Intangible Income, Intercompany Transactions, Income Shifting, and the Choice of Location

Abstract

The links between intangible income, intercompany transactions, income shifting and the choice of location are investigated using data on U.S. parent corporations and their manufacturing subsidiaries. The objective is to better understand the income shifting process and its implications. In particular, do opportunities for income shifting distort "real" behavior such as the choice of location and the volume of intercompany transactions? Do prospective benefits from income shifting change behavior in both high-tax and low-tax locations? The results present a coherent, consistent picture. Income derived from R&D based intangibles accounts for about half of the income shifted from high-tax to low-tax countries. R&D intensive subsidiaries engage in a greater volume of intercompany transactions and, therefore, have more opportunities for income shifting. In addition, subsidiaries in locations with either very high or very low statutory tax rates, with a strong incentive to shift income in or out, also undertake a significantly larger volume of intercompany transactions. Finally, R&D intensive U.S. parent companies respond to the opportunities for income shifting by investing in countries with either very high or very low statutory tax rates. As a sidelight, we find that the allocation of debt among subsidiaries and the shifting of R&D based intangible income together account for virtually all of the observed difference in profitability between high and low tax countries.

Capital Mobility and Capital Tax Competition

“…Much empirical evidence suggests that multinational enterprises and multistate corporations (in the absence of unitary combination) have considerable latitude in reallocating profits across jurisdictions in response to tax differentials through the use of various financial accounting manipulations, including the use of transfer prices, loans and other intercompany transactions, and judicious allocation of general expenses (Hines, 1999;Grubert, 2002, 2004;Grubert, 1998Grubert, , 2003Bartlesman and Beetsma, 2003;Buettner and Wamser, 2007;Hines, 2004, 2006) and that such income shifting is increasing over time (Altshuler and Grubert, 2006). The benefits of income shifting are determined primarily by the statutory tax rate, as firms face obvious incentives to shift revenues to jurisdictions with relatively low statutory tax rates and deductions to jurisdictions with relatively high statutory tax rates.…”

Anti profit-shifting rules and foreign direct investment

“…There is also evidence that firms adjust prices for intrafirm trade, so called transfer prices, to lower the tax base in high-tax countries (e.g., Swenson, 2001;Bartelsman and Beetsma, 2003;Clausing, 2003). The extent to which this is possible, however, varies across industries, and intrafirm transactions related to roy-alty payments, R&D, intangible assets, or advertising are found to be particularly tax-sensitive (Harris, 1993;Grubert, 2003;Dischinger and Riedel, 2011).…”

Fixing the System: An Analysis of Alternative Proposals for the Reform of International Tax

“…32 Grubert and Slemrod (1998) use a similar cost of shifting function to examine how income shifting opportunities can impact the after-tax profits of operating in Puerto Rico. Grubert (2003) derives the cost of capital for investments in low and high tax countries using a model in which intercompany transactions provide the opportunity for income shifting. He also uses a quadratic cost of shifting function.…”