A study of cross-border profit shifting: Evidence from Australia

Abstract

Although prior studies have evaluated the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) Project and BEPS countermeasures from legal and regulatory perspectives, little research has been conducted in Australia to quantify the scale of BEPS and empirically assess the effectiveness of BEPS countermeasures implemented by the Australian Parliament. This thesis comprises two empirical studies that address two research questions: (1) to what extent does cross-border profit shifting occur in Australia; and (2) has the extent of cross-border profit shifting reduced after the introduction of Australian BEPS countermeasures from 2013? The two studies use two different strategies to identify cross-border profit shifting, based on publicly available data from 2007 to 2020. In the first study, two alternative matching methods are applied to match two groups of Australian companies to identify profit shifting activities using two channels: intra-group transfer pricing and debt financing and/or interest expense loading. The first group comprises foreign-owned Australian companies (FOACs) that are Australian subsidiaries of foreign multinational enterprises (MNEs), which have strong incentives to shift profits out of Australia to avoid Australian tax (the treatment group). The second group includes predominantly domestic-owned listed Australian companies (DOLACs) that have little incentive to avoid Australian tax owing to the dividend imputation system (the control group). Selected financial ratios of FOACs are compared with those of comparable DOLACs to identify profit shifting by FOACs using the two channels. Two alternative difference-in-differences designs are used to compare the extent of profit shifting by FOACs between the pre-BEPS period (2007 to 2012) and the post-BEPS period (2013 to 2020) to evaluate the effectiveness of Australian BEPS countermeasures targeting these two channels. The second study adopts and adapts the widely cited approach developed by Hines and Rice (1994) to identify profit shifting activities in general. The essence of this approach is that the profit before tax reported by a FOAC consists of two components: (1) the 'true' profit generated by real economic activities and, (2) the 'shifted' profit associated with tax rate incentives to shift profit. This study measures the sensitivity of profit before tax reported by FOACs to the tax rate differentials between Australia and other countries where the related multinational groups operate as an indicator of BEPS. This study further examines whether the estimated tax rate sensitivity has decreased after the implementation of BEPS countermeasures. Overall, both studies find evidence of cross-border profit shifting by FOACs throughout the entire 14-year study period from 2007 to 2020. The first study also finds that FOACs used tax-induced intra-group transfer pricing and, to a lesser extent, interest expense loading to shift profit out of Australia. However, the two empirical studies find no evidence that cross-border profit shifting from Australia to lower tax countries has reduced after the launch of the OECD BEPS Project and the implementation of BEPS countermeasures in Australia from 2013. The insignificant results may reflect the likelihood of law enforcement or administrative time lags, or the possibility that the countermeasures are not effective. Show more