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Trang 3NORTHWESTERN UNIVERSITY
TAXES AND TRANSFER~PRICING:
INCOME SHIFTING AND THE VOLUME OF INTRA-FIRM TRANSFERS
A DISSERTATION
SUBMITTED TO THE GRADUATE SCHOOL IN PARTIAL FULFILLMENT OF THE REQUIREMENTS
Trang 4Copyright 1995 by Jacob, John All rights reserved UMI Microform 9614764
Copyright 1996, by UMI Company All rights reserved This microform edition is protected against unauthorized
copying under Title 17, United States Code
UMI
Trang 5Copyright by John Jacob 1995 All rights reserved
Trang 6Taxes and Transfer Pricing:
Income Shifting and the Volume of Intra-Firm Transfers
John Jacob
Taxing authorities have often alleged that multinationals shift income between different geographic regions to minimize global
taxes Prior research has found patterns of incomes reported and
taxes paid that are consistent with this However, these patterns
are also consistent with firms using legitimate operational measures
to influence the location of income This dissertation attempts to
discriminate between these alternate explanations by using data derived from the geographical segment disclosure in annual reports of firms about the volume of firms' inter-geographic area transfers Firms with large amounts of intra-firm international transfers are hypothesized to have greater opportunities to shift income through the use of transfer prices
The dissertation also examines whether the pattern of income shifting through transfer prices has changed subsequent to the Tax
Reform Act of 1986 The Tax Reform Act, and the changes in the
Trang 7transfer pricing regulations that followed, considerably increased
the scrutiny of international transfer prices by the IRS However,
the incentives for firms to use transfer prices to shift income also increased significantly because of the change in firms' foreign tax
credit position in this period This study examines which of these
effects predominates by testing for income shifting in both periods
The sample used is a randomly selected group of U.S
multinationals The empirical results suggest indications of income
shifting through transfer prices in both the pre- and the post- Tax
Reform Act of 1986 periods Firms with high volumes of inter-
geographic area transfers are found to pay lower global taxes than
other similar firms Firms with high volumes of inter-geographic
area transfers appear to have paid lower U.S taxes than other similar firms prior to the Tax Reform Act of 1986 and higher U.S
taxes than these firms subsequent to it This is consistent with
the tax incentives in both periods The profits reported in the
U.S and in the foreign region are also found to be suggestive of
tax motivated income shifting through transfer prices These
results are robust to the use of different formulations for the variables
Chairman: Professor Thomas Lys
Trang 8I would like to thank the chairman of my dissertation committee, Professor Thomas Lys for encouraging me to pursue this topic and for his comments and suggestions on various drafts of this
document I thank Professor Bala Balachandran for his support and
also for introducing me to tax practitioners I am indebted to
Professor Carla Hayn for her many comments and recommendations which
helped to improve this study I thank Professor Robert McDonald,
for his advice and the insights I gained from sitting in on his
Taxes and Decision Making course I am grateful to Professor Ramu
Thiagarajan for his suggestions and advice
I would like to acknowledge the assistance of Ernest Aud of International Business Services at Ernst & Young's Chicago office in providing me with reference material and some insights into the
tax practitioner's point of view I thank Scott McShane, also of
International Business Services at Ernst & Young's Chicago Office for many useful conversations on the subject of this dissertation Financial support frem the Accounting Research Center at the Kellogg Graduate School of Management is gratefully acknowledged
Trang 9long absences and unorthodox hours while this dissertation was in progress
Finally I would like to thank my fellow doctoral students - Julia D'Souza, Jowell Sabino, Bjorn Jorgenson, Linda Vincent, Peqgy Bishop, Rita Czaja, Roby Lehavy, Mark Soczek, Byoung Ho Kim, Eric Weber, Rachel Schwartz and SongKyu Sohn for their companionship and
encouragement
Trang 10Chapter Chapter Chapter Chapter Chapter Chapter Chapter Tables TT: III: IV: VI: VII: References Appendices Introducticn Institutional Background Related Research
Research Question and Hypotheses
Trang 11Table 1: Table 2: Table 3: Table 4: Table S: Table 6: Table 7: Table 8: Table 3: Table 10: Table 11: Table 12: LIST OF TABLES Two Digit SIC Code Classification of Sample Firms
Descriptive Statistics and Univariate Tests Correlation Matrix of the Variables
Regression Results for Global Taxes Paid Regression Results for U.S Taxes Paid Regression of Difference of Profitability Between Regions
Regression of Reported U.S Profitability Regression of Foreign Profitability
Tests for Differences in Income-Shifting Into and Out of the U.S
