Business Cycle and TPM of TNCs

doi:10.4236/me.2011.24060

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Modern Economy, 2011, 2, 546-551

doi:10.4236/me.2011.24060 Published Online September 2011 (http://www.SciRP.org/journal/me)

Business Cycle and TPM of TNCs

Junrong Liu

School of Tourism and Management & Economics, Leshan Normal University, Leshan, China

E-mail: [email protected]

Received June 23, 20 11; revised July 26, 2011; accepted August 5, 2011

Abstract

This article is devoted to analyses on effects of the four phases of business cycle on transfer pricing manipu-

lation (TPM) of transnational corporations (TNCs) and TNCs’ possible TMP practices through business cy-

cle. The researcher herein holds that business cycle arouses the fluctuation of economical indicators and pol-

icy changes, which subsequently affect TNCs’ production, financial situation, sales and their resource alloca-

tion globally. Acting as a reasoning business being, TNCs should take according strategies to manipulate

transfer pricing to harbor the possible benefit and escape from any risk ahead, by taking advantage of their

“Trans-nationality”.

Keywords: Business Cycle, Transfer Pricing, Manipulation, TNCs

1. Introduction

Economic cycle is an objective economic phenomenon,

which affects all economic activities and government

economic policies. Multinationals’ transfer pricing in

internal trade also be subjected to economic cycles. And

the impact of economic circular fluctuations on the mar-

ket and government policy changes directly influence

multinational transfer pricing strategies and the transfer-

ring direction, which, without the proper management,

would cause great waste of resources. In view of this,

this paper is sacrificed to that the exploring the impacts

of evolution of economic cycle four phases on the trans-

fer pricing manipulations (TPMs) of the multinationals’

intra-firm trade.

1.1. The Motivation of Internalization

Transnational companies in nature are the results of in-

ternationalized internalization of firms’ trade and the

economic organizations that are capable of harboring the

best resources in the world, to seeking for the maximum

market profits at the lowest cost. Unless the considera-

tion for long-term strategy, they always try to avoid all

negatives. Actually, the instinct advantages TNCs have

are not their vast resources and the advanced technology

and management techniques but their Trans-Nationality

as the core advantage. Multinational corporations, ac-

cording to the level of technology and specialization in

different countries, take the international specialized

production strategies and construct the network of senti-

nel production of specialized factories worldwide, and

spare parts’ manufacturing division and logistics leading

to the favorable locations, assembling bases and direct

marketing sub-cen ters. In orde r to face up the fierce mar-

ket competition, Transnational corporations have produ-

ction activities in different countries linked together th-

rough the production system, which covers investment

and trade activities, and convert a majority of their trade

into intra-firm trade among the parent company and sub -

sidiaries or among the affiliates. [1,2] The trans-nation-

ality of TNCs makes them enjoy the broad geographical

space, wide market and convenient finance, and thus

renders TNCs much mobility in dealing with various

risks.

1.2. The Functions of Transfer Pricing

Trade Internalization has made TNCs’ trans-nationality

effective and enables them to make up international op-

erating costs, harboring their competitive advantage. [3]

Internalization theories hold that because of external

market’s defects that raise market transaction costs, TNCs

prefer internal transactions to external market transac-

tions. Internal transfer pricing refers the pricing manipu-

lation on products, services, intangible assets and funds

so on, which are transacted within TNCs. Transfer Pric-

ing Manipulation (TPM) is a practice by TNCs in mak-

ing prices that would be higher or lower than the oppor-

tunity cost to avoid (not to evade illegally) national con-

J. R. LIU547

trol or take opportunity to exercise arbitrage strategies.

As the world market is not fully unified one, TNCs

can be the beneficiary of international operations. The

effective use of the global production and marketing

network makes the feasibility of transferring resources

within firms become the TNCs advantage which is ex-

clusive to any Non-TNCs.[4] TNCs’ transfer pricing

operations is the right practice in tak ing the advantage of

defects in the global market to achieve their business

goal. [5]

2. The Impact of the Economic Variables on

TNCs’ TPM

The economic variables herein are the macroeconomic

indicators which states business cycle, including ex-

change rates, tax rates, interest rates, GDP growth rates

and market consumption situation and so forth. Before

discussing the impacts of the economic cycle on TPM by

multinational corporations, we should come to the im-

pact of the economic variables on TNCs’ TPM.

