draining development.pdf - Khazar University

Tax Evasion and Tax Avoidance: The Role of International Profit Sharing 111The setup of the rest of this chapter is as follows. In the next section,we briefly introduce the concept of profit shifting by multinational firmsand discuss empirical approaches that have been used to detect profitshifting. In the following section, we review existing studies on profitshifting out of developing countries. The section builds on and extendsour earlier work, in Fuest and Riedel (2009). The subsequent sectiondiscusses the particular role of tax havens. In the penultimate section, wesuggest and discuss the pros and cons of different econometric identificationstrategies and data sets that can be used to gain new insights intothe phenomenon of profit shifting out of developing countries. We alsoprovide some evidence from one of the data sets that supports the viewthat a significant amount of profit shifting out of developing countriesand into tax havens does take place. The last section concludes.Multinational Firms and the Concept of Profit ShiftingIntrafirm profit shiftingFor purposes of taxation, the profits of a multinational firm have to beallocated to the individual jurisdictions where the firm files for incometaxation. This is usually accomplished through the method of separateaccounting. Each entity (subsidiary or permanent establishment) of themultinational firm individually calculates the income it has generated.Transactions between different entities of a multinational firm (controlledtransactions) should, in principle, be treated as transactions withthird parties (uncontrolled transactions). However, multinational firmsmay use controlled transactions to shift income across countries. Forinstance, they may shift income from high-tax jurisdictions to low-taxjurisdictions using transfer pricing or intrafirm debt.The concept of income shifting raises the question of whether a trueor objective distribution of profits earned by the individual entities of amultinational firm can be identified. Achieving this is complicated for anumber of reasons. In particular, the entities of multinational firms typicallyjointly use resources specific to the firm such as a common brandname or firm-specific expertise. Pricing these resource flows appropriatelyis difficult because goods traded between unrelated parties are usuallydifferent. It is an important characteristic of many multinationalfirms that the individual entities jointly use resources that could not be