Assessing Profit Shifting Using Country-by-Country Reports: A Nonlinear Response to Tax-Rate Differentials

We analyze profit-shifting behavior of Multinational Enterprises (MNEs) using a novel and unique dataset composed of Country-by-Country Reports (CbCRs) for year 2017 compiled worldwide by all MNEs having at least a subsidiary in Italy. By accessing CbCRs we are able to estimate BEPS - base erosion and profit shifting - using a firm-level data with a better representativeness than commonly used dataset. In fact, many studies are based on available large financial accounts databases that under-represent specific subset of firms and locations such as activities carried out in investment hubs. We provide evidence of this under-representativeness in this work. Our paper, apart from providing an estimation of BEPS as a response to CIT rates by applying the standard linearity assumption, follows recent work into analysing the existence of nonlinear responses to taxation. We go beyond preceding work by exploring non-linearity in a dataset composed of MNEs of all nationalities - thus providing evidence of the existence of a strong non-linear response in a more diversified dataset - and by focussing on the non-linear response of profit shifting to tax rate differentials and not only to CIT rates. We find that profit allocation in a country is non-linearly dependant to the differences in tax rate with respect to the average CIT rate faced by the MNEs in the rest of the world. We further investigate non-linearity pointing out that quadratic estimation presents some issues in countries with high CIT rate. We therefore provide a higher degree, cubic, estimation as a solution to these caveats. We find that the effect of changes in CIT rate differential over profit allocation is statistically and economically significant when allowing for an inverse U shaped semi-elasticity. Finally, we estimate profit shifting and revenue losses. We find that in 2017 a total of i?½ 887 billion of profits was shifted due to differences in tax rates with a global revenue loss of i?½ 245 billion. The distribution of shifted profits is found to be highly concentrated in few countries and this result may have relevant policies implications, suggesting that international tax reforms aimed at guaranteeing a minimum level of taxation may be very effective in reducing the incentive for MNEs to locate profits in these jurisdictions only based on tax reasons, thus may be a very efficient way to reduce BEPS.