Thursday, October 14, 2021
Travis Chow (Hong Kong; Google Scholar), Jeffrey L. Hoopes (North Carolina; Google Scholar) & Edward L. Maydew (North Carolina; Google Scholar), Profit Shifting During Foreign Tax Holidays:
We undertake the first empirical analysis of profit shifting by U.S. firms during foreign tax holidays. We show that foreign tax holidays have become a prevalent and powerful tax planning strategy among U.S. firms. We find that U.S. firms significantly increase their outbound profit shifting while participating in foreign tax holidays. However, we also find that profit shifting associated with tax holidays comes at the cost of increased tax uncertainty. Our results have important implications for policy making and for understanding firm behavior.
This study investigates profit shifting by U.S. firms during foreign tax holidays, including both real and paper profit shifting. Tax holidays are temporary tax reductions that governments grant to firms, usually predicated on the firm making new operational investments in the country. In addition to spurring real profit shifting by attracting operational investments, firms may see these low tax rates as opening up additional tax planning opportunities. Specifically, foreign tax holidays may attract paper profit shifting, allowing tax benefits not only for profits from real investment but also for shifted profits. For example, recent reports indicate that Microsoft obtained a tax holiday in Puerto Rico, allowing the company to take advantage of a zero percent tax rate. After obtaining this tax holiday, Microsoft allegedly shifted $39 billion of income to Puerto Rico, leading to the largest audit in dollar terms that the Internal Revenue Service (IRS) had ever conducted (Kiel 2020)