our sensitivity analyses shows that our main regression results presented in Table 5 are
robust to a modified TPRICE index, self-selection bias (i.e., matched propensity scores), and
alternative independent variable measures.

VII. CONCLUSION
We examine the influence of multinationality, tax havens, and intangible assets on transfer
pricing aggressiveness and the joint effects of intangible assets, multinationality, and tax havens on
transfer pricing aggressiveness of U.S. firms. We find that multinationality, tax haven utilization,
and intangible assets are significantly positively associated with transfer pricing aggressiveness. We
also observe that firms magnify their transfer pricing aggressiveness through the joint effects of
intangible assets, multinationality, and tax havens.
Our study is subject to several limitations. First, our sample is drawn from publicly listed U.S.
firms because data are not available for private U.S. firms. Second, the components of our transfer
pricing aggressiveness index are derived from aggregated financial data at the group level. We do
not have access to details about the key transactions between group members incorporated in tax
havens and other group members, so we are unable to obtain a complete picture of the extent and
nature of transfer pricing aggressiveness. Although it is a requirement to disclose material related-
party transactions according to FAS No. 57, Related Party Disclosures (FASB 1982), it is possible
that some firms may not have disclosed complete details of their related-party transactions for
materiality reasons, or because the transactions do not comply with debt covenant arrangements, or
may impede a firm from raising further capital. However, as we are dealing with the top publicly
listed U.S. multinational firms, we are confident that materiality is unlikely to be a major issue in
our study.
Future research on transfer pricing aggressiveness could consider several issues. First, it could
examine the change in transfer pricing aggressiveness before and after the significant changes to the
U.S. transfer pricing tax legislation to determine whether firms are increasing their governance
around transfer pricing tax risks or are developing transfer pricing agreements with tax authorities.
Second, the nature of the transfer pricing arms length standard, pursuant to Section 482 of the IRC
and supporting U.S. Department of the Treasury regulations, and the variability in country-specific
transfer pricing rules, presents major challenges to the application of FIN48 (U.S. Department of
the Treasury 2007). Because of the inherent difficulty in ensuring that transactions are carried out
on an arms length basis, a firms management faces uncertainty in determining whether a firms tax

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50 Taylor, Richardson, and Lanis

position could be sustained following examination by the IRS. Thus, future research could address
the uncertainty over the application of transfer pricing legislation and the choice of transfer pricing
methods and economic inputs on the tax position of firms, pursuant to FIN48. Further, our measure
of transfer pricing aggressiveness (TPRICE) could be used as both a dependent variable (as in this
study) or as an independent variable in future studies. For instance, the association between FIN48
UTB estimates and our measure of TPRICE could be examined to ascertain the degree to which one
key area of tax risk (i.e., transfer pricing) gives rise to UTPs for a firm. Finally, future research
could also examine transfer pricing aggressiveness in other countries around the world, especially
in developing countries.

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APPENDIX A
Extracts from 10-K Annual Reports That Illustrate the Coding of the Eight TPRICE
Index Items
(1) The existence of interest free loans between related entities:
 Duke Energy also provides funding to and sweeps cash from subsidiaries that do not
participate in the money pool. For these subsidiaries, the cash is used in or generated from
their operations, capital expenditures, debt payments, and other activities. Amounts
funded or received are carried as open accounts, as either Investment in consolidated
subsidiaries or as Other deferred credits and other liabilities, and do not bear interest
(Duke Energy 2012 10-K Annual Report). This narrative results in a score of 1.
 Loans advanced to joint ventures AuruMarch (Pty) Limited. The loan is interest free
and has no fixed terms of repayment. Thani Ashanti Alliance Limited: The loan was
fully impaired during 2012. (Anglogold Ashanti Ltd. 2012 10-K Annual Report). This
narrative results in a score of 1.
 Intragroup balances are interest free and are payable on demand (Anglogold Ashanti
Ltd. 2012 10-K Annual Report). This narrative results in a score of 1.
(2) The existence of debt forgiveness between related entities:
 During the years ended December 31, 2012 and 2011, Duke Energy paid advances of
$16 million and $15 million, respectively, to Cinergy Corp. for Green Frontier
Windpower LLC PTC funding contributions. During the year ended December 31,
2010, Duke Energy forgave a $29 million advance to Cinergy Corp (Duke Energy
2012 10-K Annual Report). This narrative results in a score of 1.
 In June 2010, we acquired our partners 65 percent interest in JFP and entered into a
long-term supply agreement. In connection with the acquisition, we recorded equity
earnings of $24.1 million, which was composed of equity earnings, gains on the

