The Impact of Tax and Transfer Pricing on a Multinational Firm's Strategic Decision of Selling to a Rival

We consider an integrated multinational firm (MNF) who produces a product in a low‐tax country and sells it in a high‐tax country. The global firm faces the decision of whether to sell the product (and at what price) to an external rival in the retail market who has an alternative outside sourcing option. Using a Cournot competition model, we show that two salient elements of the global tax planning—namely the tax rate disparity and the regulatory restrictions on transfer pricing between the MNF's low‐tax and high‐tax divisions—have significant impacts on the MNF's decision of selling to the rival. We find that when the tax rate disparity is low, the MNF will sell, but only to a low‐cost rival, a result that is in‐line with the traditional understanding in a tax‐free setting. However, when the tax rate disparity is high, the outcome of selling or not reverses: the MNF will sell only to a high‐cost rival. We also find that under the requirement of minimum order quantity, the MNF may sell to the rival at a price even higher than the latter's alternative sourcing cost. Another interesting finding of our analysis is that the regulatory restriction on transfer pricing may bring benefit rather than burden to the global firm.