Can European Banks’ Country-by-Country Reports Reveal Profit Shifting? An Analysis of the Information Content of EU Banks’ Disclosures

Abstract

We create a novel database of hand-collected information from the country-by-country reports (CbCRs) of more than 100 multinational bank groups headquartered in the EU for 2014-2016. We compare this new dataset with information from Orbis and Bank Focus to assess in how far the new disclosure obligation increased transparency on banks' tax avoidance behavior. Our descriptive analysis shows that CbCRs uncover a large fraction of worldwide profits and real activities in terms of employees of EU bank groups, especially in tax havens. We also document a striking disconnect between reported profits and real activity, noting considerable heterogeneity between different tax havens and bank groups from different headquarter countries. Regression analysis based on CbCR data and Bank Focus data leads us to expect a tax semi-elasticity of banks' reported profits of about-4.6. In this regard, CbCRs are indicative of a more pronounced tax sensitivity than conventional databases suggest. However, the lack of important economic variables (total assets and staff cost) impedes an exact estimation of banks' profit shifting based on CbCR data alone and with standard methods. These insights are especially relevant in the context of the ongoing political discussions whether to introduce a public CbCR for all large multinational firms in the EU.

Real Effects of Public Country-by-Country Reporting and the Firm Structure of European Banks

“…Furthermore, many tax havens offer provide also strict banking secrecy facilitating the obfuscation of economic activity (regulatory-havens). Hence, banks may worry about increased knowyour-customer inquiries or anti-money-laundering laws as a result from as public CbCR (Dutt et al (2019b). Expected regulatory costs may play are particular role for banks with presence in regulatory havens.…”

“…Accordingly, "tax & non-regulatory havens" are tax havens with a below median rank in the FSI. As public CbCR increased financial transparency significantly at the country-level (Dutt et al, 2019b), we expect the decrease of subsidiaries located in opaque tax havens ("tax & regulatory havens") to be stronger compared to relatively transparent tax havens ("tax & nonregulatory havens"). The results in Table 7 confirm our expectation.…”

“…Third, we contribute to the strand of literature and on-going discussion about the tax disclosure by CbCreports of firms (European Parliament and the Council, 2017;Brown, 2018;De Simone and Olbert, 2019;Joshi et al, 2019;Overesch and Wolff, 2019;Dutt et al, 2019aDutt et al, , 2019b.…”

“…Hence, it is possible that the incremental information provided by public CbCR is only, if at all, of little extra value for investors and might not trigger stakeholder responses (for the limited information value of CbCR for the evaluation of a firm's tax avoidance behavior see Bornemann and Eberhartinger, 2017). Dutt et al (2019b) mitigate some of these concerns. They comprehensively analyze whether public CbC reports from EU banks reveal profit shifting and conclude that public CbCR indeed increases transparency with respect to worldwide profits and real activities and is also indicative of a more distinct tax sensitivity compared to estimations based on conventional databases.…”

“…"Consolidated basis" refers either to the prudential scope of consolidation as defined by the CRR representing a less comprehensive consolidation or to the consolidation scope under accounting rules. However, the competent authorities of countries where the majority of the banks in our sample are headquartered (France, Germany and the United Kingdom) refer to the accounting scope of consolidation (Dutt et al, 2019b).…”