Multinationals and pro t shifting:

Transcription

1 Multinationals and pro t shifting: 60 ways to cheat the tax man Guttorm Schjelderup* Norwegian School of Economics and Norwegian Center of Taxation* Uppsala May 14, 2014 Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

2 Background I Empirical studies: multinationals pay less tax than domestic rms. Burden of the corporate tax falls to a greater extent on domestic rms Consequences for the outcome of competition, ownership structure and intensity of competition. 60 pct of world trade is between a liates of multinationals so ample opportunity to manipulate prices on tangible and intangible goods Corporate tax systems and transfer pricing Separate accounting (SA); Widely used, but vulnerable to transfer pricing Formula apportionment (FA) Used in some federations (e.g., US, Canada, Switzerland); Renders transfer pricing useless but imply other tax distortions Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

3 Separate Accounting Total income by the MNC is divided among its a liates based on each a liate s accounts and the application of an arm s length pricing standard for intra- rm transactions. π = (1 t A ) π A + (1 t B ) π B If t A < t B rm wants to shift income to country A No restriction on the transfer price (TP) then optimal TP ) π B = 0 Transfer pricing and debt shifting are main instruments to shift income Correct price is the arm s length price (ALP), i.e., the price that independent parties would agree on (OECD double tax convention) Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

4 Formula Apportionment Pro t income in each state is consolidated into a single pro t measure and divided (apportioned) across states based on activity weights such as sales, capital payroll etc. KA π = (1 t A ) (π A + π B ) K A + K B Let k i = K i / (K A + K B ) and π = π A + π B, then + (1 t B ) (π A + π B ) π = π [(1 t A ) k i + (1 t B ) (1 k i )] KB K A + K B Increasing the value of π A by overinvocing sales to the a liate in B will not reduce tax payments, since it will be followed by an equal increase in π B so that size of π = π A + π B is unchanged. Tax distortion: incentive to invest less in the high tax country Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

5 Debt shifting Tax savings arises because tax deductions in high-tax countries exceed the corresponding tax payments in low-tax countries (let R = interest rate, K = capital) t B RK {z } tax savings deductions t A RK {z } > 0 if t B > t B tax obligation debt shifting creates a money machine restricted by taxable income to deduct interest expenses against, and/or thin capitalization/interest deduction limitation rules Multinationals use internal debt (debt between a liates) can be alikened to equity except for that equity does not carry interest (so debt is the preferred mode of nancing) Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

6 Example of debt shifting: Belgium Norwegian state owned multinationals: Statoil and Statkraft Statoil internal bank (coordination center) is in Mechelen/Belgium Serves 130 a liates worldwide/surplus 300 Mill. Euro (2008) O cial statement: "streamlining" of nancial management Implicitly; Statoil is better at banking than banks (tailormaking) Belgian coordination regime is very popular The tax base is costs minus wages and nancial costs No taxation of revenue E ective tax rate very low Regime deemed harmful (EU Commission) Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

7 An simple model of transfer pricing Nielsen, Schindler and Schjelderup (2013); Multinational consisting of two rms A and B located in country A and B. Firm A produces an intermediate input S at marginal cost q with a linear production technology and the use of equity only (can be relaxed), and ships it at a price G + q to a liate B that sells it locally Pro t of a liate A is π A = (1 t A ) [(G + q) S qs] = (1 t A ) GS so pro t is the mark-up above marginal cost G (perfect competition so if the intermediate was traded its true price is q) Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

8 Firm conceals true TP; government wants to detect it Firm B conceals the true cost of the input good S by exerting costly e ort c. De ne the costs of e ort by e = e(c, l), l is a parameter for the quality of the tax code; A high l increases the e ort-related costs of concealing mispricing; e cl > 0. Concealment costs are convex in concealment e ort c, i.e., e c, e cc > 0. Tax authorities exert detection e ort d which a ects the probability (p) of detecting abusive transfer pricing p = p(g, S, c, d) 2 [0; 1] with p G, p S, p d > 0 and p c < 0. Firm is ned if abusive pricing is detected. Fine is Φ = Φ(G, S) and non-increasing in its arguments. Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

9 Firm B pro ts No detection. If abusive transfer pricing is not detected by the tax authorities, the after-tax pro t π B n in a liate B is π B n = (1 t B )[F B (K, S) (G + q)s e(c, l)] RK, where R is the constant world market interest rate and where the rm is nanced by equity which is not tax deductible. Detection. In the case that tax authorities detect that the transfer price deviates from the arm s length price (market price), a liate B s after-tax pro t (π B d ) is given by π B d = (1 t B )[F B (K, S) (G + q)s e(c, l) Φ(G, S)] RK. Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

10 Maximization where max K,G,S,c E[Π] = πa + [1 p(g, S, c, d)]π B n + p(g, S, c, d)π B d = (1 t B )[F B (K, S) qs] RK +(t B t A )GS (1 t B )C (G, S, c, d, l) C (G, S, c, d, l) e(c, l) + p(g, S, c, d)φ(g, S) is the sum of the concealment e ort cost and the expected ne (t B t A )GS is the net tax gain from shifting pro t to country A. Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