Regression of Difference of Operational Profitability Between Regions
Regression of Difference in Non-operational Profitability Between Regions
Trang 12Table 13:
Table 14:
Table 15:
Tests for Differences in Income Shifting Between the
Pre- and Post TRA'86 Period 134
Regression of Difference in Profitability Between
Regions (individually for each year) 137
Regression of Difference in Profitability Between Regions: Dependent Variable Scaled by Sales in the
Trang 13LIST OF APPENDICES
Appendix I: Geographic Segment Disclosure For Twin
Dise Co for 1994 146
Appendix II: Estimation of Average U.S and Foreign
Tax Rates Using Income Tax
Footnote Information 147
Appendix III: Incentives for Management of Transfer
Trang 14INTRODUCTION
Taxing authorities have long contended that firms use
transfer-prices to shift income from high to low tax countries
thereby minimizing global tax payments Some analysts estimate that
the annual tax revenue loss to the U.S due to transfer-pricing
abuses to be in excess of $30 billion.' The Executive director of
the Multistate Tax Commissicn, Dan Bucks, asserts that "Che
transfer pricing problem ranks on a scale equivalent to the S & L bail-out '"?
Managers of multinationals, however, maintain that tax
minimization plays a relatively minor role in the determination of
transfer prices They claim that objectives such as subsidiary
autonomy, optimizing managerial incentives and performance
evaluation are of equal, if not greater, importance
Transfer pricing between related parties is governed, in the U.S., by Section 482 of the Internal Revenue Code which constrains taxpayers who are owned or controlled by the same interests to deal
*Pp.D Quick and M.L Levey in the Journal of European Business Jan/Feb 1992
2
Address to the National Tax association-Tax Institute of America symposium, 1991 quoted in the National Tax Journal 1991
Trang 152
with each other at arm's length The arm's length standard requires that related tax payers, when dealing with each other, establish a transfer price comparable with the price that would be charged in
a transaction between unrelated parties Since many of the products
transferred between related parties are unique,’ finding a
comparable transaction between unrelated parties is often difficult Companies are alleged to have exploited the resulting ambiguity to their advantage, choosing the price for intra-firm transactions
which minimizes taxes This has led to numerous disputes between
corporations and the IRS Section 482 "has undoubtedly created more uncertainty and disputes with the IRS involving greater amount of tax dollars than any other part of the law."‘ For example, as of
April 30, 1991, the IRS had recommended increases to income of $13.1
billion for section 482 cases involving either foreign or U.S
controlled corporations that GAO identified in the appeals
inventory §
The gravity of the problem is also highlighted by the fact
} Items transferred between the divisions of a multi-national include sub- assemblies, components, technological know-how and patents which it does not sell to outside customers and for which a market price may be hard to establish
* Tax notes (December 16, 1985) quoted in "Taxes and Business Strategy"
(Scholes & Wolfson)
Trang 16that a large, and growing, proportion of world trade is conducted
between units of multinational corporations A United Nations
publication® stated that approximately 40% of imports in the United States in 1974 and 50% of United States exports in 1970 were within
transnational corporate systems There is reason to believe that
these percentages have not fallen in the interim period
Shifting of income between geographical areas through transfer
prices is of interest to accounting researchers because the
manipulation of transfer prices distorts the measurement of income,
specifically the operating income reported in the various
geographical areas in the geographic segment disclosures The
subject is particularly relevant at this time because the FASB is currently reviewing the guidelines for industry and geographic
segment disclosures The subject is also of interest to the
formulators of tax policy because of the tax revenue effects of geographical income shifting
Prior research in accounting suggests that firms shift income
inter-temporally to achieve certain reporting objectives Shifting
of income from one geographical location to another to minimize
taxes has not been researched as extensively Earlier papers on
geographical income shifting have established the existence of links
Trang 17
4
between the tax rates that companies face in various countries and the income they report and the taxes they pay in these countries {see for e.g Harris, Morck, Slemrod and Yeung (1993), Grubert, Goodspeed and Swenson (1993) and Klassen, Lang and Wolfson (1993)) While this is a possible outcome of the management of transfer prices, the possibility that this could be the result of legitimate
tax-minimizing operating decisions on the part of firms has not
been entirely discounted.’
