A comparative empirical study of international transfer pricing practices and audits in New Zealand, Australia and China

Abstract

Transfer pricing is the price used for internal sales of goods and services between profit centres within the same firm (Anthony and Govindarajan, 1998). The issue of transfer pricing has long been a source of frequent managerial concern and frustration (Rushinek and Rushinek, 1988). Compared with domestic business, pricing considerations for multinationals involved in international business are far more complicated. Multinational Enterprises (MNEs) are exposed to a greater variety of environmental disturbances than domestic firms. The constantly changing international environment can have a significant impact on multinational transfer pricing practices (Tang, 1982, Ghosh and Crain, 1993).

The objectives of this study are four-fold. First, it investigates the similarities and differences in international transfer pricing (lTP) practices by MNEs in New Zealand, Australia, and China. Second, it ascertains whether an ITP tax audit is an important concern of MNEs in formulating their ITP policies. Third, it identifies the characteristics of MNEs that make them more vulnerable to ITP tax audits. Fourth, it examines the ITP monitoring system in China.

Data were gathered through a questionnaire survey of 300 New Zealand subsidiaries, 250 Australian subsidiaries and 500 Chinese subsidiaries. The overall usable response rate was 20 percent. Four Chinese tax authorities were interviewed. Non-parametric statistical analysis was carried out using data collected through the questionnaire survey.

The research presents comprehensive statistical evidence on the ITP practices of the developing and developed economies in this study. Survey results revealed statistically significant differences between the ITP methods used by Chinese companies and their New Zealand and Australian counterparts. Statistically significant differences were also found between the two sets of companies regarding the degree of emphasis placed on environmental factors that affected their ITP policies.

Tax authority transfer pricing auditing was an important concern in ITP decisions for New Zealand and Australian companies. In contrast, it was relatively unimportant for Chinese firms. This is, perhaps, because New Zealand and Australian tax authorities are more aggressive than their Chinese counterparts in administering and enforcing their transfer pricing rules.

A number of corporate attributes were associated with the potential risk of tax audits. Three corporate attributes, i.e., nationality, size and financing, are significant and positively related to ITP tax auditing - the dependent variable - both directly and interactively. This survey also found that the New Zealand Inland Revenue Department (IRD) and the Australian Tax Office (ATO) tended to audit large-sized multinationals; in contrast, the Chinese tax authorities focused their tax audit efforts on relatively small-sized firms. As the audits of large firms require sophisticated techniques, the Chinese tax authorities claimed that they lacked sufficient staff resources and experience to tackle the ITP issues raised by large MNEs. In this study, seven factors were identified as constraining the Chinese ITP monitoring system.

This study has significant implications for ITP theory and practices. It provides a useful insight into ITP practices and audits across New Zealand, Australia and China, providing MNEs and other businesses, which already operate or intend to operate between these three markets, with guidance in complying with the transfer pricing regulations of the three Asia-Pacific national economic regimes involved.