International taxation and the income shifting behaviour of multinational enterprises

by Hoffman, Michael Douglas

This dissertation examines the ability of MNES to shift before-tax income between jurisdictions to take advantage of differences in tax rates. To shift income, MNES cm structure transactions between subsidiaries in high-tax and low-tax jurisdictions such that transfer pricing can altow more income to be reported in the low-tax jurisdiction and more expenses to be deducted fkorn income in the high-tax jurisdiction. W e global income is unchanged, the MNE'S global tax liability can be reduced. We undertake theoretical and empirical examinations of income shifting. We examine the effects of transfer pricing and income shifting on the user cost of capital when deferrd taxation is used and a credit is provided for foreign taxes paid. We find the MNE will slYft as much income as possible fiom a high-tax to a low-tax jurisdiction through cross-border charges, thus reducing the cost of capital. Also, we fmd an increase in the host-country tax rate actually benefits a MNLE provided enough pre-tax income can be shified to the iow-tax jurisdiction. We show a thin capitalisation constraint (a restriction on the debt-to-equity ratio) is binding only when the return on equity exceeds the host-country after-tax interest rate; the foreign tax credit position of the MNE is irrelevant. Further, it may not be not optimal to borrow in the jurisdiction with the higher tax rate. Empirically, we examine the income shifting behaviour of MNES that have a presence in Canada. Our data set contains confidentid information collected on annual T2 corporate tax retums filed by Canadian-based corporations and includes information not publicly available. We fhd there is some evidence that MNES with a presence in Canada are shifting income to subsidiaries in Iow-taxjurïsdictions. Also, we find that income shifting depends upon the size of the international tax dif3erential and the effect of a change in the tax differentiai is not constant across jurisdictions. Having a subsidiary in a low-tax jurisdiction cm have a substantial impact on the Canadian tax liability. Using another data set, we fmd there is evidence that MNES are timing payments during times of tax changes.