Tax Arbitrage Research Articles

Globalization and taxation: Implications on national tax policies and international tax competition

This review examines the profound impact of globalization on national tax policies and the ensuing tax competition among countries. Globalization, characterized by increased economic integration and cross-border capital and labor mobility, has significantly influenced national tax structures and policies. Countries are compelled to adapt their tax systems to remain competitive in attracting and retaining investments, leading to a shift from traditional income taxes to consumption-based taxes and adjustments in corporate tax rates. This competition often results in a "race to the bottom," where countries continuously lower tax rates to outbid each other, thereby affecting government revenues and public service funding. The review explores how globalization erodes traditional tax bases, creating challenges for national policymakers who must balance the need for competitiveness with revenue requirements and equity considerations. Through case studies, the effects of tax competition are analyzed, highlighting the outcomes of various national strategies in attracting global capital. Additionally, the role of international tax treaties and agreements in shaping global taxation dynamics is scrutinized. Treaties aimed at avoiding double taxation and preventing tax evasion, such as those orchestrated by the OECD’s Base Erosion and Profit Shifting (BEPS) initiative, and EU tax policies, are pivotal in harmonizing tax rules and reducing tax arbitrage opportunities. These agreements foster international cooperation, attempting to create a more stable and fair global tax environment. The interaction between national tax policies and global agreements is complex, involving coordination and occasional conflict. The effectiveness of these international efforts in addressing the challenges posed by globalization is assessed, considering both successes and limitations. Emerging trends, such as the taxation of the digital economy and the increasing involvement of developing countries in global tax discussions, are also explored. The review provides insights into the dynamic interplay between globalization and taxation, offering recommendations for policymakers to navigate the intricate global tax landscape. Future challenges and opportunities are discussed, emphasizing the need for continued international cooperation and adaptive national policies. Keywords: Globalization, National Tax Policies, Tax Competition.

Shareholder value orientation, corporate cash piles, and the myth of financial accumulation

Financialization scholars argue that the growing financial balance sheets of non-financial corporations indicate a “financial turn in accumulation” driven by the rise of shareholder value orientation (SVO). In this paper, I test whether greater shareholder influence or shareholder-aligning managerial incentives can explain the more rapid accumulation of financial assets among US NFCs. I find that shareholder power is associated with some increase in short-term financial assets but only in the case of certain shareholder types, in particular high turnover institutional investors. The magnitudes of the effect are small however, and only pertain to smaller firms. Moreover, ownership concentration by these impatient investor types is declining. The results suggest that changing corporate governance patterns have little capacity to explain balance sheet financialization. I argue that mainstream accounts focused on the precautionary savings of new, research-intensive firms and tax arbitrage amongst multinationals offer a better explanation for growing financial balances than the financial accumulation hypothesis. Neither of these imply a substitution of financial for real investment, which calls into question an important mechanism thought to connect financialization to secular stagnation and rising inequality.

Drivers of tax avoidance by MNEs in the developing countries under the digital economy: a modified-TISM approach

PurposeThe present research identifies a total of nine factors influencing tax avoidance under the international taxation regime of the developing countries and establishes a hierarchical relationship through modeling of the identified factors using modified-total interpretive structural modeling (M-TISM).Design/methodology/approachDue to “scale without mass” properties of the digital economy, businesses reduce their physical presence in the countries of economic activities. Aided with digital features, multinational enterprises (MNEs) avoid, abolish, or adopt flexible tax burden in the developing nations through by-passing the permanent establishment condition for company taxes or the income characterization prerequisite for royalty taxation. The present research endeavors to identify the drivers of tax avoidance in the developing countries, especially exacerbated due to digital technologies (economy). In addition, the authors also examine the hierarchical relation between the extracted drivers of tax avoidance.FindingsThis research presents a considerable driving force of elements like historical foundation of tax-treaties, dominance of the developed countries, influence of trade bodies in policy matters and finally information and communications technologies (ICTs).Originality/valueIdentified elements drive the actors like professional enablers, tax havens, international organizations, and intangible assets in the form of intellectual properties (IPs) which act upon tax arbitrage situations both under the domestic and treaty regulations, finally culminating into profit shifting, tax manipulations or avoidance.

