Assessing impact of base erosion and profit shifting on performance of subsidiaries of multinational corporations in Baltic countries

Abstract

Research background: The problem of base erosion and profit shifting by multi-national corporations has been debated from different perspectives because of its multiple impact on the key actors in the economy. Studies refer to its positive impact on companies via corporate taxes saved, but its negative impact on governments via reduced tax collection. A number of empirical studies conducted in different countries support the substantial BEPS impact on company performance, but report differences in its magnitude. Other authors claim that, despite a wide range of tax avoidance opportunities available, tax avoidance is limited due to institutional measures imposed (tax audits, penalties for non-compliance) and high implementation costs. A majority of the previous empirical research covered large countries (USA, Germany) or regions (e.g. Europe), but there is a gap in the re-search assessing the BEPS impact on multinational corporations’ subsidiaries’ performance in countries with lower corporate income tax rates such as the Baltic countries.
 Purpose of the article: To assess the impact of base erosion and profit shifting on multinational corporations’ subsidiaries’ performance in the Baltic countries.
 Methods: Empirical research is conducted based on the framework employed by Hines and Rice (1994) to measure BEPS impact on company performance. Regression analysis with fixed effects was applied to a sample of 3,422 Latvian, Lithuanian and Estonian subsidiaries of multinational corporations, which are characterized by low corporate tax rates. The data for the period of 2007–2015 was retrieved from the Amadeus database.
 Findings & Value added: The research revealed that Baltic countries’ tax differentials between multinational corporations’ parent and subsidiary countries might have a significant impact on the subsidiary’s financial performance. When the tax rate differences between Baltic and the foreign countries decrease by 1%, reported profits in Baltic countries increase by 2.3%, indicating profit-shifting behaviour. This is in line with the empirical literature and practices applied by multinational corporations. It is also in favour of anti-tax avoidance measures introduced by the EC to be adopted by Baltic and other EU countries.

Assessing Profit Shifting in Lithuanian Firms

“…Based on median values, 10% increase in difference of statutory tax rates between host and parent countries explains 1.26 times higher pre-tax earnings of multinational subsidiary in Lithuania. This is in line with our previous research [5]. Estimated impact remained robust across few tax variable specifications.…”

Debt or Profit Shifting? Assessment of Corporate Tax Avoidance Practices across Lithuanian Companies

“…In this study, the indirect method was based on Hines and Rice (1994), as firm-level information on intra-firm transfer prices for Lithuanian companies was unavailable. The current study continues our previous research of corporate tax avoidance in Lithuania (Kundelis & Legenzova, 2019;Kundelis et al, 2021). Our study is in line with Nicolay et al (2017), who was one of the first to construct an empirical study employing two empirical models: profit shifting via transfer pricing manipulation and debt shifting to test the substitution between those two channels.…”

“…Empirical studies also demonstrate that MNEs and their subsidiaries use transfer pricing manipulation to shift profits within a group from high-tax to low-tax countries (Clausing, 2003). As discussed in our previous research (Kundelis & Legenzova, 2019), empirical studies (Hines & Rice,1994;Huizinga et al, 2008;Lohse & Riedel, 2013;Dischinger et al, 2014;Casillo-Murciego & López-Laborda;2017;de Mooij & Liu, 2020, etc. ) found evidence of the significant yet varying in its scope impact of tax differentials on company's debt shifting and transfer mispricing activities.…”

“…Therefore, the evidence suggests profitability be negatively related to the corporate tax rate. In our previous research (Kundelis & Legenzova, 2019), indirect evidence of profit-shifting behaviour was documented by comparing the effective tax rates between parents and subsidiaries operating Baltic other countries and profits reported by sample companies operating in Baltic countries and showed that decrease of tax differential by 1%, resulted in 2.3 increase in profits reported in Baltics.…”

Earnings management: Local or global phenomenon in the Visegrad Four?

“…Four models are employed to estimate the level of discretional accruals and real earnings management. [18] assess the impact of base erosion and profit shifting on multinational corporations' subsidiaries' performance in the Baltic countries. [19] examine the impact of multiple block holders on earnings management when the main conflict of interest is between controlling shareholder and other shareholders.…”