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forgiveness of debt and guarantees, and a gain realized on the fair value of Balls equity
investment as a result of the required purchase accounting (Ball Corporation 2012 10-
K Annual Report). This narrative results in a score of 1.
(3) The existence of impaired loans between related entities:
 Note payable, affiliates. On August 5, 2011, Coal Holdco made a loan to DH of $10
million with a maturity of three years and an interest rate of 9.25 percent per annum.
The Note payable, affiliate was written off during the first quarter 2012 as it was
determined that no claim would be filed related to the note. (Dynegy Inc. 2012 10-K
Annual Report). This narrative results in a score of 1.
(4) The provision of nonmonetary consideration (e.g., services or nonliquid assets) without
commercial justification between related entities:
 In February 2008, the Company filed with the CRA and the IRS an application for a
Canada-U.S. bilateral advanced pricing agreement (BAPA) with respect to certain
intercompany transactions (Covered Transactions) between Interface, Inc. (including
its U.S. subsidiaries) and its Canadian subsidiary, InterfaceFLOR Canada, Inc. The
BAPA covers tax years 2006 through 2011. The Covered Transactions include
intercompany buy-sale distribution, contract manufacturing, provision of management
services, and licensing intangibles. Some of the Covered Transactions are the same
types of transactions that were the subject of dispute in the reassessment for tax years
2001 and 2002 described above (Interface Inc. 2012 10-K Annual Report). This
narrative results in a score of 1.
(5) The absence of formal documentation held by the firm to support the selection and
application of the most appropriate arms length methodologies or the absence of formal
documentation relating to transfer pricing between related entities:
 Since we conduct operations worldwide through our foreign subsidiaries, we are
subject to complex transfer pricing regulations in the countries in which we operate.
Transfer pricing regulations generally require that, for tax purposes, transactions
between our foreign affiliates and us be priced on a basis that would be comparable to
an arms length transaction and that contemporaneous documentation be maintained to
support the tax allocation. Although uniform transfer pricing standards are emerging in
many of the countries in which we operate, there is still a relatively high degree of
uncertainty and inherent subjectivity in complying with these rules. To the extent that
any foreign tax authorities disagree with our transfer pricing policies, we could become
subject to significant tax liabilities and penalties. Our tax returns are subject to review
by taxing authorities in the jurisdictions in which we operate. Although we believe that
we have provided for all tax exposures, the ultimate outcome of a tax review could
differ materially from our provisions (Checkpoint System 2012 10-K Annual Report).
This narrative results in a score of 1 as they have not provided details of their arms
length methodologies in their annual report, even though they have discussed the
general requirements for documentation.
(6) The disposal of capital assets to related entities without commercial justification:
 In October 2011, the IRS issued its audit report for fiscal years 2007 and 2008. We
reached agreement with the IRS on some but not all matters related to these fiscal years.
The significant issues that remain unresolved relate to the allocation of income between
Medtronic, Inc. and its wholly owned subsidiary operating in Puerto Rico, and
proposed adjustments associated with the tax effects of our acquisition of Kyphon Inc.
(Kyphon). Associated with the Kyphon acquisition, we entered into an intercompany
transaction whereby the Kyphon U.S. tangible assets were sold to another wholly
owned Medtronic subsidiary in a taxable transaction. The IRS has disagreed with our