Carbon taxes and the geography of fossil lending

Using data on syndicated loans, we find that the introduction of a carbon tax is associated with a decline (increase) in bank lending to coal, oil, and gas companies in domestic (foreign) markets. This manifestation of tax arbitrage is particularly pronounced for banks with large fossil-lending exposures, suggesting a role for bank specialization. Lending to private companies in foreign markets increases relatively more, implying bank incentives to avoid public scrutiny. We also find that banks reallocate a relatively larger share of their fossil loan portfolio to countries with less strict environmental regulation and bank supervision.

Tax‐efficient supply chain allocation in a competitive environment

AbstractMany regulations have been enacted to prevent the multinational firm's (MNF's) tax avoidance and cause the enforcement cost of incoming shifting. This paper investigates the impact of the enforcement cost on a firm's tax‐efficient supply chain allocation strategy, wherein the firm can either create a research and development (R&D) center that innovates the intangible assets or create a distributor that acts as a marketing hub, in a low tax region to explore tax arbitrage. We show that when the firm engages in market competition and the impact of the enforcement cost is low, it prefers to create a distributor in the low tax region to align the benefits of tax saving and internal coordination. While if the impact of the enforcement cost is high, the firm prefers R&D center in the low tax region that can effectively mitigate the enforcement cost and achieve tax saving. When the market competition becomes more intense, the firm becomes more likely to choose R&D center in the low tax region to alleviate market competition. In this scenario, the social welfare is always higher when the firm allocates distributor in the low tax region. When an external supplier exists, the firm is still more likely to choose R&D center in the low tax region to reduce the supplier's wholesale price. What's more, in the presence of external supplier, the social welfare can be higher under either allocation format.

Competing multinationals’ backshoring decisions: Tax arbitrage versus production reliability tradeoff

In the post-pandemic era, global supply chains are increasingly experiencing disruptions. To mitigate the effects of production disruptions, many multinational firms (MNFs) are centralising their supply chains by removing production subsidiaries back to the domestic countries (i.e. backshoring), at the expense of tax arbitrage benefits. This study conducts an analytical game-theoretical model to examine competing MNFs’ incentives to backshore, considering the trade-off between tax arbitrage and production reliability improvement. The MNFs’ equilibrium backshoring decisions, corresponding production quantities, and transferring prices are derived. We find that lower geographic tax differences and higher foreign country (or lower domestic country) disruption rates will jointly incentivise the MNFs to backshore; however, this does not guarantee higher expected profits for the two competing MNFs. The setting of symmetric MNFs could also result in the asymmetric equilibrium of backshoring strategy when the disruption risks in the same country are more correlated, which is induced by the competition mitigation incentives. Additionally, we find that backshoring always benefits customer surplus but may be detrimental to social welfare. Moreover, we endogenize the tax rate and investigate the government's tax regulation design problem. A main finding is that inducing MNFs’ backshoring by setting low tax rates would be unwise for the government under some conditions. To check the robustness of the main model, several extensions are also discussed.

Offshore FDI, tax havens, and productivity: A network analysis

AbstractResearch summaryMultinational enterprises (MNEs) use tax havens to benefit from international tax arbitrage and increase their capital efficiency. These activities are purported to distort global financial markets, erode national corporate tax bases, and are singularly targeted in the media. Despite this, MNEs continue to increase the dispersion of their tax haven activities by investing in multiple tax havens. We study how this dispersion affects home and host country productivity. We model the inward and outward offshore foreign direct investment (FDI) networks using longitudinal data on 212 countries. We find that increasing dispersion leads to productivity losses at home but productivity gains in the host country. Further, increasing the prominence of home and host countries in the offshore network, by connecting with central, well‐developed tax havens, improves their productivity.Managerial summaryIs offshore FDI routed through tax havens always unproductive to the MNEs' home and host countries? While governments attempt to contain such investments, MNE managers disperse them into multiple tax havens and continue benefitting from tax arbitrage. We show that all offshore FDI is not unproductive. As managers route their investments through multiple tax havens, their home countries may experience productivity losses, but the host countries receive productivity gains. Further, using central, well‐established tax havens bring productivity gains to both home and host countries. We thus show that MNEs' home countries need to reassess their offshore FDI policies since several of them also host these investments. Our paper extends a multilateral perspective on offshore FDI and possible benefits attainable, particularly from central tax havens.

