That Ol’ Share-of-Wallet Issue

NeuGroup’s Assistant Treasurers’ Leadership Group tackles managing banks and the corporate wallet.

stock market ticker62

Libor to SOFR Switch Will Be Challenging

Response to CME’s SOFR futures contracts may provide early signal.

NGI Skyline

Get the Latest Insights

Sign up to have an eye in the room where it happens. Connect to NeuGroup Insights 

Treasury & Taxation

Countries Ignore Profits Headed to Havens

Share |
June 29, 2018

Study shows that the incentives aren’t there to go after profits shifted to tax havens

Money compassAlmost 40% of multinational profits get moved to low-tax countries every year, a new study says. What’s worse, the high-tax countries losing that potential tax revenue don’t do much about it, instead focusing their efforts on getting fleeing profits back from other high-tax countries.

“We show theoretically and empirically that in the current international tax system, tax authorities of high-tax countries do not have incentives to combat profit shifting to tax havens,” write Thomas Tørsløv, Ludvig Wier and Gabriel Zucman of University of Copenhagen and University of California, Berkeley, respectively. “They instead focus their enforcement effort on relocating profits booked in other high-tax countries—in effect stealing revenue from each other. This policy failure can explain the persistence of profit shifting to low-tax countries despite the high costs involved for high-tax countries.”

The study, "The Missing Profits of Nations" from the National Bureau of Economic Research (NBER), underwritten by the Danish Ministry of Taxation and the FRIPRO program of the Research Council of Norway, says US MNCs are the biggest profit-shifting offenders, while tax revenue losses are highest in the European Union and developing countries.

The reason high-tax countries go after absconded profits in other high-tax countries is that it’s more easily done. The authors use as an example France. One euro brought back to France is worth the same whether it comes from Germany or from Bermuda, they write, but “it is easier for the French tax authority to relocate one euro booked in Germany, for three reasons.” First, the authors say, information is more readily available on the profits booked in Germany, “while no or little information typically exists on the profits booked in Bermuda.” Second, France will succeed in getting the profits because MNCs probably won’t spend the time or effort fighting tax authorities. That’s because for them, “whether profits are booked in France or Germany makes little difference to their global tax bill, since the tax rates in France and Germany are similar.”

Finally, France and Germany are friends and euro colleagues. “If there is a dispute between France and Germany, it is likely to be settled relatively quickly through the dispute resolution agreements in force among OECD countries and EU countries.”

Ultimately, the effort to claw back profits from Germany “crowds out the correction of transfer prices involving transactions between France and low-tax countries.” Corrections from low-tax havens are harder to make because there is not as much data on profits booked in them, they costlier due to firms needing legal help to defend their transfer pricing plans, and take more time because a lack of cooperation.

The authors back up their claims about the size of shifted profits by analyzing the data from tax havens. Until recently, the authors say, data published by tax havens “were too limited to conduct this exercise meaningfully.” But more recently the OECD and the IMF have stepped in to help coordinate and compile the data. Included in the data sets is the amount of wages paid by affiliates of foreign multinational companies and the profits these affiliates make. With this data the authors were able to analyze “a simple macro statistic,” the ratio of pre-tax corporate profits to wages.

What it told them is that in non-tax-haven countries, “foreign firms are systematically less profitable than local firms. In tax havens, by contrast, they are systematically more profitable—and hugely so. While for local firms the ratio of taxable profits to wages is typically around 30%–40%, for foreign firms in tax havens the ratio is an order of magnitude higher—as much as 800% in Ireland. This corresponds to a capital share of corporate value-added of 80%–90% (vs. around 25% in local firms).”

What this means, the authors hypothesize, is that tax havens with high profits-to-wage ratios can be explained by “shifting effects.” This gets them to the big statistic, that nearly 40% of multinational profits, that is, those “defined as profits made by multinational companies outside of the country where their parent is located” were shifted to tax havens in a given year. This was equivalent to about $600bn in profits in 2015.

comments powered by Disqus