When profit shifting is harmful – and how it should be regulated

Tax avoidance is still a late-breaking topic. It was put on the political agenda recently by public pressure and press releases that the big multinational companies almost do not pay any corporate taxes due to advanced strategies of intra-firm trade and borrowing. Now, the OECD has released its report on "Base erosion and profit shifting" (BEPS), recommending actions to curb this kind of tax avoidance. But, (abusive) transfer pricing and debt shifting substantially differ in their implications so that regulatory frameworks need to be designed carefully.

In recent projects with various co-authors, Dirk Schindler analyzes the welfare implications of different profit-shifting strategies and derives their optimal regulation. It is shown that transfer pricing always reduces welfare while some debt shifting is beneficial in order to reduce the corporate tax wedge on mobile (multinationals') investment. The reason is that debt shifting directly shelters the normal rate of return against taxation, whereas tax-driven transfer pricing is an indirect instrument that allows to shift location-specific supernormal profits (e.g., to expropriate natural resources) in addition. The implication is that the regulation both of transfer pricing and tax havens facilitating transfer pricing should be tough (including, e.g., royalty taxes), while thin-capitalization rules should allow for some level of internal debt. Differentiating between safe-harbor rules and earnings-stripping rules to mitigate thin capitalization, the latter set of rules is always preferable, because it also restricts transfer pricing and is less harmful for capital investment. Furthermore, there is an argument for controlled-foreign-company (CFC) rules. CFC rules not only supplement thin-capitalization rules and the arm's-length principle, they also allow for second-order discrimination between domestic and foreign-based multinationals which is preferable if investment behavior of these multinationals differs due to a home bias or costs of foreign direct investment.

Other projects that Dirk Schindler is working on during his visit are on the positive analysis of profit shifting, both from a theoretical and an empirical perspective. For instance, one focus lies on embedding parental debt into a tax-efficient capital structure. According to the idea Mr. Schindler and his co-authors pursue, parental debt is not part of internal debt shifting, but is re-routed external debt that is used if there are imperfections in the capital market. Dirk Schindler received his doctorate and did his habilitation at the University of Konstanz, Germany. In 2012, he joined the Norwegian School of Economics (NHH) in Bergen, Norway, and also became a founding member of the Norwegian Center for Taxation (NoCeT).