This study extends the research by linking, for the first time, the level of global taxes paid by firms and the profits they report in various geographical areas to the volume of inter-
geographic area transactions within these companies If firms are
using transfer prices for goods transferred internationally to minimize their global taxes, it seems reasonable to assume that the greatest opportunities and incentives for such manipulation should exist for firms with large amounts of international intra-firm sales
and with large differences in tax rates between regions Finding
the hypothesized relationships between the level of taxes paid, incomes reported in various regions and the volume of international transfers provides more direct evidence on the use of transfer
Trang 18prices to decide the location of income than has been available from prior research
The analysis is performed using publicly available data which is primarily from the geographic segment and tax footnotes to the financial statements of companies.’ The advantage of using publicly available data (as opposed to using confidential tax return data) is that, because such data is reported on an on-going basis, the results of the study are verifiable by other researchers
This study also investigates whether the pattern of income shifting through transfer prices has changed in recent years relative to years prior to the Tax Reform Act of 1986 (TRA '86) The regulations governing transfer pricing and their enforcement have become more restrictive in most major trading countries in the
post TRA'86 era Simultaneously, the incentives for firms to shift
income through transfer prices appear to have increased since a
greater number of firms are in a excess foreign tax-credit
situation.?
A sample of U.S based multinationals in two time periods, one prior to TRA'86 and one subsequent to it are used to address these
To the best of my knowledge, the information disclosed by companies about the volume of international intra-firm sales in the geographic segment footnotes of firms has not been used in prior research
Trang 196
research questions The results indicate that income shifting
through transfer prices was prevalent in both the pre- and the post-
TRA'86 period Firms with large volumes of inter-geographic area
transfers appear to pay lower global taxes than firms that are
Similar in other respects The magnitude of the income shifting
also appears to be related to the difference in tax rates firms face
in their operations in different geographic areas These results
suggest that transfer-prices are the means through which the income is shifted
The impact of the income-shifting through transfer prices on the U.S taxes paid by the sample U.S multinationals appears to differ between the two periods It appears to result in a reduction of U.S taxes paid in the pre-TRA'86 period and an increase in U.S taxes paid in the post-TRA'86 period.™
The results also suggest that while there were no major differences in the use of transfer prices to shift income between large and small firms in the pre-TRA'86 period, such a difference
does exist in the post-TRA'86 period Smaller firms appear to he
using transfer prices to shift income to a greater extent than large
Alternatives to transfer prices as means to manage the location of reported income include managing the location of debt and expenses
Trang 20firms in the post TRA'86 period This could be a consequence of the greater scrutiny of transfer prices by the IRS and other taxing
authorities in recent years The focus of their scrutiny has been
on larger firms
These results are robust to the use of a variety of proxies for the difference in the tax rates firms face in their U.S and
foreign operations They are also robust to the use of different
deflators of tax and profitability measures The results also do
not appear to be driven by the data for any particular year within
the periods These findings imply that taxing authorities may be
justified in their assertions that transfer prices are being manipulated by firms that have intra-firm international transactions to reduce taxes
The rest of this study is organized as follows Chapter II
provides an overview of U.S taxation of international income,
describes the changes brought about in this by TRA'86 and narrates the evolution of the transfer pricing regulations in the U.S
Chapter III summarizes prior research in the area and the
contribution of this study Chapter IV describes the research
question and develops the hypotheses while Chapter V describes the
sample selection and research design Chapter VI describes the
Trang 218
Trang 22INSTITUTIONAL BACKGROUND
II.1 U.S Taxation of International Income
There are two main systems that countries use to tax foreign
income oc corporations Some countries, such as the U.S., use the
"world-wide" system of taxation, i.e they tax the worldwide income of resident corporations Others (e.g France) use the "territorial" system, taxing only income that resident corporations earn within the country
In the U.S., income from foreign sources is not, in general,
taxed when realized, but rather when it is repatriated to the
U.S.% Foreign corporations are taxed in the U.S., only on the
portion of their income which is from U.S sources
U.S multinationals operate abroad either through branches or
