Are Spanish companies involved in profit shifting? Consequences in terms of tax revenues

Abstract

In this paper the authors analyze the existence of profit shifting between Spain and other OECD and EU countries. Using a sample of 1,169 Spanish subsidiaries owned by foreign OECD and EU parent companies and a sample of 317 EU subsidiaries owned by Spanish parent companies, taken from the AMADEUS Database for the period 2005 to 2014, and a simple tax rate difference as a measure of the tax incentive, the authors obtain a negative effect of corporate income taxes on reported profits. When the tax rate differences between Spain and the foreign countries vary by one percentage point, reported profits vary by approximately 2.7 to 3%. This is consistent with profit shifting activity by corporations and matches the empirical results in the literature. Furthermore, the authors calculate the impact of this activity on Spain's tax revenues from the sample of Spanish subsidiary companies. They obtain that the tax revenues vary from year to year, depending on the level of taxation of the main investor countries in Spain in comparison to the Spanish tax rate. IntroductionAmong multinational enterprises (MNEs), profit shifting (PS) is a tax planning strategy within a group consisting of artificially shifting taxable income from entities located in high tax paying countries (basically, countries with high corporate income tax, CIT) to entities located in countries with lower tax rates. The PS phenomenon, like other tax avoidance and evasion devices, causes what is known as Double Non-Taxation, which refers to the minimisation and sometimes zero taxation of certain taxable income (or more generally, taxable object). Where there is PS activity, worldwide CIT revenues become lower because profits are taxed at low tax rates.Nowadays these tax minimizing activities are encouraged by the discrepancy between the features of today's economy and the international taxation standards (based on the Separate Accounting Method) created a century ago, when international exchanges of goods and services were limited and business models were simpler. While the world economy is becoming ever more globalized, current international taxation standards require MNEs to report profits separately in the different jurisdictions in which they operate. This creates an opportunity for MNEs to develop strategies to reduce their tax burden, most of which are legally acceptable, because it is difficult to determine where profits are created. 1 The digitalization of the economy, the complexity of business models and the diversity of tax rules in different jurisdictions (which creates tax loopholes) also make it easier for companies to develop these strategies.Two of the most popular PS mechanisms among MNEs are transfer pricing and thin capitalisation. Transfer prices are the prices that entities set when they exchange services and/or goods within the multinational group, i.e. the prices applicable to related-party transactions, which have to be determined as if the transactions were between independent enterprises, i.e., according to the arm's len...

Assessing impact of base erosion and profit shifting on performance of subsidiaries of multinational corporations in Baltic countries

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