Flexibility in Income Shifting under Losses
Hopland, Arnt O., Lisowsky, Petro, Mardan, Mohammed, Schindler, Dirk
The Accounting Review · 2018 · Volume 93 · Issue 3
Abstract
This study examines the flexibility of multinational firms to adjust their income-shifting strategies—whether using transfer pricing or internal debt—during the tax year to react to affiliates' operating losses. We develop the concept that under flexibility, multinationals can adjust their inter-affiliate paymentsex post(i.e., after financial outcomes are revealed, but before the end of the tax year) to minimize worldwide tax payments. Without flexibility, multinationals must commit to their affiliates' income-shifting strategiesex ante(i.e., before financial outcomes are revealed). Our central prediction is that underex postincome shifting, loss affiliates report lower transfer prices and internal leverage than profitable affiliates; underex anteincome shifting, affiliates report the same transfer prices and internal capital structure, regardless of making losses. Using novel data on direct transfer payments and internal debt of Norwegian affiliates, we find empirical evidence that transfer pricing, particularly related to user fees, but not internal debt, provides flexibility to adjust income shiftingex post. In additional tests, we confirm that our results reflect flexibility rather than loss affiliates' poor performance. Our study should interest tax policymakers and researchers by identifying how various mechanisms allow multinational firms to shift income when they face losses. JEL Classifications:F23; H25; H87.
Keywords
income shifting, losses, debt shifting, transfer prices
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