Multinational entities (MNEs) use intra-firm transfer prices as an instrument to shift profits from highly-taxed jurisdictions to lightly-taxed jurisdictions. We propose tax motivated transfer pricing as an additional incentive to undertake vertical foreign direct investment (FDI) by MNEs. We study the role of transfer pricing in a two country, partial equilibrium model of international trade with vertical FDI assuming linear contracts for vertical trading. Our analysis reveals first, that vertical FDI arises in equilibrium even in the absence of efficiency gains; second, that vertical FDI may allow the vertically integrated firm to reduce the double marginalization problem, which may be welfare improving. We further extend our analysis incorporating a regulated intra-firm trade price, endogenizing the type of vertical merger chosen by the MNE, assuming international downstream competition, and assuming two-part tariff contracts for vertical trading.