11 Benchmark Country B has weak institutions so that p (:) = e(c, l) = Φ(G, S) = 0. Then max Π = (1 t A) GS + (1 t B )[F B (K, S) (G + q)s] RK K,G,S,c Optimal G implies leaving zero taxable income in rm B; [F B (K, S) (G + q)s] = 0, GS = F B (K, S) qs h max Π = (1 t A) F B (K, S) K,S S : F B S = q K : F B K (K, S) = R (1 t A ) i qs RK We now turn to strong institutions p > 0; e(c, l) > 0; Φ(G, S) > 0 Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

12 Optimal concealment e ort (c) max K,G,S,c E[Π] = πa + [1 p(g, S, c, d)]π B n + p(g, S, c, d)π B d = (1 t B )[F B (K, S) qs] RK +(t B t A )GS (1 t B )C (G, S, c, d, l) (1 t B ) C c = 0, e c (c, l) = p c (G, S, c, d) Φ(G, S). (1) {z } p c <0 The rm balances marginal e ort costs of its investment into concealing (e c ) and the marginal return from reducing expected nes on abusive transfer pricing, that is to the decrease in the detection probability times the ne payment (right hand side) Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

13 Optimal capital investment (K) Maximizing expected pro t E[Π] w.r.t. the optimal transfer price (K ) yields FK B R (K, S) = (1 t B ). (2) The right-hand side is the marginal productivity of capital (FK B ), while the left-hand side is the e ective marginal cost of capital. Since equity is not tax deductible, the required return to capital is higher than the interest rate R. Trade mispricing (G 6= 0) only a ects the demand for capital via the use of the intermediate good S in the production function. Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

14 Optimal transfer price (G) Maximizing expected pro t E[Π] w.r.t. the optimal transfer price (G ) yields (t B t A )S = (1 t B ) C G, (3) The transfer price should be increased until the marginal tax savings from transfer pricing (left-hand side) is equal to the after-tax marginal concealment costs (right-hand side). Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

15 Optimal production of intermediate good (S) Maximizing expected pro t E[Π] w.r.t. the optimal transfer price (S) yields 2 3 FS B = 6 4 q (t B t A )G + C 7 1 t B S 5. {z } =0 if t A =t B marginal income from sales of the nal good in country B (LHS) equal to net e ective after-tax marginal costs of using S. The marginal costs of S consist of the three terms 1. The true resource costs q of the input good S. 2. (t B t A )G / (1 t B ) is the net tax savings of a marginal increase in the import of the intermediate good S. 3. C / S, which is the increase in concealment costs following a marginal increase in S Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

16 Rewriting the optimal S condition Using the foc for the optimal transfer price G to substitute for (t B t A )/(1 t B ), we obtain C FS B = q + S G C = q S G C (G, S, c, d, l) S (ε CS ε CG ), where we de ne the concealment-cost elasticities of input manipulation and trade mispricing as ε CS = C S S C 0 and ε CG = C G G C 0 If (ε CS ε CG ) = 0 then FS B real activity In general; = q and transfer pricing does not a ect C S G C S G 6= 0, ε CS 6= ε CG. Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

17 Concealment costs based on income evaded (I) In the personal income tax literature the probability of detection is an increasing function of undeclared income (e.g., Allingham and Sandmo 1972, Kleven et al. 2011). In our setting this would imply that the probability of detecion was based on the amount of income evaded; P = G S; C (G, S, c, d, l) = C (P, c, d, l) = e(c, l) + p(p, c, d)φ(p) where P = G S C G = [p P (P, c, d)φ(p) + p(p, c, d)φ0 (P)]S as C S = [p P (P, c, d)φ(p) + p(p, c, d)φ 0 (P)]G ag Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

18 Concealment costs based on income evaded (II) Substituting C G C = as and S = ag into C FS B G C = q + S S G {z } G S as +ag =0 Proposition When the cost of concealing transfer pricing depends on tax payments evaded, the transfer price neither a ects the use of the intermediate input S nor capital investments K B. Hence, the rm s real investment decision is not a ected. The tax savings and the e ective marginal concealment costs from manipulating either S or G are identical. Using S to shift pro t causes an ine ciency loss in production that makes it optimal to only use only G Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

19 Concealment costs based on deviation from ALP (I) True price is q so any deviation from the arm s length price means G 6= 0. C (G, S, c, d, l) = e(c, l) + p(g, c, d)φ(p), where P = GS as before, but p () depends on G and not P. Then C G = p G (G, c, d)φ(p) + p(g, c, d)φ 0 (P)S, C S = p(g, c, d)φ 0 (P)G. C S G C S G = G S p G (G, c, d) (P) < 0 {z } + Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20

20 Concealment costs based on deviation from ALP (II) Using this in the rst-order condition for the optimal use of S, we obtain C FS B G C = q + (4) S S G FS B G = q S p G (G, c, d)φ(p) < q. (5) Proposition When the probability of detection focuses on deviations from the true arm s-length price and places no emphasis on pro ts shifted, abusive transfer pricing has real e ects on the use of the input good (S) and investments (K ). Schjelderup. (NHH and NoCeT) Base Erosion by Multinationals Uppsala May 14, / 20