2.1. Exchange Rates

Exchange rate is the monetary value ratios between the

two nations’ currencies. The appreciation or depreciation

of one nation’s currency would create arbitrage opportu-

nity between two counties in a short time, which, for

TNCs with a huge amount of fund, is an excellent profit

opportunity. Such arbitrage should be necessarily re-

flected in the internal trad e pricing, and th e popular prac-

tices are over-pricing or under-pricing the assets to be

internationally internally tran sacted so as to achieve their

financial returns with the changes of exchange rate.

2.2. Tax Rates

Changes in tax rates also exert obvious influence on

transferring pricing of TNCs. Some scholars even be-

lieve that TNCs manipulate transfer pricing primarily for

tax avoidance or evasion. [7] TNCs generally achieve tax

avoidance in two ways through transfer pricing: First

way is the over-pricing of transfer-in to drive up cost for

tax reduction, and the other is to shift profits to the

branches in low tax countries. [6,8,9]The two methods

can be applied by the companies who are in the cou ntries

of high tax rate. When the host countries’ tax rate is low,

the more effective method for tax avoidance should be

the choice; Of course, compared with other countries, the

host country’s tax rate is very low or even free (say, that

in FTZ), low-priced transfer-out and high-priced transfer in

seem to be the best policy.

2.3. Interest Rates

A question worthy of further exploration is the impor-

tance of interest rate changes to TNCs. transfer pricing

issues. Any fluctuation in interest rates in host country

would change the financing cost of TNCs costs in the

country. In the case of low interest rates, TNCs can eas-

ily harbor financial resource at low cost, and they decline

in this time directly to transferring the low-cost capital to

their brunches in the nations of high interest rates. If

there is limitation over the tran sf er (th e policy co nstr ain ts

mainly), these funds may be transferred in disguise of

production equipment or management aids to the high-

interest rate countries through the intra-trade channels;

Additionally, TNCs also transfer their financial assets to

parent company or foreign branches, thus saving fund,

lower costs and improving return on assets. Largely,

these behaviors of TNCs are arbitrage practices over the

gap of international interest rates. The transfer prices can

be determined with TNCs’ cons idering the exchang e rate

and tax rates. Given their economic variables are con-

stant, low interest rates would lead to in-transferring at

high prices and out-transferring at low prices and vice

versa.

2.4. GDP Growth Rate

GDP growth rate is the basic indicator of economic con-

ditions and the main measurement of business cycle.

Higher growth rate of GDP indicates that the economy is

in booming phase, when firms enjoy a f avorab le busin ess

climate for development and need more tangible assets

and equipment for production and operation, and have

accumulated many new technologies since the previous

phases. In the case of slow GDP growth, corporate suffer

sluggish sales and underproduction and enlarging inven-

tory, TNCs then generally move their idle equipment to

the booming economies where their branches or parent

company are. According general economic theories and

practice, in the four phases of economic cycle, govern-

ments usually adopt an “anti cycle methodology” to re-

gulate their national economies. In the period of eco-

nomic expansion, government monetary and fiscal poli-

cies are always featured with high tax rate and high in-

terest rate; while in a recession, the governments largely

adopt a low tax rates and low interest rate. The changes

in GDP form the immediate impact on people's income

and consumption power, thereby affecting the prices of

products and marketing of TNCs.

In addition, GDP growth and exchange rate have a

close relationship. Therefore, changes in GDP would im-

mediately influence the transfer pricing manipulation

(TPM) of TNCs mainly with changes in the economic

J. R. LIU

548

development and the relevant adaptation of government

policies concerning tax rates, interest rates, exchange

rates etc. Largely speaking, when GDP grows rapidly,

TNCs will exercise high priced transfer-out of physical

assets for the production in other locations and low-

priced transfer-in of intangibles such as technology for

product upgrading and innovation. While the GDP growth

rate is high, TNCs then employ the manipulation of

high-priced transfer-out and low-priced transfer-in, and

the former transferred are mainly invisible assets such as

technologies while the latter intra-transacted are the phy-

sical assets concerning production.

