Unprofitable Affiliates and Income Shifting Behavior

Abstract

Income shifting from high-tax to low-tax jurisdictions is considered a primary method of reducing worldwide tax burdens of multinational firms. Current losses also affect income shifting incentives. We extend prior approaches by explicitly considering unprofitable affiliates and test whether the association between losses and tax incentives for unprofitable affiliates deviates from the negative association observed in profitable affiliates. Results suggest that multinational firms alter the distribution of reported profits to take advantage of losses. Our point estimate for profitable affiliates implies that an increase of one standard deviation in the tax incentive, C, of an affiliate with an average return on assets of 13.3 is associated with a lower return on assets of 0.5 percentage points. The same change in tax incentive of an unprofitable affiliate is associated with an increase in its return on assets of approximately 0.7 percentage points, holding assets, labor, productivity, and other factors constant. We further document a larger responsiveness to tax incentives between profitable and unprofitable affiliates in high-tax jurisdictions, consistent with predictions.

How Quickly Do Firms Adjust to Optimal Levels of Tax Avoidance?

“…De Simone et al () also provide a clear example of how managers adapt tax avoidance strategies in response to a change in the firm's financial performance. They propose that the existence of unprofitable affiliates temporarily changes the income shifting incentives of multinational firms.…”

Conflicting Transfer Pricing Incentives and the Role of Coordination

“…We follow the extant transfer pricing literature and exclude unprofitable affiliates and unprofitable U.S. parents (and their affiliates) because the income‐shifting incentives for entities with losses are less clear (e.g., De Simone et al. ; Power and Silverstein ) . Finally, we delete affiliates we cannot classify as either a net buyer or a net seller with its U.S. parent and exclude observations missing gross domestic product information.…”

Governance and Taxes: Evidence from Regression Discontinuity (Retracted)

“…To investigate this possibility, we investigate the timing of the effect, where we expect to see some delay in response, if, in fact, real behavior is changing. Table 5 shows how the effect of institutional ownership varies in the first, second and third years following index reconstitutions for the 6 There is nonetheless some incentive for loss firms to set up tax haven subsidiaries to prepare for future profits and also to engage in more complicated loss shifting strategies, as studied in De Simone et al [2014]; however, it may be difficult to observe such strategies without more disaggregated data. main effects we have identified so far-cash ETR, GAAP ETR and the use of tax havens.…”