On the Interdependency of Profit Shifting Channels and the Effectiveness of Anti-Avoidance Legislation

Abstract

Die Dis cus si on Pape rs die nen einer mög lichst schnel len Ver brei tung von neue ren For schungs arbei ten des ZEW. Die Bei trä ge lie gen in allei ni ger Ver ant wor tung der Auto ren und stel len nicht not wen di ger wei se die Mei nung des ZEW dar.Dis cus si on Papers are inten ded to make results of ZEW research prompt ly avai la ble to other eco no mists in order to encou ra ge dis cus si on and sug gesti ons for revi si ons. The aut hors are sole ly respon si ble for the con tents which do not neces sa ri ly repre sent the opi ni on of the ZEW. 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.

A European map regarding the strictness

“…Moreover, Becker pointed out that "APAs serve as a commitment device for non-excessive future taxation". Nicolay et al (2016) measured the strictness of the transfer pricing regulations using as an indicator of strictness the existence of formal or informal transfer pricing documentation requirements. More exactly, the authors considered that a country has strict transfer pricing regulations if that country requires (in practice or as a legal requirement) the transfer pricing documentation to be available either upon the request of the tax authorities or to be presented together with the tax return.…”

Studies on transfer pricing systems and profit shifting: impact of the international regulation on the shifting behaviour of Brazilian firms

“…Overall empirical results indicate that the stricter the TP regulation the lower the tax rate difference sensitivity on reported earnings. Nicolay, Nusser and Pfeiffer (2017) investigate how MNE adjust their profit shifting mechanisms after changes in the strictness level of TP regulations and in thin capitalisation rules. Their sample comprises 32 countries for the period of 2004-2014.…”

“…More specific, it appears that the inclusion of different regulatory factors into the analysis results in changes on TP enforcement levels for the same country. With regard to studies that propose a TP enforcement index, some assume a linear relation between regulatory provisions (Nicolay, Nusser and Pfeiffer;Beer and Loeprick, 2017), while others define different weights for different TP factors (Marques e Pinho, 2016). Studies that propose a discrete ranking for group of countries face the problem that the segregation of different categories seems arbitrary or not based on a structured comparison method, e.g.…”

“…Current studies assume that some TP characteristics imply higher tax enforcement by tax authorities, e.g. higher tax penalties and more extensive documentation requirements may denote higher tax enforcement (Beer & Loeprick, 2017;Ignat & Feleaga, 2017;Nicolay, Nusser & Pfeiffer, 2017;Marques & Pinho, 2016;Beuselink, Deloof & Vanstraelen, 2015;Lohse & Riedel, 2013). Therefore, assume the simple linear model…”

“…Current researches aim to analyse the profit shifting behaviour as a function of the cross-country tax differentials and the impact of countries' enforcement levels (Beer, De Mooji & Liu, 2018;Nicolay, Nusser & Pfeiffer, 2017;Marques & Pinho, 2016;Beuselink, Deloof & Vanstraelen, 2015;Lohse & Riedel, 2013). Relevant information about intra-firm transactions and tax rates are overall observable from public reports and from firms' financial statements, thus it is possible to obtain consistent measures for these factors.…”