2.5. Consumption Power

The consumption power is another key indicator which

reflects market size that possibly taken by TNCs. In gen-

eral, the low consumption means the small demand on

the market and vice versa. In fact, market conditions

faced by TNCs hardly affects directly their transfer pri-

ces, but given combined with other factors, it would

make big difference.

Based on the above analyses, the economic cycle will

cause changes in exchange rates, tax rates, interest rates,

GDP growth rates, market conditions and even political

stability and consumption changes, which drives TNCs

to take different transfer pricing strategies. For conven-

ience, we exhibit the relationship between TNCs’ TPM

and Changes in economic variables in the table below.

3. The Business cycle and the TNCs’ TPM

3.1. The Impact of the Evolution of Business Cycle

Phases on TNCs

Briefly speaking, the impacts of economic cycle on

TNCs can be generalized as follows: first, the change in

consumption leads to fluctuation in the sales’ of TNCs.

Usually, the economic downturn is accompanied with the

decline in national income and weak investment, which

lead to deep reduction of consumption, and thereby make

TNCs suffer the enlarging product backlog or underpro-

duction, resulting in high business opportunity cost and

low capital efficiency. Second, the governmental adjust-

ment over the policies has great implications to TNCs’

operation. Faced with cyclical economic fluctuation, the

local governments will make macro-control policies to

deal with the adverse changes in the economy, which

would conflict with TNCs’ established strategic and

plans and influence firms’ operations negatively. Third,

the economic circular fluctuation sometimes jeopardizes

TNCs’ assets. Large fluctuations in the economy may be

accompanied by political events and even wars, and di-

Table 1. The Relationship between TNCs’ TPM and Changes

in Economic Variables.

VariablesChange Transfer price

(outward) Transfer price

(inward)

up HP LP

Ex-rate down LP HP

low HP LP

Tax rate high LP HP

low HP LP

Int-rate high LP HP

low HP

(intangibles) LP

(physicals)

Growth

-rate high LP

(physicals) HP

(intangible )

down LP

(intangibles) HP

(physicals)

Consum.

power up HP

(physicals) LP

(intangibles)

rectly endanger the security of the assets of transnational

companies, and the possible dangers would be destruc-

tion, expropriation and confiscation and prohibition of

profit repatriat ion and so on.

For transnational corporations, the economic risks of

cyclical fluctuations are frequent, and one of the effec-

tive means TNCs take to avoid these risks is to take ad-

vantage of their existing global operation network to

reallocate their resources through internal transfer of

both tangible and intangible assets. This transfer must

involve pricing the goods to be transferred. For the

transfer of assets within the enterprise makes no differ-

ence on ownership, transfer pricing thus seems unimpor-

tant. However, due to the trans-nationality of the intra-

firm transfer of TNCs’ assets, which involves differences

in international tax, currency exchange rates [10], na-

tional economic sovereignty, and TNCs’ benefit internal-

distribution, TNCs’ transfer pricing becomes necessary.

Actually, internal transfer pricing allows the TNCs’

cross-boarder transfer of assets the legitimacy of export-

ing, which enables TNCs to evade tax legally and avoid

some possible high political risks from their consid erable

arbitrage pr ofi ts.

The economic cyclical fluctuations have their own dif-

ferent characteristics in each phase of business cycle,

thus TNCs’ transfer pricing face variable economic poli-

cies, which drives firms to adjust their business objec-

tives and transfer pricing manipulatio n. In this paper, we

employ the methodology of John. R. Mayer and Daniel.

H. Weinberg, who held that a complete economic cycle

consists of the four phases: recession, recovery, demand-

pull inflation and prosperity. And, we maintain that the

evolution of business cycle has significant implication

for TNCs, and would bring about changes which power-

fully influence TNCs’ performance, such as national tax

J. R. LIU549

policy change, the changes in exchange rates and interest

rates, the changes in, and as an unusual situation, the

risks over ownership of TNCs’ asset from political risks.