through foreign subsidiaries Subsidiaries are incorporated in the
foreign country and are a separate legal entity from the parent
U.S taxes on the foreign income of U.S multinationals that operate through branches are payable as they are realized and losses can be
22 The exceptions are passive foreign income which is taxable when realized under sub-part F and the income of foreign branches
Trang 2310
offset against domestic income On the other hand, the foreign
income of U.S multinationals that operate through foreign
subsidiaries is generally only taxable when repatriated to the U.S but losses cannot be used to reduce domestic taxable income
U.S multinationals operating abroad also pay taxes to foreign
governments on the income they earn abroad To mitigate the double
taxation that results because the U.S taxes global income, the U.S allows its resident corporations a credit, called the foreign tax credit, equal to the foreign taxes paid, against the U.S taxes
payable Foreign tax credits are limited to the lesser of foreign
taxes actually paid and U.S taxes which would otherwise have been
payable on the foreign income As an approximation, therefore, the
tax rate faced by U.S corporations on income earned outside the U.S is the higher of the U.S and foreign tax rates However, because U.S taxes on income earned abroad are only due when the
income is repatriated to the U.S., foreign income from low-tax countries benefits from the deferral of U.S taxes
Firms with foreign tax-credits in excess of the limitation can
carry them back two years or forward five years Foreign tax
credits are calculated in different income "baskets" (categories of
Trang 24Firms with average foreign tax rates greater than the U.S statutory tax rate will typically generate foreign tax credits in excess of
the limitation The exceptions arise because of the separate basket
computations
The foreign tax credit has two components The first, which
is the direct credit, is a credit for foreign taxes paid directly
by the U.S taxpayer Foreign taxes which are eligible for such
treatment include withholding taxes imposed by foreign countries on dividends, interest and royalties paid to the U.S parent and the
foreign taxes on the income of branches of U.S companies The
second component is the indirect or deemed paid credit which is a
credit for the foreign income taxes paid in the past on income which is now being repatriated, usually in the form of dividends, to the
U.S
The U.S rules for the taxation of international income
provide incentives for U.S multinationals to delay repatriation
of income From low tax foreign subsidiaries To prevent U.S
multinationals from indefinitely deferring the payment of taxes on
foreign income by not repatriating earnings, the "Subpart-F"
provision allows the deferral of U.S taxes only on that portion of foreign income which is invested in "active" foreign businesses.¥
Trang 25
12 II.2 TRA'86 Provisions Relevant to International Transfer Pricing The changes brought about by the Tax Reform Act of 1986 that had implications for international transfer pricing are described in the following sections
II.2.1 Number of Baskets in which the Foreign Tax Credit is Computed In general, the foreign tax credit limitation is calculated as
Foreign taxable income
Worldwide taxable income U.S tax on worldwide income
This computation is performed in each of the baskets into which
income is partitioned The provisions of TRA '86 tended to reduce
the amount of foreign taxes that could be credited by adding five additional baskets in which the foreign tax credit calculation is
to be performed The greater the number of baskets in which the
foreign tax credit is computed, the lower is the probability that all foreign taxes paid can be successfully credited
II.2.2 Change in the Top U.S Statutory Tax Rate
TRA'86 reduced the top U.S statutory tax rate on corporate
income from 46% to 34% This reduced the U.S tax on worldwide
income, which is a factor in calculating the foreign tax credit
limitation as described above The result was a change in the
Trang 26II.2.3 Rules for Allocating Expenses to Foreign Sources
As described earlier, the allowable foreign tax credit is
dependent on the amount of foreign taxable income The definition
of foreign taxable income and the amount of expenses allocated to this income are important in determining the foreign tax credits
available The formulators of TRA'86 felt that the prior law
permitted the manipulation of income and expenses to inflate foreign
source income Accordingly, they tightened the regulations
governing the recognition of foreign scurce income and the
allocation of expenses to foreign sources
Prior to TRA'86, firms could reduce the expenses allocated against foreign-source income by applying the expense-allocation
rules on a separate company basis Under this method, interest on
debt incurred by a subsidiary that had only U.S income or assets would be entirely allocable to U.S source income, independent of
the income or assets of other members of the group U.S
multinationals could avoid having any of their interest expense allocated to foreign source income by locating their debt in
subsidiaries with only U.S assets The prior regulations also
allowed taxpayers to allocate interest expense based on the
