The Direct and Indirect Costs of Tax Treaty Policy: Evidence from Ukraine

Abstract

We combine macro and micro data to quantify the revenue effects of Double Tax Treaties (DTT). First, drawing on administrative information, we estimate the tax sensitivity of income flows (dividend, interest and royalty payments) at an aggregate level. We find important direct revenue costs linked to treaty restrictions on taxing rights, in particular with respect to flows into a small number of major investment hubs. Importantly, however, high elasticities of income flows also suggest that increases of withholding rates at the individual treaty partner level would not necessarily result in more revenue collection. Second, we use firm-level information to estimate the sensitivity of reported profitability to changes in the relevant treaty network. Our analysis of reported MNE affiliate earning in Ukraine suggests that the ownership structure and operations with affiliates in certain jurisdictions explains reported profitability and should thus receive increased attention in risk assessment and transfer pricing audit activities.JEL codes: F21, F23, H25, H26, H32

Estimating the revenue costs of tax treaties in developing countries

“…We make this assumption because we do not have data available to estimate this sensitivity. However, we do discuss the potential implications of it, with reference to the empirical estimates of the same sensitivity for Ukraine by Balabushko, Beer, Loeprick, & Vallada (2017). Due to this and other assumptions, including the need to disaggregate the IMF's unilateral FDI income data into bilateral data, our estimates are only illustrative and imprecise, much like the existing estimates for the Netherlands and Bangladesh.…”

“…Most recently, the World Bank's Balabushko, Beer, Loeprick, & Vallada (2017) provide perhaps the most rigorous quantification of the revenue effects of tax treaties for one country, Ukraine. They exploit administrative data to estimate the tax sensitivity of dividend, interest, and royalty payments.…”

“…In this paper we thus provide estimates of how much revenue would increase if a higher withholding rate applied. However, in contrast with Balabushko, Beer, Loeprick, & Vallada (2017) for Ukraine, we do not have access to such detailed data for the developing countries in our sample and we do not provide estimates of how much the investments and the associated tax base would change and what revenue implications this would have if there were a tax treaty change. The investments and the associated tax revenue would likely decrease following the increase in an applicable withholding rate, and we use the potential scale of this adjustment estimated by Balabushko, Beer, Loeprick, & Vallada (2017) while discussing our results below.…”

“…However, in contrast with Balabushko, Beer, Loeprick, & Vallada (2017) for Ukraine, we do not have access to such detailed data for the developing countries in our sample and we do not provide estimates of how much the investments and the associated tax base would change and what revenue implications this would have if there were a tax treaty change. The investments and the associated tax revenue would likely decrease following the increase in an applicable withholding rate, and we use the potential scale of this adjustment estimated by Balabushko, Beer, Loeprick, & Vallada (2017) while discussing our results below. For Ukraine and its five most important partner countries in a given payment, they estimate the losses at 144 (and 169 without reflecting the behavioural change) million US dollars in 2014 for dividends and at 52 (and 184) million US dollars in 2012 for interest payments.…”

The Cost and Benefits of Tax Treaties with Investment Hubs: Findings from Sub-Saharan Africa

“…By quantifying the revenue implications of treaty-shopping, we add to recent assessments of the costs associated with tax treaties. Country-specific estimates have, for instance, been provided for Dutch treaties (McGauran, 2013), and the Ukraine (Balabushko et al, 2017). More recently, Jansky and Svidivy (2018) find that costs in terms of revenue foregone amount to up to 0.2 percent of GDP in some countries.…”