FDI and Tax haven: A network analysis of productivity effects

Multinational Enterprises (MNEs) often use tax havens to benefit from the tax arbitrage opportunities. However, these activities distort the global financial markets and erode national corporate tax bases. These outcomes may adversely impact the level of economic activity and the productivity of the MNEs' home countries. More recently, MNEs have been increasing the dispersion of their tax haven activities to either obscure their tax arbitrage activities or because other tax havens offer different risks/opportunities. However, the home-host bilateral view used to examine the impact of tax havens assumes all such ties are homogenous and fails to capture the effect of this dispersion. By adopting a multilateral perspective and using longitudinal data of over 200 UN member countries between 2001-2012, we capture the differential impact of increasing centrality and prominence of the home country and host country in the offshore OFDI and IFDI network. We argue that increasing the centrality of the host country increases the financial efficiency of its MNEs and positively impacts its productivity. However, such activities appear motivated by capital gains rather than knowledge generation. In contrast, since MNEs use tax havens to park funds and minimize taxes, increasing the centrality of the home country negatively impacts its productivity. Moreover, we find that controlling for financial development attenuates the capital efficiency gains for both home and host country from their ties to tax havens and turns the relationship between ties to tax havens and productivity of home and host country unambiguously negative. We find support for these arguments.

Optimal Taxes under Private Information: The Role of Inflation

AbstractOnce explicit information available to the taxing authority and incentives associated with private information problems are explicitly taken into account, only a limited set of policy instruments are consistent with agents not engaging in side trades. Within this spirit, we study the role of taxes and inflation in minimizing the dead‐weight loss associated with the provision of good incentives and other market imperfections when fiat money is essential. When the government has a rich information set and can observe savings, effort, and consumption in frictionless markets, the constrained efficient allocation can be achieved with affine history‐dependent consumption taxes. Thus, monetary policy is redundant. In contrast, when the government observes sales, rather than actual consumption, a tax arbitrage exists. Uniform affine consumption taxes prevent side trades. We also find that a deviation from the Friedman rule is optimal as it helps induce truth‐telling and alleviate a pecuniary externality. However, optimal monetary and fiscal policies in this setting cannot implement the constrained efficient allocation.

Literature Review: Addressing Tax Arbitrage With Hybrid Financial Instruments. A Multidisciplinary Study and Proposal for Developed and Developing Countries, M. Scherleitner. Amsterdam: IBFD. 2020.

Literature Review: Addressing Tax Arbitrage With Hybrid Financial Instruments. A Multidisciplinary Study and Proposal for Developed and Developing Countries, M. Scherleitner. Amsterdam: IBFD. 2020.

Taxes and tax‐exempt bonds: A literature review

AbstractThis article reviews and synthesizes the academic literature on income tax exemptions for interest income derived from state and local (municipal) bonds. It explores a large body of work that evaluates the impact of federal and state tax exemptions on the borrowing costs of state and local governments. It also considers how the tax exemption influences municipal financing decisions, its distributional impacts, and potential for tax arbitrage schemes. It concludes with a discussion of the viability of eliminating the tax exemption entirely or transitioning the preference to a tax credit mirroring municipal bonds sold under the Build America Bond (BAB) program.

Tax Sovereignty and Investor Protection: Why the Proposed Global Minimum Tax Is not the Final Frontier for Corporate Tax Arbitrage