Before The analysis over the impacts of the four

phases on TNCs’ transfer pricing, we first make the fol-

lowing assumptions: First, the governments act on the

theories of business cycles; Second, the enterprises re-

spond to the outside environmental change and the ad-

justment in economic policies in accordance with the

“rational economic man” approach; Third, all countries

(say country A and country B) be at different phases of

business cycles; Fourth, national economic activity are

independent from the political ideology; Fifth, other fac-

tors within enterprises are fixed. The purpose of these

assumptions is to simplify our analysis, and in fact, these

assumptions are consistent with economic theories and

the traditional practice of g eneral economic activity.

1) Economic recession. In recession phase of business

cycle, the particular country (say country A) adopts loose

monetary and fiscal policies of economic expansion, say

lower interest rates, low tax rate and high governmental

transfer and so on. In the economic downturn phase, the

Government welcomes the entry of foreign capital, while

the outflow of assets and funds are under strict control;

At this time, tax rate decreased significantly, while the

country's currency is expected to appreciate; And the

difficulties faced with by TNCs are baggy consumption,

sluggish sales, rising inventories and underemployment.

2) Economic recovery. In this period, the country

(country A) will continue to maintain accommodative

monetary and fiscal policy, and hold the welcoming atti-

tude to foreign investment, but policy efforts are to be

weakened, and the market conditions faced by transna-

tional corporations continue to improve, sales increase,

and excess inventory decreases.

3) Demand-driven inflation. Because people’s demand

and investment are increasing, the economy grows rap-

idly, but the signs of inflation become clear for faint,

while the economy is still being steadily improved.

Meanwhile, the government policies turn neutral and

hence the preferential policies offered by government to

TNCs have gone. However, at this time, TNCs enjoy

better business climate with increasing product sales,

boosting corporate income and a gradual expansion of

production and larger market share. The only drawback

is that the cost of TNCs expresses a significant upward

trend, which further encourages th e inflation in the coun-

try, and change in exchange rate will makes TNCs suffer

losses in profit repatri a t i o n and from export.

4) Economic booming. With the further development

of the economy, the country (country A) entered the

boom phase of business cycle, with rapid production

promotion, investment scale-up, credit expansion, the

price level rising and increasing employment. Meanwhile,

consumer demand is climbing up and the market is in its

expansion. At this stage, the macroeconomic contains

two forces, that is, the power driving economy to grow

and the strength forcing the economy down-turning. In

the boom phase, the country (country A) mainly takes

tight monetary policies and fiscal policies to deal with

the economic overheating, and thereby the bank interest

rates rise, and corporate tax increase. The government

would manage the expectation of investment revenue to

control the total investment, thus preventing the econ-

omy from reducing to be of recession from excessive

expansion. In this phase, the government in short run

restricts the entry of foreign capital, while depreciation

of the currency lies under strong expectation, which

brings some detriment on TNCs in prof it repatriation and

exporting. And in spite of increasing corporate sales, due

to the rise of costs, TNCs’ actual profit would drop from

that of the previous phase, making TNCs lack for moti-

vation for business exp a nsion.

3.2. The TPM Employed in Each Phase

With the environment faced by the four stages pictured

above, TNCs will employ transfer pricing strategy ac-

cordingly in order to achieve reasonable tax avoidance,

and thus optimize the global resource allocation, corner

greater arbitrage opportunities and ensure the efficiency

of asset proliferation.

1) The TPM in recession

At this stage, due to underemployment and glissading

sales, TNCs will ship resources in a branch in a particu-

lar country (country A) to its sister branch in another

country (country B)to ensure the effective use of total

corporate resources. Country A in recession should take

low-tax policies to stimulate economic development,

whereby TNCs would transfer out at high-price to enjoy

the advantages o f low taxation ; Add itionally, becau se the

currency of country A are to appreciate, TNCs can corner

arbitrage opportunities for exchange rate fluctuation. For

TNCs in any country in recession, they are witnessing

the market shuff le and product upgrading, so they would

transfer out tangible assets concerning production, op-

eration and management through intra-trade channel, and

move into technologies at low prices to equip the new

production for the future market. Besides the transfer of

capital, TNCs can also take advantage of the loose mo-

netary polices to financing in country A and then transfer

the fund to country B, reducing corporate costs and en-

hancing asset utilization, harbor tax relief and interna-

tional arbitrage opportunities.

