Purba, Arnaldo
Description
The ownership, location and internalisation (OLI) framework
introduced by Dunning (1977) explains why multinational
enterprises (MNEs) establish subsidiaries overseas. According to
the OLI framework, MNEs have advantages over companies that
operate at the domestic level, including more power, such as
patent, trademark and international reputation (ownership), more
flexibility to choose locations for better access to customers
and lower tariffs (location) and,...[Show more] most importantly, broader
opportunities to set up intra-firm prices and processes
(internalisation). While there have been strong indications that
Indonesian affiliates of foreign MNEs have been using the
internalisation aspects of the OLI framework, such as profit
shifting, to avoid Indonesian corporate income tax (CIT), there
are no peer-reviewed studies on the existence of profit shifting
by MNEs in Indonesia.
When an MNE shifts profit out of a host country, it
simultaneously reduces both the taxable income and the accounting
profit reported in the host country. Therefore, in this thesis,
profit is represented by two measurements: taxable income and
accounting profit before tax.
Using confidential tax return data for the period 2009–2015,
this thesis investigates the issue of profit shifting in
Indonesia by conducting three related studies, which are outlined
below.
Study 1 investigates whether foreign-owned Indonesian companies
(FOICs) shift profits out of Indonesia by examining the effect of
the difference in statutory corporate tax rates (STR) between the
source country of investment and Indonesia on the profit reported
by FOICs in Indonesia. The regression results show that the lower
the tax rate of the parent country relative to Indonesia, the
lower the profit reported by FOICs, providing empirical evidence
consistent with the profit shifting occurring in Indonesia.
Study 2 further investigates whether FOICs shift profits out of
Indonesia by following an approach introduced by Hines and Rice
(1994) based on the Cobb–Douglas production function with some
modifications. The regression results show that a tax rate that
is one percentage point lower in the parent country reduces the
accounting profit and taxable income reported by FOICs in their
Indonesian tax returns by 2.56% and 2.89%, respectively. These
findings are consistent with the findings of Study 1 and provide
further evidence of profit shifting from Indonesia to low-tax
countries.
Study 3 attempts to provide more direct evidence of the existence
of cross-border profit shifting in Indonesia by investigating
whether FOICs use the two most commonly used channels to shift
profits: intra-group transfer pricing and debt financing. This is
done by matching FOICs with comparable domestic-owned Indonesian
companies (DOICs) and comparing the paired sample in terms of (1)
earnings before interest and taxes scaled by sales (to detect
profit shifting using transfer pricing), and (2) long-term debt
to related parties scaled by assets (to detect profit shifting
using intra-group debt financing). The results suggest that while
FOICs use both channels to shift profits, transfer pricing plays
a more significant role than debt financing.
This thesis contributes to the literature by providing empirical
evidence of profit shifting by MNEs to erode the CIT base of
Indonesia.
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