proportion of U.S and foreign gross income as an alternative to allocating these expenses based on the proportion of U.S and
Trang 2714
being manipulated (for e.g., through the use of transfer prices), firms could manage the interest expense allocated to foreign sources
Subsequent to TRA'86, the interest expense of an affiliated group cf& corporations must be apportioned into U.S and foreign sources on the basis of all the assets of the group In addition, gross income cannot be used to compute the portion of the interest
expense allocated to foreign operations The allocation has
necessarily to be performed on the basis of the location of assets These developments had the effect of reducing foreign source income and thus decreasing the foreign taxes that firms could offset against their U.S tax liabilities
Ir.2.3 Transfer Pricing of Imports
Trang 28II.3 History of the U.S Transfer Pricing Regulations
The earliest predecessor of Section 482 of the Internal Revenue Code, which governs transactions between related parties,
dates to 1921 This legislation empowered the Commissioner of the
Internal Revenue Service (IRS) to allocate income among related parties in order to prevent tax evasion or to clearly reflect the
income of the parties This predecessor to the current Section 482
was incorporated into the 1928 Revenue Act and the Commissioner's authority to make adjustments to transfer prices was expressly based on his responsibility to deter tax avoidance and to ensure that the
income of related parties was correctly depicted Regulations
issued in 1935 specified that the arm's length standard was the
fundamental principle governing transfer pricing However, because
of the predominantly domestic character of U.S business in this
period, and the relatively small number of U.S firms with
multinational affiliates, the impact of these provisions was
limited
The business and regulatory climate in which U.S
multinationals operated changed substantially by the early 1960s The Treasury Department recommended in 1961 that significant modifications be made in the regulations governing the taxation of
U.S enterprises with foreign affiliates The department maintained
Trang 2916
This prompted the House ways and Means Committee in 1962 to propose legislation which specified, in greater detail, directives for
apportioning income between U.S and foreign related parties The
Senate version of the bill however reaffirmed the existing Section 482 and the Conference Committee asserted that the purpose of the proposed legislation cculd be achieved by an amendment of the
regulations Treasury responded, in 1968, by announcing regulations
that, in the main, governed international transfer pricing till recent years
These regulations described the circumstances under which
Section 482 applied In general, the regulations covered (and
continue to cover) five specific types of intercompany transactions: The sale of tangible property
The use of tangible property
The transfer or use of intangible property The performance of services
Loans or advances
The regulations described various methods that could be used
to determine an arm's length price for tangible assets These
methods (listed in the order of priority) were:
Trang 30- The resale price method which is intended to determine an
arm's length price for transfers to sales subsidiaries This price
is determined by measuring the value of the distribution function through an examination of gross profit margins earned on the distribution of the products in question
- The cost-plus method-which is typically used to determine an arm's -length price for components or unfinished goods that will be subject to substantial additional manufacturing, processing or assembly prior to final distribution
- The fourth method which was to be used if none of the preceding three methods could be used to determine an arm's length
price This method covers a number of distinct approaches to
determining an arm's length price, one of them being the reasonable rate of return method
In addition to these recommended approaches to determining an arm's length price for tangible assets, the regulations provided guidance on the treatment of loans and advances betweeen related
parties An arm's length rate of interest was to be charged This
arm's length rate of interest was defined as the rate that would
have been charged, at the time the indebtedness arose, in
independent transactions with, or between, unrelated parties under
similar circumstances
Trang 3118
in effect, essentially unchanged until the enactment of TRA'86 The
increasing globalization “of business and allegations that
multinational companies do not pay their fair share of taxes prompted Congress and the U.S Treasury, in the last decade, to enact a number of measures to make tax avoidance through transfer
pricing more difficult The Tax Reform Act of 1986 decreed that
transfer-prices for the transfer of intangible assets from one related party to another had to be commensurate with the income that
these intangibles generated.“ The Conference Committee Report to
the act also mandated that the IRS conduct a comprehensive study of rules governing inter-company transactions to examine whether
modifications in the regulations were required The IRS responded
in October 1988 with "A Study of Inter-company Pricing," commonly referred to as the "White Paper."
