Tax-Motivated Income Shifting Research Articles

Tax-Motivated Income Shifting in Audit-Firm Networks: Comparing Big 4 and Non-Big 4 Firms

Recent research provides evidence consistent with tax-motivated income shifting taking place in Big 4 networks. Non-Big 4 networks have global footprints and audit a significant proportion of private-firm clients. Thus, we cannot make sense of audit-firm networks’ tax avoidance proclivities and the impacts their tax advice may have on aggregate client-firm income-shifting figures without examining non-Big 4 affiliates’ tax planning strategies. This study uses a private-firm dataset of Big 4 and non-Big 4 associated firms from 26 European countries finding evidence consistent with non-Big 4 affiliates being more aggressive income shifters than their Big 4 counterparts. Using a battery of supplemental analyses we demonstrate that the negative association between Big 4 membership and tax-motivated income shifting is weaker when network exposure to the political costs of aggressive tax planning is lower. We also show that political cost considerations are more likely to moderate debt allocation policies in Big 4 than non-Big 4 networks. Our findings suggest that political cost considerations are an important driver of the relation between Big 4 affiliation and tax-motivated income shifting even in our setting where firm size is strongly positively associated with tax expertise, political power, and global footprint and have important implications for anti-avoidance legislation.

Products, Services, and Tax-Motivated Income Shifting

Products, Services, and Tax-Motivated Income Shifting

Cost Structure and Tax-Motivated Income Shifting

ABSTRACT We examine whether cost structure influences tax-motivated income shifting. We predict and find that U.S. multinational corporations (MNCs) with a less rigid cost structure engage in greater levels of tax-motivated income shifting relative to MNCs with a more rigid cost structure. This result is consistent with a less rigid cost structure providing greater flexibility to enable MNCs to take advantage of income-shifting opportunities. Further, we find that this relation is more pronounced when firms face greater costs in adjusting their operations, have less transfer pricing flexibility, and operate in a more uncertain environment. These results suggest that firms with less rigid cost structures possess the strategic operating and accounting flexibility necessary to take advantage of income-shifting opportunities. We provide evidence suggesting that a firm’s cost structure, a fundamental attribute of a firm’s business model, is a distinct and incrementally important determinant of tax-motivated income shifting. Data Availability: All data used in this study are publicly available. JEL Classifications: G32; H26; M41.

Equity Incentives and Tax-Motivated Income Shifting

Equity Incentives and Tax-Motivated Income Shifting

Local Tax Advisory Firm Boundaries and Client Tax-Motivated Income Shifting: Evidence from PwC Europe

Local Tax Advisory Firm Boundaries and Client Tax-Motivated Income Shifting: Evidence from PwC Europe

Digitalization and Tax-Motivated Income Shifting

Digitalization and Tax-Motivated Income Shifting

The Effect of U.S. Country-by-Country Reporting on U.S. Multinationals’ Tax-Motivated Income Shifting and Real Activities

The Effect of U.S. Country-by-Country Reporting on U.S. Multinationals’ Tax-Motivated Income Shifting and Real Activities

Tax-Motivated Income Shifting in Audit Firm Networks: Comparing Big 4 and non-Big 4 Firms

Tax-Motivated Income Shifting in Audit Firm Networks: Comparing Big 4 and non-Big 4 Firms

Patent Concentration, Asymmetric Information, and Tax-Motivated Income Shifting

We study the relation between patent concentration and tax-motivated income shifting. Using affiliate-level data for European multinational corporations (MNCs) and employing the relative share of patents held by an MNC as a measure for patent concentration, we predict and find that tax-motivated income shifting is increasing in the degree of patent concentration. This effect is economically meaningful: A one standard deviation higher patent concentration increases the extent to which affiliate-level profits are sensitive to income-shifting incentives by 25.6 percent. Additional tests exploiting variation in the information set of the local tax authority suggest that patent concentration facilitates tax-motivated income shifting by reducing comparable information available to the local tax authority. Overall, our results suggest that patent concentration shapes an MNC’s incentives to shift income via patents. Our findings also indicate that the effectiveness of tax-policy measures in curtailing this form of income shifting critically depends on their ability to improve the information set of the local tax authority.