Over the past decade, international tax governance has evolved with bewildering speed in response to the challenges of digitalization and widespread corporate tax avoidance. Since the launch of the Group of 20 (G20)-Organisation for Economic Co-operation and Development (OECD) base erosion and profit shifting (BEPS) initiative in 2012, 135 countries and 14 international organizations have joined the BEPS Inclusive Framework, committing to implement new global standards on corporate tax, which has already been lauded as a revolution in the architecture of international tax law and policy. Even further expanding the scope of the OECD’s work on international taxation in a landmark announcement in March 2021, the U.S. administration further proposed imposing a global minimum corporate tax at a rate of 21% to be implemented through an international agreement by mid-2021. If the new OECD initiative is agreed, will the plan to implement a minimum corporate tax be fully implemented by G20 members, and if so, will it do enough to address the tax challenges of digitalization embodied in corporate tax arbitrage? Although the evidence suggests legislative and public policy compliance is likely to be high among G20 members, this article argues the minimum tax initiative is unlikely to go far enough to address deficiencies in global tax dispute resolution, which are extremely germane to the success of the proposed minimum tax. As explained in this article, U.S. leaders and global policymakers must enhance the mutual agreement procedure (MAP), a cornerstone of tax dispute resolution, given a growing body of tax litigation in investment law that threatens the implementation of BEPS 2.0. To do so, global policymakers must also reconcile the conflict of norms between tax sovereignty and investor protection contained in the investor-state dispute settlement (ISDS) regime. Only by addressing the conflict between the principles of tax sovereignty and investor protection can they prevent a tidal wave of investor disputes that will challenge the implementation of the minimum tax through national tax laws.

Fundamental Changes to Indonesia’s Tax System to Attract Investment

The government of Indonesia made several major tax changes in 2020 aimed at attracting investments to boost jobs creation and ultimately the growth of the Indonesian economy. The corporate income tax rate was reduced, followed by changes in the tax system from worldwide to territorial taxation with exemptions for foreign income and an inward expatriate regime to attract highly skilled labour and to encourage the transfer of knowledge and technology. In addition to that, the withholding tax rate on interest on bond payments to non-residents was also lowered. This article will highlight these changes and compare them to the practice in other countries. The article will also include a brief analysis of possible tax arbitrage and tax avoidance situations arising from the changes.

The Use of General Anti-Avoidance Rules as Quasi-Transfer Pricing Control Mechanisms in the Commonwealth Caribbean

In spite of being deemed non-cooperative jurisdictions for the purposes of taxation by the European Union, the member states of the Caribbean Community (CARICOM) maintain the ideals of taxation autonomy in dealing with their fiscal affairs. With Jamaica being the only CARICOM jurisdiction that has enacted comprehensive transfer pricing legislation that complies with the OECD Guidelines, other Member States have sought to use general anti-avoidance rules (GAAR) to manage and assess this type of transaction. These GAAR are encompassed in the statues of the various Caribbean jurisdictions and tend to be interpreted purposively in order to capture instances of tax arbitrage through transfer pricing. This article will assess the policies existing in three CARICOM nations – Guyana, St. Lucia, and Trinidad and Tobago – and determine their effectiveness in addressing the implications of base erosion and profit shifting in transfer pricing.

Spillovers of cum-ex and cum-cum trading with single stock futures

We examine single stock future (SSF) trading and respective underlyings around dividend ex-dates to study a specific form of dividend tax arbitrage, widely known as cum-ex and cum-cum trading, across Europe. Both strategies are designed to profit from illicit refunds of tax withheld from dividends, using SSF to share the realized gains between colluding parties. Our results document trading spillovers into more favorable tax regimes. High trading activity disappears in markets with enacted tax reforms. SSF have been considerably overpriced during the cum-ex period. All findings are robust to controls, such as volume, volatility and institutional ownership. Ex-day price drops are largely unaffected by changes in investors' tax heterogeneity.

Global distribution network design: exploration of facility location driven by tax considerations and related cross-country implications

ABSTRACT Multinational corporations (MNCs) are moving not only their headquarters but also their logistics operations to low-tax jurisdictions to minimise the tax burden. However, the logistics and fiscal domains are guided by different principles. This study aims to explore the cross-country implications of locating facilities in low-tax jurisdictions to take advantage of tax arbitrage. A single case study is developed, considering a fashion MNC that moved its European warehouse from Italy to Switzerland. The study offers theoretical insights about cross-country logistics network reconfiguration, formalising three possible scenarios and deepening the related implications. A quantitative evaluation of those scenarios is proposed, updating logistics cost items by including fiscal specifics and exploring the mutual interdependence between logistics and fiscal elements. To improve the study’s managerial contribution, the influence of contextual parameters is also investigated, showing that facility location for tax purposes does not necessarily lead to maximise net income after taxes.