The White Paper argued that several deficiencies exist in the
method used to test the arms-length nature of transfer prices It
noted that the regulations rely heavily on finding comparable
transfer prices or comparable transactions; little guidance is
provided in the absence of these comparables It also indicated
that the IRS's access to companies' pricing records is limited In
addition, the White Paper asked Congress to examine whether existing
Trang 32
penalties are sufficient to deter taxpayers from setting overly aggressive transfer prices and to compel them to provide accurate information about the methods used to compute them
In response to the concerns voiced in the White Paper, the
Revenue Reconciliation Act of 1989 and the Omnibus Revenue
Reconciliation Act of 1990 introduced mandacory record keeping
provisions for the U.S subsidiaries of foreign corporations These
acts also increased the penalties for substantial misstatements of
transfer prices In addition, the 1989 Act added the so called
"earnings stripping" rules which limits the deductions that firms can claim for certain excess related party interest and restricted the ability of firms to reduce the taxable income of a U.S subsidiary through excessive interest payments
In January 1992, the IRS issued the proposed Section 482 regulations which incorporated many of the suggestions made in the
1988 White Paper In addition they introduced the concept of a
“comparable profit interval" The comparable profit interval is a range of profits earned by companies in the same industry as the
firm under examination and that perform similar functions A
comparable profit interval was to be used to examine the arm's length validity of transfer prices and royalty rates determined under any method other than when a exact comparable transaction
Trang 3320
The proposed regulations issued in January 1992 were
criticized by companies who felt that it imposed unfairly high data requirements and deviated from the arm's length standard which had
hitherto governed international transfer pricing The idea of a
"comparable profit interval," in particular, was not well received Responding to this criticism, the IRS in January 1993 issued the
"Temporary and proposed regulations under Section 482." These
proposed regulations employ a more flexible approach than the regulations suggested in January 1992 and allow tax payers greater freedom to tailor methods to determine appropriate transfer prices
to the particular facts and circumstances of each case The
regulations also require that tax payers document the methods by which they determined the transfer price and disclose these to the IRS when requested
To summarize, Congress and the Treasury have become
increasingly concerned about the use of transfer-prices by related
parties to avoid taxes With the exception of the most recent
"proposed regulation," the trend, over time, has been to wake the rules more restrictive, increase the documentation requirements and the penalties for misstatements of transfer-prices
11.4 Transfer Pricing Regulations in Other Countries
Trang 34most industrialized countries are directed by the "arm's length"
standard The principles that underlie these regulations are
outlined in "Transfer Pricing and Multinational Enterprises," a report compiled by the 0.E.C.D committee on fiscal affairs in 1979
This report affirms the arms-length principle as the most
influential guiding factor in determining international transfer prices and contains suggestions to operationalize these principles
in specific instances
The following sections briefly describe the transfer pricing regulations in some of the major trading partners of the U.S.! Canada
Subsection 69(2) of the Income Tax Act prescribes that when the amount owed by a Canadian taxpayer to a related nonresident is greater than a resonable arm's length amount, the deduction is
restricted to the reasonable amount A similar standard is applied
to amounts charged by the Canadian firm to its related foreign customer for goods and services
Germany
The German Foreign tax law (section 1) recommends that the income of related parties be reallocated if income has been shifted abroad through transactions that would not have been entered into
Trang 35
22
by unrelated parties
Japan
Japanese transfer pricing rules are largely based on the U.S
rules and the O.E.C.D guidelines The rules prescribe that
payments for inventory, services, interest or royalties should be
based on the arm's length standard The recommended methods to
determine the arm's length price and the order of priority of their use are very similar to the U.S regulations
United Kingdom
Section 770 of the 1988 Taxes Act permits the United Kingdom Inland Revenue to adjust the taxable income of the U.K party to the amount that would have been reported if the transaction had been between unrelated parties
II.4.1 Foreign Response to U.S Transfer Pricing Regulations
As international taxation is, to some extent, a zero sum game, the major trading partners of the U.S have responded to the more restrictive regulations in the U.S by increasing the stringency of
their own regulations The countries that have substantially
strengthened their transfer pricing regulations during the nineteen eighties include Canada, Japan, Korea and the EEC countries in Europe *
Trang 36
RELATED RESEARCH
This section summarizes prior research in the broad area of tax-motivated income shifting by multinationals
III.1 Research on Income Shifting Using Actual Transfer Prices Empirical work using actual transfer prices has been limited
because access to transfer-prices used by companies is difficult
Transfer prices, by their nature, are guarded by companies as
sensitive information The only study that uses actual transfer
prices is Bernard and Wiener's (1990) examination of transfer
pricing by U.S multinationals in the petroleum industry Using
data from the Department of Energy, they find that there are
systematic differences between transfer and arm's-length prices for transferz to the U.S from many oil-exporting countries However, their results do not indicate that taxes were the reason for these deviations from arm's length prices.”