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valuation of these assets and proposed that all U.S. goodwill, the value of the ongoing
business, and the value of the workforce in place related to the Kyphon acquisition be
included in the tangible asset sale. We disagree that these items were sold, as well as
with the IRS valuation of these items. The IRS continues to evaluate the overall
transaction that Medtronic entered into and because a foreign subsidiary acquired part
of Kyphon directly from the Kyphon shareholders, the IRS has argued that a deemed
taxable event occurred (Medtronic Inc. 2012 10-K Annual Report). In this example,
the IRS has audited and queried the value of capital assets transferred between group
subsidiaries and is scored as 1.
(7) The absence of arms length justification for transactions between related entities:
 Should the cash flow from operations be insufficient, it could breach its financial and
other covenants and may be required to refinance all or part of its existing debt, utilize
existing cash balances, issue additional equity, or sell assets. AngloGold Ashanti cannot
be sure that it will be able to do so on commercially reasonable terms, if at all
(Anglogold Ashanti Ltd. 200610-K Annual Report). This narrative results in a score of 1.
 Because of the location of and limited local demand for natural gas in Equatorial
Guinea, we consider the prices under the contracts with Alba Plant LLC, AMPCO, and
EGHoldings to be comparable to the price that could be realized from transactions with
unrelated parties in this market under the same or similar circumstances (Marathon Oil
2012 10-K Annual Report). This narrative results in a score of 0.
 The Companys related parties include its subsidiaries, associates over which it
exercises significant influence, its joint ventures, and key management personnel.
Transactions with related parties for goods and services are made on normal commercial
terms and are considered to be at arms length (Gold Corporation Inc. 2012 10-K
Annual Report). This narrative results in a score of 0.
(8) The transfer of losses between related entities without commercial justification:
 On July 20, 2007, we, and our consolidated subsidiaries, received a notice from the
IRS containing proposed adjustments to our consolidated subsidiaries tax filings in
connection with an audit of the 2001 and 2002 tax years. The IRS did not contest the
validity of our reincorporation in Bermuda. The most significant adjustments proposed
by the IRS involve treating the entire intercompany debt incurred in connection with our
reincorporation in Bermuda as equity. As a result of this recharacterization, the IRS has
disallowed the deduction of interest paid on the debt and imposed dividend withholding
taxes on the payments denominated as interest. Proposed adjustments on this issue, if
upheld in their entirety, would result in additional taxes with respect to the 2002 tax
year of approximately $190 million, plus interest, and would require us to record
additional charges associated with this matter (Ingersoll-Rand Company Limited
200810-K Annual Report). This narrative results in a score of 1.

APPENDIX B
Checklist and Decision Rules for Scoring the Eight TPRICE Index Items
 Review the sections within the 10-K annual report for details of each of the eight TPRICE
index items: (1) financial income and expenses note, (2) trade and other receivables note, (3)
investments in controlled entities and associated entities notes, (4) trade and other payables
note, (5) interest bearing liabilities note, (6) related-party transactions, (7) asset disposal, and
(8) tax losses.
 For TPRICE ITEM1, loans provided from the parent to subsidiaries or vice versa that are
interest free are scored as 1; otherwise 0.

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 For TPRICE ITEM2, a loan provided to a group member without any requirement to pay
back the loan or evidence of forgiveness of an intragroup loan without commercial
justification is scored as 1; otherwise 0.
 For TPRICE ITEM3, the write-down or impairment of loans advanced to group members
without commercial justification is scored as 1; otherwise 0.
 For TPRICE ITEM4, if there is no statement that services or nonmonetary assets provided to
group affiliates is on commercial or arms length terms, then the transaction is scored as 1;
otherwise 0.
 For TPRICE ITEM5, if a formal transfer pricing policy or methodology is described, then
review related-party transaction notes to see if a particular transfer pricing method is
described. Nonexistence of a formal policy regarding related-party or intracompany transfers
of assets, services, and funds is scored as 1; otherwise 0. Some firms describe the existence
of a formal transfer pricing arrangement established with the IRS, so this is scored as 0.
 For TPRICE ITEM6, if assets are transferred between group affiliates with no description that
the transaction was undertaken on normal commercial terms, this is scored as 1; otherwise 0.
 For TPRICE ITEM7, if related-party transactions are not described as being on normal
commercial terms, this is scored as 1; otherwise 0.
 For TPRICE ITEM8, if there have been tax losses transferred between group affiliates, this is
scored as 1; otherwise 0.
 Evidence to support a score of 1 can be obtained from both narrative and/or accounting data.
For example, a single line item Interest free loans in the financial statements could be used
as evidence to support scoring TPRICE ITEM2.
 If an item is deemed not applicable (e.g., no material intragroup loans), then reduce the
number of items comprising TPRICE in view of that.

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