On the interdependency of profit shifting channels and the effectiveness of anti-avoidance legislation

The issue of base erosion and profit shifting has been on the international policy agenda for several years now. The aim of this paper is to examine how firms adjust their profit shifting mechanisms in a changing institutional environment. In particular, we test whether firms substitute one profit shifting strategy for another if respective costs change. To this end, we exploit changes in the strictness of transfer pricing regulations and thin capitalization rules over time in a panel of European multinational firms and study a quasi-experimental reform setting in France. We confirm existing evidence that tightening transfer pricing regulations reduces the tax sensitivity of earnings before interest and taxes (EBIT) substantially. Our results show, however, that this reduction includes both a reduction in profit shifting activity via the transfer pricing channel and a substitution with debt shifting. Moreover, firms using debt shifting to begin with rely more heavily on tax optimization of transfer prices when thin capitalization rules are strengthened. If transfer pricing regulations are also strict, the conditional reform effects show that the substitutive response is more pronounced for a subsample of firms with a high share of intangible property (IP). The difference-in-difference approach for the French tax reform illustrates an increase in profit shifting based on transfer prices for treated firms facing new restrictions on debt shifting. Again, the effect is stronger for IP intensive firms

Profit shifting within multinationals : an analysis of its tax-minimization potential and of anti-avoidance measures that extend taxation of interest and royalties at source

This dissertation provides new insights into the tax-minimization potential of profit shifting within multinationals. It identifies representative tax planning arrangements and analyses their impact on the cost of capital and effective average tax rates of cross-border investments between EU member states and the United States using the Devereux/Griffith model. In addition, this dissertation provides arguments for and analyses the effects of different methods for extending the taxation of interest and royalties at source. It empirically investigates whether companies substitute between different profit-shifting channels, as well as how this affects the effectiveness of existing regulations for source-based taxation of intragroup payments. Finally, the dissertation presents alternative measures for extending taxation of interest and royalties at source. It highlights the different objectives and effects of these measures and provides rough estimates of the tax revenue gains and losses resulting from two of these reform options in selected countries

Extending taxation of interest and royalty income at source : an option to limit base erosion and profit shifting?

This paper discusses tax policy measures to reduce corporate tax avoidance by extending taxation in the source country without imposing double taxation. We focus on four options: Bilaterally restricting interest and royalty deductibility, introducing an inverted tax credit system, levying withholding taxes on all interest and royalty payments and levying withholding taxes as an anti-avoidance regulation. We calculate the tax revenue effects of introducing a minimum withholding tax on royalty payments and an inverted tax credit. For the withholding tax we find that the US would suffer the greatest tax revenue losses, while some other countries would increase their tax revenue. In general, gains and losses depend not only on net balances in royalty income flows but also on withholding tax and credit rules under the status quo. The inverted tax credit would increase tax revenue in particular in high-tax countries. Revenue redistribution would only arise if withholding taxes were replaced by the inverted credit

Profit Shifting and ‘Aggressive' Tax Planning by Multinational Firms: Issues and Options for Reform

This paper discusses the issue of profit shifting and ‘aggressive’ tax planning by multinational firms. The paper makes two contributions. Firstly, we provide some background information to the debate by giving a brief overview over existing empirical studies on profit shifting and by describing arrangements for IP-based profit shifting which are used by the companies currently accused of avoiding taxes. We then show that preventing this type of tax avoidance is, in principle, straightforward. Secondly, we argue that, in the short term, policy makers should focus on extending withholding taxes in an internationally coordinated way. Other measures which are currently being discussed, in particular unilateral measures like limitations on interest and license deduction, fundamental reforms of the international tax system and country-by-country reporting, are either economically harmful or need to be elaborated much further before their introduction can be considered

Profit shifting within multinationals : an analysis of its tax-minimization potential and of anti-avoidance measures that extend taxation of interest and royalties at source

This dissertation provides new insights into the tax-minimization potential of profit shifting within multinationals. It identifies representative tax planning arrangements and analyses their impact on the cost of capital and effective average tax rates of cross-border investments between EU member states and the United States using the Devereux/Griffith model. In addition, this dissertation provides arguments for and analyses the effects of different methods for extending the taxation of interest and royalties at source. It empirically investigates whether companies substitute between different profit-shifting channels, as well as how this affects the effectiveness of existing regulations for source-based taxation of intragroup payments. Finally, the dissertation presents alternative measures for extending taxation of interest and royalties at source. It highlights the different objectives and effects of these measures and provides rough estimates of the tax revenue gains and losses resulting from two of these reform options in selected countries

On the interdependency of profit-shifting channels and the effectiveness of anti-avoidance legislation

The issue of base erosion and profit-shifting (BEPS) has been on the international policy agenda for three years now. A key element in the discussion are strategies of multinationals using intra-group interest and royalty payments as well as transfer pricing to reallocate profits within the group in a tax minimizing manner. In recent years, antiavoidance regulations have been introduced to limit these cross-border shifting activities. Existing evidence looks at the effectiveness of these regulations separately. The idea of this paper is to analyse the interdependence between different anti-avoidance regulations in place. Our empirical results confirm existing findings on the tax sensitivity of EBIT and the reduction of this sensitivity due to stricter transfer pricing regulations. In addition our results suggest that the positive impact of transfer pricing regulations is strongly mitigated if strict thin capitalization rules apply

On the interdependency of profit-shifting channels and the effectiveness of anti-avoidance legislation

The issue of base erosion and profit-shifting (BEPS) has been on the international policy agenda for three years now. A key element in the discussion are strategies of multinationals using intra-group interest and royalty payments as well as transfer pricing to reallocate profits within the group in a tax minimizing manner. In recent years, antiavoidance regulations have been introduced to limit these cross-border shifting activities. Existing evidence looks at the effectiveness of these regulations separately. The idea of this paper is to analyse the interdependence between different anti-avoidance regulations in place. Our empirical results confirm existing findings on the tax sensitivity of EBIT and the reduction of this sensitivity due to stricter transfer pricing regulations. In addition our results suggest that the positive impact of transfer pricing regulations is strongly mitigated if strict thin capitalization rules apply

On the interdependency of profit shifting channels and the effectiveness of anti-avoidance legislation

The issue of base erosion and profit shifting has been on the international policy agenda for several years now. The aim of this paper is to examine how firms adjust their profit shifting mechanisms in a changing institutional environment. In particular, we test whether firms substitute one profit shifting strategy for another if respective costs change. To this end, we exploit changes in the strictness of transfer pricing regulations and thin capitalization rules over time in a panel of European multinational firms and study a quasi-experimental reform setting in France. We confirm existing evidence that tightening transfer pricing regulations reduces the tax sensitivity of earnings before interest and taxes (EBIT) substantially. Our results show, however, that this reduction includes both a reduction in profit shifting activity via the transfer pricing channel and a substitution with debt shifting. Moreover, firms using debt shifting to begin with rely more heavily on tax optimization of transfer prices when thin capitalization rules are strengthened. If transfer pricing regulations are also strict, the conditional reform effects show that the substitutive response is more pronounced for a subsample of firms with a high share of intangible property (IP). The difference-in-difference approach for the French tax reform illustrates an increase in profit shifting based on transfer prices for treated firms facing new restrictions on debt shifting. Again, the effect is stronger for IP intensive firms