Ikawa (1989) uses average transfer prices in various product categories to examine whether transfer prices for international product transfers between related parties are correlated with tax
7 Due to political instability in some major oil producing countries in the period covered by their study, taxes may not have been the major incentive to shift income
Trang 3724
rates, political risk, exchange controls and customs tariffs He
uses Department of Commerce data for 1982 which contains average prices for transfers of goods into the U.S in various product categories, separately for transactions between related parties and between unrelated parties He finds that the deviations of prices for transfers between related parties from those for transfers between unrelated parties were significantly associated with all of the hypothesized variables and in a direction which implies shifting of income through transfer prices
The limitations of Ikawa's study were that the data he used was for inbound transfers only (i.e., transfers into the U.S.)
Transfers out of the U.S could not be investigated The data he
used was aggregated so that no firm specific inferences could be
made In addition, the data was limited to one year (1982) and
therefore the generalizability of his results to other years is not
evident
TIT.2 Research Using Data on Aggregate Profitability
A number of papers address the problem using proxies to detect
tax avoidance through transfer-pricing Using 1982 aggregate data
on a cross-section of 33 countries, Grubert and Mutti (1991) analyze
Trang 38in the countries these affiliates operate in and find that these
variables are significantly negatively correlated Their results
predict that a drop in the statutory tax rate from 40 percent to 20 percent leads to an increase in the ratio of after tax profits to sales from 5.6 percent to 12.6 percent, which is more than the increase that would be predicted by the decrease in tax rates These results are consistent with tax-motivated income-shifting
Hines and Rice (1990) also analyze country-level aggregate data for 1982 on the majority-owned foreign affiliates of U.S
multinationals They examine the effect of host-country tax rates
on the location of these firms’ pre-tax operating profits, interest
income and total profits They find significant and large negative
correlations between host country tax rates and the aggregate profitability measures that they use
111.3 Research Using Firm Specific Tax Data from Financial
Statements
Harris, Morck, Slemrod and Yeung (1993) investigate whether the U.S taxes paid by U.S based multi-nationals are related to the
existence of subsidiaries in low and high tax countries Their
Trang 3926
taxes which is consistent with them shifting income from the U.S
into low tax countries Conversely, firms that have subsidiaries
in high tax countries are found to pay higher U.S taxes which is consistent with them shifting income from these high tax countries
to the U.S They interpret these results as evidence of tax-
motivated income shifting
These results, however, are also consistent with firms
differing in the relative emphasis they place on minimization of
explicit (as opposed to implicit) taxes Those firms which place
a premium on the minimization of explicit taxes are likely to use a portfolio of approaches including locating businesses in low tax
countries to decrease foreign taxes, locating operations in
possessions corporations and using other tax saving devices in the
U.S to reduce domestic taxable income These firms would pay lower
levels of explicit taxes but perhaps, higher levels of implicit taxes by way of infrastructural costs and lower pre-tax rates of
return in tax favored locations Other firms might prefer to pay
higher levels of explicit taxes and lower levels of implicit taxes
These firms would locate operations in countries where both
productivity and explicit taxes are high (for e.g., Japan and
Western Europe), and not use possessions corporations or tax
shelters within the U.S to the same extent as the other set of
Trang 40Morck, Slemrod and Yeung report, i.e., firms with subsidiaries in
low tax countries also pay lower U.S taxes and firms with
subsidiaries in high tax countries pay higher U.S taxes than otherwise similar firms
Harris (1993) studies the response of multi-national
corporations to the Tax Reform Act of 1986 (TRA) The TRA reduced
the corporate tax rate from 46% to 34% and simultaneously decreased
investment incentives Harris hypothesizes that these changes
increased the incentives for multi-nationals to shift income into the U.S and deductions out of the U.S using transfer-prices and
other methods He does not find support for this hypothesis in a
random sample, but the results for a sub-sample identified as more sensitive to TRA's changes are consistent with the hypothesis
IIr.4 Research Using Data on Firm Specific Profitability
Grubert, Goodspeed and Swenson (1993) study foreign domiciled
corporations doing business in the U.S through subsidiary
corporations Using U.S tax returns filed by the U.S subsidiaries
of foreign corporations, they find that these corporations pay significantly less tax than either U.S domestic companies or U.S
multinationals By adjusting for the age profiles of foreign and