Minimizing risk of transfer pricing audit and awakening the giant of corporate stewardship: an ethical decision making model for multinational enterprise transfer pricing

Journal of Legal, Ethical and Regulatory Issues, July, 2007 by Connie R. Bateman

ABSTRACT

This manuscript presents an ethical decision making model (EDMM) for transfer pricing (TP). The EDMM has been theoretically and empirically supported in the strategic management, marketing, and ethics literatures, but never applied in a TP context. The model is embedded into the realities and risks presented in TP literature to reveal shortcomings in the ethical reasoning styles of multinational enterprise (MNE) managers. One shortcoming reveals that TP programs have been managed with an overly dominant focus on cost/benefit-based reasoning (teleological), which seeks to minimize effective global tax rates and/or to avoid or effectively manage the risk of tax audits. Another shortcoming reveals that only partial consideration has been made of rule-based reasoning (deontological), which should not only attend to TP laws and regulation but to foundational values, moral laws and corporate responsibilities. These shortcomings have, in part, left low tax countries in a compromised position, voicing strong concerns over the socio-economic impacts that MNE activities are having on their country and culture, officially labeling the strategic use of TP as a 'restrictive business practice' (RBP), and calling for higher levels of corporate stewardship. The EDMM is thus brought into the TP arena and positioned as a tool for MNE managers to use when determining an appropriate and ethical TP.

INTRODUCTION

"The social and ecological effects of intra-firm trade need serious examination. Driven by economic growth and profit maximization, the TP practices of TNCs (transnational corporations) can impede sustainable development by depleting natural resources in host countries, with or without the consent of local politicians. It may be argued that this is just a sub-problem of secondary importance in wider international "green issues". To the contrary, the TP-FDI (foreign direct investment) interlinkage has produced a problem of prime importance that the coveted arm's length principle can totally eclipse. For many TNCs, natural resources are a key FDI determinant. An FDI company may strip a forest bare, or chemically pollute a main river and displace an entire community, yet pay little tax income to the host government through TP false accounting ... The moral responsibility rests with all the parties ..." (Mehafdi, 2000).

Indeed, TP-related business activities have left low tax countries with a mixed blessing; tax and employment-related gains set against a growing backdrop of economic, social, and political losses which have significantly and negatively impacted persons, publics, cultures, and formal governments. Damage done has been often irreparable on physical (depletion of natural resources faster than they can be replaced, environmental damage, health hazards), economic (employment realities such as wages being paid (e.g., paying employees less), increased poverty, increased national debt, loss of tax income), and psychological (national pride threats caused by differential employee pay, loss of trust in MNE and reputation) (Mehafdi, 2000; Zyglidopoulous, 2002).

One by one, the political faces of low tax countries are crying out and essentially demanding that a more ethical reasoning process is used by MNEs when crafting TP programs. One such voice is that of Dr. Sulaiman, representing the Malaysia Ministry of Domestic Trade and Consumer Affairs, who identifies transfer pricing as a 'restrictive business practice (RBP)':

"The Malaysia Ministry of Domestic Trade and Consumer Affairs will emphasize fair trade practices (not restrictive business practices which strategically use transfer pricing) which seek to balance the interest of both business and consumers ... this will be done independent of the WTO agenda and will take cognizance of the socio-economic development needs of the country" (Ruzki, 2002).

The impact that a certain stakeholder (person or group) can have on managerial TP decisions will, in part, depend upon the perceived salience of their respective request(s). A reporting by Zyglidopoulous (2002) adds an interesting 'twist' to the paradigm within which MNEs process, respond to, or ignore low-tax country pleas from stakeholders such as Dr. Sulaiman.

"... stakeholder salience depends on the interplay of three potential stakeholder characteristics: power, legitimacy, and urgency. Where "power" is defined as "the probability that one actor within a social relationship would be in a position to carry out his own will despite resistance" ... "legitimacy" is defined as "a generalized perception or assumption that the actions of an entity are desirable, proper or appropriate within some socially constructed system of norms, values, beliefs, and definitions" ... "urgency" defined as a situation that is time-intensive and critical ... stakeholders possessing all three characteristics (power, legitimacy, and urgency) will have a high level of salience. Stakeholders possessing only two characteristics will have moderate levels of stakeholder salience, while, stakeholders with only one of these characteristics will have low levels of salience" (Zyglidopoulous, 2002).