Abstract:
Advance Pricing Agreements (APAs) are commonly used by multinational groups to gain certainty about their transfer prices for tax purposes. I focus on a multinational company that invests in a foreign subsidiary in a low-tax country. Applying a binomial model for flexible investment planning, I analyze whether and under what circumstances the multinational company should consider requesting an APA. I show that APAs are worth considering when high double taxation may arise and when the tax rates in the involved countries differ sufficiently to outweigh the drawbacks associated with time and fee effects. Furthermore, I find that increasing double taxation and an increasing tax rate differential increase the relative attractiveness of an APA request. That said, multinational companies need to also control for opposing effects when considering an APA request.