Multinationals have an incentive to shift taxable profits to low tax countries by manipulating the transfer prices of intragroup transactions. Transfer prices must conform to the arm's length standard. However, market prices are not available if transferred assets or performed services are firm-specific. In these cases, companies have considerable leeway in assessing transfer prices. Research and development (R&D) intensity is used as a proxy for firm-specific assets and services that are associated with enhanced opportunities to shift profits. An empirical analysis based on firm-level data on German outbound
FDI during the period from 1996 until 2005 reveals that the tax response of intragroup transactions depends on the R&D intensity of multinational companies. The impact of taxes on investments decreases with an increasing R&D intensity, with the result that the local tax rate becomes less important for investment decisions of R&D intensive multinational companies.