Group subsidiaries, tax minimization and offshore financial centres: Mapping organizational structures to establish the \u2018in-betweener\u2019 advantage

International business and public policy research have examined the techniques that multinational enterprises (MNEs) use to shift revenues to subsidiaries in offshore financial centres (OFCs) in order to minimize tax liability and arbitrage for their advantage. While study of such tax arbitrage strategies has looked to geographical locations and legal dimensions to better understand these strategies, it has ignored the structural and organizational relationship between MNEs and their subsidiaries. We define two distinct types of OFC-based corporate entities based on their location among and apparent control over other MNE affiliates: ‘stand-alone’ OFCs at the end of a chain of MNE subsidiaries; and ‘in-betweener’ OFCs with equity control over further entities and hence apparent flexibility to redirect profits to other MNE subsidiaries further down the chain. We hypothesize that when MNEs have in-betweener OFCs controlling a substantial share of overall MNE profits, this indicates greater MNE interest in aggressive tax planning (ATP). We then evaluate empirical support for our claims based on an ‘equity mapping’ approach identifying stand-alone and in-betweener OFCs in 100 of the largest MNEs operating globally. This study demonstrates that a key factor determining tax arbitrage is not the amount of value registered on OFC subsidiaries’ balance sheets, but rather the portion of the group’s operating revenues and net income controlled by OFC subsidiaries. National taxing authorities could benefit from tracking in-betweener OFC locations and behaviour to counter ATP strategies, decrease sovereign arbitrage, and increase MNE tax revenue.

An evolutionary approach to international political economy: the case of corporate tax avoidance

Corporate tax avoidance is both widespread and diverse in its practical mechanics. The scope of the phenomenon often leads economists to conclude that in the jungle of economic competition, tax planning (or optimisation) is among the necessary tools to ensure the survival of the fittest. This theory is increasingly associated with a Darwinian theory of economic evolution. In this paper, I develop a contrasting framework of the evolutionary political economy of corporate tax avoidance. Analysing core concepts of Old Institutionalist Economics (OIE), I examine the core drivers of corporate tax avoidance in a globalised system of states. The major contrast, I find, is between that of the corporate and legal personality and the institutional environment in which it operates. Historically, each corporate entity has been considered a separate legal person, yet a series of ‘mutations’ of incorporations laws created a widening gap between theory and reality, and these, in turn, give rise to tax arbitrage. Narrowing this gap, however, impinges on another venerable historical institution, the institution of sovereignty and sovereign inequality.

The Australian Tax Planning Playbook: Volume 1

Has income tax become voluntary in Australia? It appears that for some, nil or very low tax bills are a very real prospect. Those with flexibility over how they earn income can use a range of legal means of ‘tax arbitrage’ to pay a lower marginal tax rate. Those highly motivated to achieve the lowest possible tax bill can structure their financial affairs so as to stream income through a mix of companies, trusts, property assets, superannuation funds and adult family members over time. This paper presents some of the simpler strategies that are part of the ‘Tax Planning Playbook’. In doing so, it shows how tax planning is available to people across the income distribution. It is not surprising that taxpayers make use of the opportunities available to them and respond to the incentives they face. However, a system that encourages tax planning is an affront to the commonly-held core principles of good tax design of fairness, efficiency and simplicity. It also raises questions about the longer-term sustainability of Australia’s tax system. Addressing tax planning requires a wholesale rethink about the design and role of income in Australia’s tax system.

The interesting story of participatory notes in India

The term 'participatory notes' (P-Notes) was not very familiar to everyone in our country until recent past. P-Notes are tools used for making investments in the stock markets. They are used outside India for construction tools in shares listed in the Indian stock market. That is why they are also called offshore derivative instruments. In the last one decade (since July 2004) when tax arbitrage via capital gain tax was almost disappeared, the demand of P-Notes has actually increased. Investment through P-Notes formed an important source of foreign portfolio investors (FPIs) to Indian stock market during the last two decades. Due to their opaque structure, they have been on regulatory radar and subject to stringent regulations to check misuse of funds. The present study attempts to examine extensively the journey of P-Notes in emerging stock market like India. It has also been attempted to critically examine the market watchdog regulatory regime to tighten the noose on P-Notes.