Income shifting and corporate taxation: the role of cross‐border intrafirm transfers

Abstract

PurposeThe purpose of this paper is to examine the cross‐sectional relation between the value of cross‐border intrafirm transfers (CITs) and three dependent variables: return on investment (ROI), the US effective tax rate (ETRUS), and the global effective tax rate (ETRGL) to assess the existence or nonexistence of cross‐jurisdictional income shifting.Design/methodology/approachRegression analysis is used to test the relationship between CIT and accounting performance and effective tax rates.FindingsThe results indicate that ROI and ETRUS increase whereas ETRGL decreases with the extent of CITs after we control for variables that impact earnings and taxes (e.g. size, industry classification, internationalization, tax shelter, and growth). This suggests that firms earn income, on average, in jurisdictions with tax rates greater than the USA, such that diverting income from overseas to the USA is a tax‐saving action. The tax results are consistent with Jacob and Mills and Newberry's findings that firms shifted income into the USA. The results also reveal that companies that engage in CITs are those that are large, relatively more profitable, and pay more US taxes.Research limitations/implicationsThis study does not differentiate between transfer pricing schemes for tax minimization reasons from those done for earnings management purposes, which should be addressed by future research.Practical implicationsResults have public policy implications as an understanding of how CITs affect accounting performance and taxes is important for the craft of tax policy and transfer price regulation.Originality/valueThis study furthers our understanding of the impact of CITs on earnings and taxes, an important component of accounting research which has not been properly addressed by prior studies.

Multinationals' income shifting decisions, taxes and intra-company transfers: empirically testing market valuation

“…Intra-firm inter-geographic area transfers proxy for income shifting because firms can artificially set transfer prices to report higher income in lower tax jurisdictions and less income in higher tax jurisdictions (see Jacob, 1996;Klassen et al, 1993;Olibe and Rezaee, 2007;2008). A firm's propensity to shift income abroad increases as the after-tax return in the foreign country increases relative to the after-tax US return.…”

“…They also report that firms that engage in international transfers have higher market-to-book ratios, suggesting that transfers add market value through their effect on earnings and taxes. Olibe and Rezaee (2008) examine the cross-sectional relation between the value of transfers and three dependent variables: Return on Investment (ROI), the US effective tax rate (ETRUS), and the global effective tax rate (ETRGL) to assess the existence of cross-jurisdictional income shifting. They report that ROI and ETRUS increase whereas ETRGL decreases with transfers.…”

“…Intra-firm transfers involve the exchange of products and services within a firm that spans different taxing jurisdictions (Olibe and Rezaee, 2008). By employing artificial transfer prices in these transactions and concentrating debt financing in high tax subsidiaries, a MNC can shift taxable income within its network of subsidiaries, reducing its overall tax liability.…”

“…Under this condition, US MNCs can use intra-firm transfers to shift income away from the USA and designate the shifted income as permanently reinvested. 11 Several studies (e.g., Olibe and Rezaee, 2008;Collins et al, 1998;Klassen et al, 1993) report evidence that multinationals use transfer prices to shift income to low-tax countries, including the USA. 12 Compustat data and cross-checked data yielded similar results.…”

“…We investigate the relation between transfers and foreign pretax profit margin (FOINC) and tax costs (TAX). 3 Several studies (e.g., Olibe and Rezaee, 2008;Collins et al, 1998;Klassen et al, 1993) report evidence that multinationals use transfer prices to shift income to low-tax countries, in some cases including the USA. 4…”