Profit shifting in multinationals:

Transcription

1 Profit shifting in multinationals: In search of evidence Ragnhild Balsvik, NHH Follow the money: Financial secrecy, international taxation and development, CMI 17th October

2 Profitshifting: defined Activity whereby multinationals, by the use of internal transactions are able to shift profits between their affiliates to reduce the overall taxburden of the company. Profit shifting is not necessarily illegal Any textbook on international finance will discuss transfer pricing in relation to taxes Tax planning is big business Probably large grey-zones between legal and illegal tax planning 2

3 Profit shifting: The capital structure channel Debt structure of companies Internal debt shifting: borrowing from affiliates in low-tax countries and lending to affiliates in hightax countries Thin capitalization rules 3

4 Profit shifting: The transfer pricing channel Transfer pricing Prices of internal transactions across borders can be manipulated in order to save taxes Prices on purchases from affiliates abroad are set high if tax rate is high relative to tax rate where the affiliate is located Intra-firm trade accounts for about 60% of world trade: thus the potential for profit shifting through transfer pricing is large The arms length principle 4

5 The role of empirical research in this area Hard to know how much the tax base in a country is affected by profit shifting Hard to get data on illegal activity Quantify the effect of profit shifting on the corporate tax base Understand what mechanisms that are important for profit shifting Results may provide guidelines for policy reform 5

6 The search for evidence Potential data sources Firm level accounting information Tax rates for different countries Multinational status of firms Location of foreign affiliates Firm level trade data with information about products and prices 6

7 Direct evidence Bernard, Jensen and Schott (2006) Compare prices of intra-firm vs arms-length exports from US based multinationals Crucial: information in the customs data about whether trade is with affiliate or not Aim: to explain what drives differences between arms-length and transfer prices (= price wedge) Find: price wedge increases when exporting to countries with lower tax rates that the US Back-of-the-envelope calculation of loss of tax revenue: $ 5.5 billion 7

8 Indirect evidence Compare profitability of domestic firms and multinationals While controlling for as many other differences between domestic and multinational firms as possible Typical finding: multinationals have lower profitability than domestic firms Grubert et al. (1993), Grubert (1997) Addition: relate these differences in profitability to tax differences between countries. Harris et al. (1993), Huizinga and Leuven (2008) 8

9 Indirect evidence from Norway Langli and Saudagaran (2004) Compare the profitability of Norwegian-owned and foreign-owned companies in manufacturing and trade in the years 1993 to 1996 Main finding: foreign owned companies have 2,6 percentage points lower profit margins than Norwegian owned companies Møen and Tropina ( ) Extends the analysis: , and all sectors Main finding: foreign owned companies have 2,4 percentage points lower profit margins than Norwegian owned companies 9

10 Back of the envelope calculations If all companies were domestically owned: how much more tax would be paid? Multiply the estimated difference in profitmargins with sales of the foreign owned companies gives the potential increas in taxable income Multiply this with the marginal tax rate Tax avoidance of 26%, or 15 billion NOK (2008) This estimate is subject to many uncertainties Also uncertain how much of this is due to illegal manipulation of transfer prices 10

11 Summary Clearly multinationals shift profits according to tax incentives Challenge is to document to what extent such profit shifting is illegal Direct evidence using prices of internal and external transactions is prefereable Unfortunately: Norwegian customs data does not contain information about whether trade is with affiliated or unaffiliated party Indirect evidence for Norway suggests that net profits are shifted out of Norway The potential erosion of the tax base is substantial 11