Internal Information Quality and Tax-Motivated Income Shifting

ABSTRACTThis study examines whether the quality of a firm's internal information environment influences its tax-motivated income shifting activities. Although income shifting is an important tax-planning strategy, evidence regarding its determinants is limited. We find that higher internal information quality (IIQ) is associated with greater tax-motivated income shifting, which suggests that higher IIQ enables managers to better identify and execute income shifting opportunities. We find that the influence of IIQ on tax-motivated income shifting varies with firm characteristics. Specifically, we find that higher IIQ is associated with tax-motivated income shifting for firms with greater uncertainty and greater coordination needs. Overall, these results suggest that the improved information obtained through higher-quality internal information environments allows managers to increase tax-motivated income shifting.

Tax-Motivated Income Shifting and the Information Environment

We examine the information environment consequences that occur when U.S. multinational corporations (MNCs) engage in outbound income shifting. Using a new measure of outbound income shifting that considers evidence of prior outbound shifting and firms’ incentives, we find income shifting increases information asymmetry, private information gathering, and information uncertainty. Cross-sectional tests reveal that the presence of monitoring institutional investors mitigates the information environment consequences of income shifting. Our study provides evidence that significant information environment consequences are associated with tax-motivated income shifting.

The Effect of Financial Constraints on Tax-Motivated Income Shifting by U.S. Multinationals

When a U.S. multinational corporation shifts income from the U.S. to foreign jurisdictions, it incurs costs and reaps benefits. The benefits may be reduced if the shifted income must be returned to the U.S. as a dividend in the short term and face the same U.S. tax it would have if the income had not been shifted. Firms, then, have incentive to defer repatriation of earnings and to fund domestic cash needs with external financing. The cost of external financing, however, is increasing in financial constraints, leading to the prediction that constrained firms will be unable to defer repatriation and, therefore, will reap no benefits from shifting. Consistent with this prediction, we find that financially constrained firms shift less income from the U.S. to foreign countries than their unconstrained peers. We estimate that financially constrained firms shift out 20% less of pre-shifted income than unconstrained firms. Translating this percentage to dollar values, the mean (median) constrained firm shifts $16 million ($7 million) out of the U.S. each year while the mean (median) unconstrained firm shifts $321 million ($134 million) out of the U.S. each year. Assuming that the inability to defer repatriation is the primary constraint preventing the U.S. worldwide tax system from being a de facto territorial system, we use our findings to estimate that changing to a pure territorial tax system would increase outbound income shifting by U.S. multinationals by 8%.

Earnings Shocks and Tax-Motivated Income-Shifting: Evidence from European Multinationals

This paper presents a new approach to estimating the existence and magnitude of taxmotivated income shifting within multinational corporations. Existing studies of income shifting use changes in corporate tax rates as a source of identification. In contrast, this paper exploits exogenous earnings shocks at the parent firm and investigates how these shocks propagate across low-tax and high-tax multinational subsidiaries. This approach is implemented using a large panel of European multinational affiliates over the period 1995-2005. The central result is that parents' positive earnings shocks are associated with a significantly positive increase in pretax profits at low-tax affiliates, relative to the effect on the pretax profits of high-tax affiliates. The result is robust to controlling for various other differences between low-tax and high-tax affiliates and for country-pair-year fixed effects. Additional tests suggest that the estimated effect is attributable primarily to the strategic use of debt across affiliates. The magnitude of income shifting estimated using this approach is substantial, but somewhat smaller than that found in the previous literature.

A Comparison of the Tax-Motivated Income Shifting of Multinationals in Territorial and Worldwide Countries

This paper tests for differences in the tax-motivated income shifting behaviors of multinationals subject to different systems of taxing foreign earnings. I find that multinationals subject to territorial tax regimes shift more income than those subject to worldwide tax regimes, but that the difference in shifting is not statistically different when the worldwide firms can defer repatriation of the shifted income. In additional tests, I find that all firms have cash trapped in foreign countries by withholding taxes on dividends and that worldwide firms (specifically those domiciled in the U.S.) have cash trapped by the residual home country tax due on repatriation of foreign dividends.

