Do Transfer Pricing Laws Limit International Income Shifting? Evidence from European Multinationals

Lohse, Theresa; Riedel, Nadine

doi:10.2139/ssrn.2334651

Cited by 54 publications

(33 citation statements)

References 16 publications

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“…All elements refer to discrete factors that are associated mainly with the existence of transfer pricing documentation requirements, penalties for failures in transfer pricing documentation, evidence of transfer pricing disclosure, whether the statutes of limitations is greater than 5 years and whether advanced pricing agreement rules are available. The transfer pricing strictness index is then computed via weighted average of the indicator variables related to these transfer pricing elements to create a five-level categorization of transfer pricing strictness similar to the one proposed by Lohse and Riedel (2013). The weights included in their computation refer to a percentage of importance of each category of transfer pricing elements attributed by the authors.…”

Section: Profit Shifting and Tax Enforcementmentioning

confidence: 99%

“…Comparison of the various enforcement rankings across different studies provides some conflicting outcomes. For example, in the case of Austria, transfer pricing rules do not implement formal documentation requirements, but such documentation is commonly required in practice (Lohse and Riedel, 2013). In this case, Beuselinck et al (2015) regard Austria as a high-enforcement country, and Lohse and Riedel (2013) classify the country in the second highest enforcement rank.…”

Section: Profit Shifting and Tax Enforcementmentioning

confidence: 99%

“…For example, in the case of Austria, transfer pricing rules do not implement formal documentation requirements, but such documentation is commonly required in practice (Lohse and Riedel, 2013). In this case, Beuselinck et al (2015) regard Austria as a high-enforcement country, and Lohse and Riedel (2013) classify the country in the second highest enforcement rank. In Marques and Pinho (2016), Austria has an enforcement index of approximately 0.4273, in the middle of the index range of [0,1].…”

Section: Profit Shifting and Tax Enforcementmentioning

confidence: 99%

“…For this purpose, we focus on creating groups of countries that share similar transfer pricing characteristics. Information about transfer pricing rules across countries is collected from professional guidelines prepared by the Big Four audit firms; these guidelines are widely applied in profitshifting research, for example, Ignat and Feleag a (2017), Nicolay et al (2017), Marques and Pinho (2016) and Lohse and Riedel (2013). We select 57 qualitative and quantitative characteristics that are directly observable.…”

Section: Transfer Pricing Rulesmentioning

confidence: 99%

“…The literature on profit shifting and tax enforcement suggests that specific transfer pricing rules are more effective in inhibiting the profit-shifting behavior of firms. The predominant approach is to create an enforcement ranking of countries based on the assumption that larger penalties and more extensive information requirements imply higher tax enforcement (Marques and Pinho, 2016; Beuselinck et al ., 2015; Lohse and Riedel, 2013). While this approach is intended to provide an indirect measure of tax enforcement, it carries some noticeable limitations.…”

Section: Introductionmentioning

confidence: 99%

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The impact of countries' transfer pricing rules on profit shifting

Rathke

Rezende

Watrin

2020

JAAR

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PurposeThis study investigates the impact of different transfer pricing rules on tax-induced profit shifting. Existing studies create different enforcement rankings of countries based on specific transfer pricing provisions on the assumption that larger penalties and more extensive information requirements imply higher tax enforcement. This assumption carries limitations related to the impact of transfer pricing rules in different countries and to the interaction of different tax rules. Instead, the authors propose a nonordered segregation of groups of countries with different transfer pricing rules, and they empirically investigate the impact of these transfer pricing rules on the profit-shifting behavior of firms.Design/methodology/approachThe authors apply the hierarchical clustering method to analyze 57 observable quantitative and qualitative characteristics of transfer pricing rules of each country. This approach allows the creation of groups of countries based on a comprehensive set of regulatory characteristics, to investigate evidence of profit shifting for each of these separate groups. Profit-shifting behavior is measured by the variation in the volume of import and export transactions between local firms and related parties located in other countries.FindingsThe results indicate that firms have a higher volume of intrafirm transactions with related parties located in countries with a lower tax rate. This result is consistent with the profit-shifting hypothesis. Moreover, the results show that relevant differences in transfer pricing rules across countries produce different effects on the volume of intrafirm transactions. The authors observe that the existence of domestic transfer pricing rules that override the OECD Transfer Pricing Guidelines may inhibit profit shifting. In addition, the results suggest that the OECD guidelines may facilitate profit shifting. Overall, it is observed that some transfer pricing rules may be more effective than others in curbing profit shifting and that firms are still able to manipulate transfer prices under some tax rules.Research limitations/implications(1) The authors focus on the Brazilian context, which provides a suitable set of profit-shifting incentives for the analysis, since it combines an extreme corporate tax rate, a highly complex tax system, and a unique set of transfer pricing rules. (2) Profit-shifting behavior is captured by the volume of intrafirm transactions. The authors would prefer to observe the transfer price directly; however, this information is not disclosed by firms, for it may represent a limitation to the investigation. Nonetheless, theory shows that the profit-shifting behavior is reflected by the manipulation of both transfer prices and intra-firm outputs.Practical implicationsThe authors find that the volume of intrafirm transactions may decrease or increase, depending on the transfer pricing system of the foreign country (including the tax-differential effect). It suggests that some transfer pricing rules are more effective than others in curtailing the profit-shifting behavior and that firms are still able to find vulnerabilities in current rules and take advantage of them in deploying a profit-shifting strategy.Social implicationsResults provide knowledge about how key differences on transfer pricing rules across countries influence the profit-shifting behavior. The results of the study may have valuable application in solving regulatory mismatches, to eliminate blind spots in transfer pricing rules and thus to contribute to the current review of OECD guidelines and to the global tax reset movement.Originality/valueRecent studies suggest that if tax-avoidance incentives are somewhat weak, it becomes difficult to observe the shifting behavior of firms. The puzzle is to check whether profit shifting is nonexistent under weak incentives or whether this is a matter of methodological limitations. The authors’ analysis is applied to a complex tax background with strong profit-shifting incentives; thus, it allows the authors to obtain robust evidences of the shifting behavior and the effect of different transfer pricing rules.

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Section: Profit Shifting and Tax Enforcementmentioning

confidence: 99%