Tanguy van Ypersele (AMSE) – Profit Shifting with Multiple Instruments

We study the behaviours of multinational corporations regarding two common tax planning methods used to transfer taxable income from high to low-tax countries. Corporations can disguise equity or internal financing as debt by using loans from subsidiaries in tax havens and gain tax deductions in high-tax countries. At the same time, corporations can manipulate transfer prices to take advantage of tax differences. Both methods are different in nature and are regulated in specific ways. Profit shifting using excessive leverage using parasitic tax havens to gain tax deductions in high-tax countries without paying taxes on internal loans. Thin-capitalization rules limit tax deductions by defining a maximum eligible level of leverage. Transfer pricing manipulation requires production on both sides. Internal prices must be justified and are subject to potential adjustment by tax collection agencies. Each tax planning method and its enforcement affect the cost of capital in different countries and, consequently, investments. Tax bases are influenced by profit-shifting regulation and so does equilibrium tax rates.