Evaluation of the correlation between tax evasion and transfer pricing in the framework of international transactions

Abstract

The increasing globalization of economic activity has intensified concerns regarding tax evasion and the use of transfer pricing strategies by multinational enterprises. This study aims to evaluate the relationship between tax evasion and transfer pricing within the framework of international transactions, with a particular focus on European Union member states. Given the difficulty of directly measuring these phenomena, the analysis employs proxy variables, using Foreign Direct Investment inflows as an indicator of multinational activity and potential profit shifting, and taxrelated and institutional indicators as explanatory factors. The empirical investigation is based on a panel dataset covering European Union countries over the period 2012-2024. The model incorporates Corporate Income Tax rates, Gross Domestic Product, the Corruption Perceptions Index, and the Index of Economic Freedom, alongside a dummy variable distinguishing between low-tax and high-tax jurisdictions. Based on these variables two model specifications are estimated in order to assess the robustness of the relationship between corporate taxation and Foreign Direct Investment inflows: a baseline model including a tax regime dummy variable and an extended model incorporating economic size, proxied by Gross Domestic Product. The results suggest that multinational enterprises do not base their decisions solely on statutory tax rates, but rather consider a broader set of factors, including market size, institutional environment, and economic conditions. From the perspective of transfer pricing, the results suggest that firms may rely on profit-shifting strategies to mitigate tax differentials, thereby weakening the direct link between tax rates and observable investment flows.