Abstract
ABSTRACT We investigate tax-induced profit shifting in Brazil and the impact of tax havens on the shifting behavior of firms. Profit shifting research in Brazil is virtually non-existent, although the shifting incentives in Brazil are prominent. Our research fills this gap with evidences in the novel Brazilian context. Profit shifting is a tax-minimization strategy where multinational enterprises perform intra-firm transactions to allocate taxable profits to low-tax locations. Brazil combines a remarking set of profit shifting incentives, especially a high corporate tax rate, extremely complex tax system, and distinguished transfer pricing rules. Further researches may leverage from the shifting incentives in Brazil, since it provides opportunities to investigate additional factors that affect the shifting behavior of firms. We analyze 989 transaction-by-country observations for the period of 2010-2017. Baseline analysis follows the robust least squares approach with controlling covariates. Linear estimate model derives from the conventional Cobb-Douglas production function, to analyze the impact of shifting incentives on profit maximization. We find that Brazilian firms have a high level of intra-firm transactions with related parties located in low-tax countries, especially with tax havens. It represents a strong evidence of profit shifting behavior in Brazilian firms.
Highlights
Profit shifting is a well-known tax avoidance strategy where multinational enterprises (MNE) perform transactions with foreign related parties, to transfer taxable profits from high-tax to low-tax countries
Results show that Brazilian firms have higher volume of transactions with related parties located in countries with lower tax rates, i.e., for two foreign countries, results show that Brazilian firms have higher volume of intrafirm transactions with the country that applies the lower income tax rate
Notice that the marginal penalization rates of substitution between costs ∂Ci/∂m, ∀i,j, and the costs at the right hand side of the equality follow the sign of MNE is able to intensify the net gains from profit shifting the profit shifting direction, Δτ, since the sign of the price by varying production schedules and manipulating deviation Δp indicates which country is being harmed, inventories turnover. This result proofs the following: i.e., Low-transfer-price case (LTP) case implies Δτ < 0, Δp < 0 → z = zi, dD/d(Δp) < 0, while the High-transfer-price case (HTP) case implies Δτ > 0, Δp > 0 → z = zj, dD/d(Δp) > 0. It means that profit shifting always provides a global gain, regardless if it Proposition 2: under optimal conditions regarding the transfer price p* and the marginal rates of substitution between costs ∂Ci/∂m, ∀i,j, increases in intra-firm outputs m always increase the total amount of profit shifting, increasing the global net profits refers to LTP or HTP case, and this gain is increasing up of the MNE
Summary
Profit shifting is a well-known tax avoidance strategy where multinational enterprises (MNE) perform transactions with foreign related parties, to transfer taxable profits from high-tax to low-tax countries. MNE are able to override the anti-shifting rules by taking advantage of the so called “tax havens”, which are jurisdictions with favorable tax regimes and weak tax enforcement, which usually have little to none tax provisions on transfer prices (Desai, Foley, & Hines, 2006; Dharmapala, 2014; Lohse, Riedel,& Spengel, 2012) In this case, the MNE can shift taxable profits away from the high-tax countries while reducing the chances of penalization from the host countries. Results show that Brazilian firms have higher volume of transactions with related parties located in countries with lower tax rates, i.e., for two foreign countries, results show that Brazilian firms have higher volume of intrafirm transactions with the country that applies the lower income tax rate This result is a strong evidence of profit shifting in Brazil, since firms are able to shift taxable profits to foreign countries by means of both mispricing and volume factors (Clausing, 2000; Riedel, 2018). The remaining of this study is structured as follows: section 2 presents a model for the profit shifting incentive, section 3 describes the data and identification strategy, section 4 presents the results, and section 5 concludes
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