Income Shifting Using a Cost Sharing Arrangement

Income Shifting Using a Cost Sharing Arrangement

By Lisa De Simone, Richard Sansing
July 18,2017Working Paper No. 3265

This study investigates the use of a cost sharing arrangement (CSA) by a multinational corporation (MNC) to shift the income attributable to valuable intellectual property (IP) to low-tax foreign jurisdictions. Using a strategic tax compliance model, we identify three major effects that determine whether an MNC will use a CSA to develop the IP rather than develop the IP domestically: a marketing intangible effect, an undervaluation effect, and an enforcement effect. First, we find that the MNC is more likely to use a CSA to develop the IP when the MNC has valuable domestic marketing intangibles, such as a global brand. Second, the MNC is more likely to use a CSA if the nature of the IP development project allows the MNC to understate the fair market value of the IP. Third, the MNC is less likely to use a CSA if the tax authority can cost effectively challenge the position and impose retroactive revaluations of the IP. We also compare the effects of the rules in the U.S. to the OECD transfer pricing guidelines used in most other countries.