Unprofitable Affiliates and Income Shifting Behavior

TLDR

Income shifting from high‑to‑low‑tax jurisdictions is a key strategy for multinational firms to reduce global tax burdens, and current losses influence these incentives. The study extends prior work by examining whether the link between losses and tax incentives differs for unprofitable affiliates compared to profitable ones. The authors build on existing models by incorporating unprofitable affiliates and testing the loss–tax incentive relationship across profitable and unprofitable affiliates. Results show that multinational firms shift reported profits to exploit losses, with a one‑standard‑deviation increase in tax incentives lowering profitable affiliates’ ROA by 0.5 percentage points but raising unprofitable affiliates’ ROA by 0.7 percentage points, and that this responsiveness is greater in high‑tax jurisdictions.

Abstract

ABSTRACT Income shifting from high-tax to low-tax jurisdictions is considered a primary method of reducing worldwide tax burdens of multinational firms. Current losses also affect income shifting incentives. We extend prior approaches by explicitly considering unprofitable affiliates and test whether the association between losses and tax incentives for unprofitable affiliates deviates from the negative association observed in profitable affiliates. Results suggest that multinational firms alter the distribution of reported profits to take advantage of losses. Our point estimate for profitable affiliates implies that an increase of one standard deviation in the tax incentive, C, of an affiliate with an average return on assets of 13.3 is associated with a lower return on assets of 0.5 percentage points. The same change in tax incentive of an unprofitable affiliate is associated with an increase in its return on assets of approximately 0.7 percentage points, holding assets, labor, productivity, and other factors constant. We further document a larger responsiveness to tax incentives between profitable and unprofitable affiliates in high-tax jurisdictions, consistent with predictions.