Wealthy individuals and multinational corporations utilizing low effective tax rates, lax regulatory standards, and secrecy to offshore their taxable profits to reduce home country tax bills are able to shift them offshore in order to reduce home country taxes bills. We find using publicly available trade data that service trade between tax haven affiliates is six times larger than between non-haven affiliates even after controlling for standard trade determinants.
Profit Shifting
Profit per worker in haven economies (excluding Puerto Rico and the Isle of Man ) is over twice that seen in non-haven countries, which helps explain why global MNE profits are so much higher than expected if foreign income reflected real economic activity abroad.
Base erosion and profit shifting – using tools such as transfer pricing manipulation and deductible payments – cost countries approximately USD 100-240 billion annually in lost tax receipts, representing 4-10% of global corporate income tax receipts. It reduces both voluntary compliance by multinational enterprises (MNEs) as well as the legitimacy of international taxation regimes.
Garcia-Bernardo and Jansky estimate the scale of profit shifting using country-by-country reporting (CbCR) data. To account for its nonlinear relationship between profits location and backward-looking effective tax rates, this model yields an estimate of how much revenue multinational enterprises (MNEs) shift into havens with zero or low corporate income taxes.
Intra-firm Service Trade
According to the OECD, intrafirm trade in more sophisticated products and services such as chemicals or machinery and transport equipment accounts for an estimated 60% of global trading. This type of trade runs contrary to basic ideals of market economies and thus makes implementing arm’s length principles difficult for states.
We examine the determinants of corporate trade patterns and examine their influence on international taxation. Our study indicates that choosing an optimal corporate form depends both on local knowledge as well as tax costs/benefits such as taking advantage of tax treaties.
Microdata on foreign direct investment (FDI) relationships between affiliates enables us to investigate these two factors and their interaction. When considering Taxwedge against Profit distribution, higher distribution increases Taxwedge-Flow-through relations – supporting our hypothesis that multinational corporations with deeper local knowledge tend to be more sensitive to tax costs.
Intra-firm Trade with Affiliates
An important hallmark of international trade is its concentration between affiliates rather than with non-affiliates. This intrafirm trade violates market economy ideals and, as a result, constitutes one of the main causes of tax evasion.
Previous studies examining the impact of taxes on organizational form relied solely on country or firm-level data without taking into account that foreign affiliates could take various legal forms, including subsidiaries or flow-throughs.
Microdata on foreign affiliates allows us to examine how taxation influences legal form selection for foreign affiliates and how this impacts trade patterns within and between firms. The results support our prediction that new affiliates established as flow-throughs are less likely to import from parent firms and display reduced risk-taking, loss propensity and investment costs as well as lower profitability than their parent firms.
These results support the theory that taxation determines how much of a parent firm’s sales should be allocated to its foreign affiliates, while also suggesting that tax wedges play an integral part in multinationals determining where to set up new foreign affiliates.
Trade with Non-affiliates
Tax havens provide an appealing avenue for individuals and corporations seeking to evade paying their taxes; this can sometimes involve illegal practices that lead to money laundering and other activities which damage global economies in the long run.
We employ firm-level data on service trade and foreign affiliates to examine the role of tax havens in international taxation. The results indicate that multinational firms use their tax haven subsidiaries as an indirect way to transfer profits through service trade – evidence suggests this propensity towards imports in services categories like intellectual property (patents and trademarks), headquarter services, information services and financial services (investments, lending and money management).
It has become clear to all: tax havens are far bigger and more integral to global economies than anyone ever imagined, as well as having severe economic and political ramifications.