Earnings Shocks and Tax-Motivated Income-Shifting: Evidence from European Multinationals

This paper presents a new approach to estimating the existence and magnitude of tax-motivated income shifting within multinational corporations. Existing studies of income shifting use changes in corporate tax rates as a source of identification. In contrast, this paper exploits exogenous earnings shocks at the parent firm and investigates how these shocks propagate across low-tax and high-tax multinational subsidiaries. This approach is implemented using a large panel of European multinational affiliates over the period 1995-2005. The central result is that parents’ positive earnings shocks are associated with a significantly positive increase in pretax profits at low-tax affiliates, relative to the effect on the pretax profits of high-tax affiliates. The result is robust to controlling for various other differences between low-tax and high-tax affiliates and for country-pair-year fixed effects. Additional tests suggest that the estimated effect is attributable primarily to the strategic use of debt across affiliates. The magnitude of income shifting estimated using this approach is substantial, but somewhat smaller than that found in the previous literature.

Tax Motivated Income Shifting and Korean Business Groups (Chaebol)

Abstract: This paper examines tax‐induced income shifting behavior among affiliated firms in Korean business groups (chaebols). Korean corporate income tax law does not require consolidated tax returns, and business groups with a large number of affiliated member firms have incentives to shift income across member firms to reduce the overall taxes of the group. For a large number of Korean companies that are subject to external audits, we perform univariate and multivariate regression analyses on the income shifting behavior of chaebol firms compared with non‐chaebol control firms. Our evidence suggests that tax‐motivated income shifting activities exist among chaebol firms, and that the extent of income shifting is found to depend on its effect on non‐tax cost factors such as the earnings, leverage, and cash flow rights of the controlling shareholders. We also find that income shifting is more pronounced in chaebol firms where the control‐cash flow divergence is relatively large, suggesting that income shifting is affected by the controlling shareholders' opportunism. Our study provides some insights on the intra‐group income shifting activities where research is limited.

Tax Motivated Income Shifting and Korean Business Groups (Chaebol)

This paper examines tax-induced income shifting behavior among the affiliated firms in the Korean business groups (chaebol). Korean corporate income tax law does not require consolidated tax returns, and business groups with a large number of affiliated member firms have incentives to shift income across member firms to reduce overall taxes of the group. Korean chaebols provide a good experimental setting to explore within-jurisdictional income shifting because, under the peculiar governance structure of chaebol firms, business decisions for each affiliated firm are coordinated by the controlling owner-manager of the group, so a coordinated strategy among the affiliated firms can be utilized to reduce overall tax burdens for the group as a whole. For a large number of Korean companies that are subject to external audits, we perform univariate and multivariate regression analyses on income shifting behavior of chaebol firms compared with non-chaebol control firms. Our evidence supports tax-motivated income shifting activities of chaebol firms. The extent of income shifting is found to depend on its effect on nontax cost factors such as earnings, leverage, and cash flow rights of the controlling shareholders. We also find that income shifting occurs mainly through operating rather than nonoperating income, suggesting that transfer pricing could be a likely channel for income shifting. Furthermore, we do not find much difference in income shifting activities across chaebol groups, and the endogeneity test supports the chaebol's income shifting activities even after controlling for the variables endogenous to the chaebol affiliation. Our study provides some insights on the within-jurisdictional income shifting activities where research is limited.

Security Analyst and Stock Market Efficiency in Anticipating Tax-Motivated Income Shifting

In the context of the statutory tax rate reductions enacted in the Tax Reform Act of 1986, this paper investigates the degree to which capital market participants anticipate and correctly interpret temporary income effects of tax-motivated income shifting. We find evidence consistent with financial analysts' earnings forecasts failing to anticipate earnings management that shifts income from fourth quarters in higher tax rate years to immediately following first quarters of lower tax rate years. The evidence suggests that this failure is not the result of a decision to ignore the income shifting, but rather an inability to recognize temporary components of reported earnings. We also find evidence that market prices do not fully reflect the temporary income effects of tax-motivated income shifting, and that analyst inefficiency explains about half of the market inefficiency. We interpret these inefficiencies as potentially important costs of tax planning that could limit the ability of public firm managers to implement otherwise optimal tax strategies.