UNRAVELING TRANSFER PRICING PARADOX: DO TUNNELING INCENTIVES REALLY DRIVE PROFIT SHIFTING?

Abstract

Purpose – This study unravels the paradoxical relationship between tunneling incentives and transfer pricing practices in Indonesian consumer non-cyclical sector companies. By examining the moderating role of foreign ownership, we investigate whether tunneling incentives truly drive profit shifting or whether transfer pricing serves alternative functions.

Design/methodology/approach – Employing panel data regression analysis on 140 firm-year observations from 28 companies listed on the Indonesia Stock Exchange during 2020-2024, this study examines the effects of tax minimization, tunneling incentive, and debt covenant on transfer pricing, with foreign ownership as a moderating variable. Model selection was conducted through Chow, Hausman, and Lagrange Multiplier tests, with diagnostic checks for classical assumptions and robustness tests.

Findings – Contrary to theoretical predictions, tunneling incentive exhibits a significant negative effect on transfer pricing (t = -2.154, p = 0.033), suggesting that lower tunneling incentives paradoxically correspond to higher transfer pricing practices. Tax minimization and debt covenant show no significant effects. Foreign ownership significantly moderates only the debt covenant-transfer pricing relationship, while failing to moderate tax minimization or tunneling incentive relationships.

Practical implications – The findings challenge conventional assumptions about transfer pricing determinants and suggest that tax authorities and policymakers should consider multiple motives beyond tax minimization, particularly the legitimate business functions of transfer pricing. For corporate managers, the results indicate that foreign ownership adds complexity to transfer pricing decisions, especially regarding debt covenant compliance.

Originality/value – This study contributes to the transfer pricing literature by documenting a counterintuitive negative relationship between tunneling incentives and transfer pricing, questioning conventional agency theory predictions in the Indonesian context. The findings provide novel empirical evidence that transfer pricing serves both opportunistic and efficiency-enhancing functions.

Paper type: Empirical research