2) The TPM in recovery

In the economic recovery period, as TNCs face the

similar fiscal and monetary policy with that in economic

recession, their transfer pricing strategy is also roughly

J. R. LIU

550

the same. With minor policy changes, there are some

adjustments within TPM of TN Cs. At this time, with the

gradual economic recovery of country A and vigorous

market, TNCs gradually cater for the economic impro-

vement and start transferring in intangible assets (such as

Proprietary technology, trademarks, patents) at low price

to meet the increasing production in country A, when

transfer-out at high price is still dominant.

3) The TMP in demand-driven inflation

At this stage, the government policies of country A

become neutral and the nation is suffering the pressure of

the devaluation of its currency. The low tax policy ad-

vantages enjoyed by TNCs have disappeared, while the

demand-driven inflation in the country A makes the

value of international assets of TNCs shrinking. How-

ever, the current active market and greater profit margins

in this country provide TNCs a better business climate.

Considering the advantages and disadvantages syntheti-

cally, TNCs will transfer out mainly intangible assets at

low price, while transfer in the tangible assets concerning

production, operation and management from country B

to meet the production requirement and capital needs in

country A, thus they increases the carrying cost, and

thereby circumvent the tax in country A and the loss of

assets from currency depreciation, and access to arbi-

trage opportunities in country B. The period is the prime

season for TNCs’ business operation, and in this phase,

enterprises should consider not only the in-transferring

but the out-transferring for the local high tax rate and the

security of their assets.

4) The TMP in economic boom

In economic boom phase, the government usually ex-

ercise tight fiscal and monetary policies, that is, high tax

rate and high interest rates; And the country (country A)

suffers high inflation and currency devaluation; Besides,

market gets saturated and competition fierce; Fourth,

TNCs have large corporate sales, but profit margins are

narrow; Additionally, in this time, the factors economic

growth and recession coexist. To response to this adverse

environment, TNCs mainly forth-put the low price policy

in intra-trade transfer pricing, which aims to 1) avoid-

ance of tax, 2) preventing the devaluation of assets from

currency depreciation, 3) avoiding inefficient use of

corporate assets. Therefore, the usual TPMs are transfer-

ring out the resources at low price to the efficient pro-

duction location (say country B) for high capital revenue

and transferr ing in technologies and patents at high pr ice

to upgrade produ c ts for future competition.

3.3. Generalization

Based on the argument above, we generalized TNCs’

TPM in Table 2 and Figure 1 as follows:

Table 2. Business cycle, Economic variables and TPM.

Phases

of Business

cycle

Tax rate

and Ex-rateINT-

rate

GDP

growth

rate

Consum-

ption

TPM

Inward

(price)

TPM

Outward

(price)

RecessionL L L L L H

RecoveryL L L L L H

InflationH H H H H L

Boom H H H H H L

Figure 1. Schematic diagram of business cycle & TPM.

4. Concluding Remarks

Business cycle affects all factors of economy, and the

factors directly affect the pricing products and services

transacted within TNCs. This paper merely theoretically

analyzes the impact of business cycle on TNCs transfer

pricing. Anyhow, th is study has its due some implication

for government administration and enterprise governance.

The findings of the paper show that within the four

stages of business cycle, TNCs take a different transfer

pricing strategies, and these strategies come out of TNCs

property of “rational economic being”, which would off-

set the local government “counter-cycle” policies, ag-

gravating economic overheating, exacerbating economic

recession and inflation. In addition, this study helps our

understanding TMP of TNCs in each phase of business

cycle, which provides the government with a perspective

to view of TNCs’ TPM and better their policy making.

J. R. LIU

551

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