VOLUME 1 NO 1 | OKTOBER 2019 ISSN 2686-5718 DOES FINANCIAL SECRECY AFFECT PROFIT SHIFTING? I Wayan Agus Eka Direktorat Jenderal Pajak. Email: [email protected] ABSTRACT Global efforts to increase financial transparency have been made throughout the last decade. Nevertheless, profit shifting among Multinational Companies still become a crucial issue worldwide. This study investigated whether financial secrecy is one of the determinants of profit shifting that has been overlooked in previous profit shifting studies. Using multiple regression analysis, I concluded that financial secrecy negatively affects profit shifting, meaning an increased transparency will induce taxpayers to shift profit out of the country since ending secrecy equals higher risk for the tax evaders. The finding implies two important recommendations: first, to continue the global efforts to promote financial information exchange for tax purposes and second, to strengthen domestic anti-profit shifting regulations. Keywords: financial secrecy, financial transparency, banking secrecy, profit shifting, exchange of informa- tion. ABSTRAK Inisiatif global untuk meningkatkan transparansi telah dilakukan dalam satu dekade belakangan ini. Di sisi lain, pengalihan laba oleh perusahaan multinasional tetap menjadi isu penting. Penelitian ini menginvestigasi apakah kerahasiaan data keuangan merupakan salah satu variabel determinan dari pengalihan laba yang selama ini belum pernah diperhitungkan dalam penelitian-penelitian sebelumnya. Menggunakan analisis regresi berganda, penelitian ini menyimpulkan bahwa kerahasiaan data keuangan secara negatif memengaruhi pengalihan laba, yang berarti bahwa peningkatan transparansi memberikan insentif kepada Wajib Pajak untuk mengalihkan laba ke luar suatu negara karena peningkatan risiko yang dialami para Wajib Pajak. Penelitian ini menghasilkan dua rekomendasi: pertama, usaha untuk mewujudkan pertukaran informasi keuangan secara menyeluruh harus tetap dilanjutkan dan kedua, diperlukan penguatan peraturan untuk mencegah dan mengatasi pengalihan laba. 27 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40 1. INTRODUCTION A better understanding of profit shifting cannot be separated from the study of tax Over the last decade, taxation has havens. One of its characteristics is finan- become a major issue for top political cial secrecy. Jansky and Prats (2015) leaders. They have started to realize the argued that there are two main reasons importance of raising tax revenue to why tax havens play an important role in finance sustainable developments. profit shifting: (i) low or nil tax rate and (ii) Taxation has also become a mandatory secrecy provision (banking secrecy, lack of agenda in global economic forums in exchange of tax information, etc.). Johan- the midst of economic uncertainty and nesen and Zucman (2014) also found that trade wars. the end of Swiss bank secrecy through a Since tax revenue has become tax treaty amendment with France results the major revenue source after the in a roughly 11% decline in the Swiss declining of commodities prices, every deposits held by French residents. OECD nation has an interest to protect its tax (1998) report emphasizes that defining tax base. It is not an easy job since 30% of haven is not only from a tax perspective, the international transactions involve but also stress on the lack of exchange of affiliated multinational corporations information and transparency. (MNCs) that raise the concern of profit Tax haven, offshore financial center shifting (United Nation, 2017). G20/O- and secrecy jurisdiction are usually used ECD countries then took an initiative to interchangeably to describe a country that curb the base erosion and profit shifting induces profit shifting. However, the known as BEPS Action Plan (OECD, unclear and disagreement on tax haven 2015). and offshore financial center definition There is no precise number of contributed to the weakness in analyses how much the tax revenue is lost to (Cobham, Jansky & Meinzer, 2015). The profit shifting. OECD estimated the last term, secrecy jurisdiction, was promot- revenue loss at 4%-10% of the corpo- ed by Murphy (2008). He defined the rate tax revenue or USD100-240billion secrecy jurisdiction as a jurisdiction which at 2014 levels (OECD, 2015a). Among all provides facilities that enable people or countries, non-OECD countries (which entities escape or undermine the laws, are commonly developing countries) rules and regulations of other jurisdictions bear more costs from profit shifting elsewhere, using secrecy as a prime tool than developed countries (Crivelli, de (Murphy, 2008). Mooij & Keen, 2015). Clausing (2016) In connection with profit shifting, estimated that profit shifting is costing there are relatively more studies that use roughly between $77billion to $111bil- tax haven and offshore financial center lion of 2012 US tax revenue. Further- terms than secrecy jurisdiction. Two nota- more, the most recent research from ble studies, Hines and Rice (1994) and Torslov, Wier, and Zucman (2018) Johannesen and Zucman (2014), study estimated that 40% of MNCs profits are how tax haven affect US firms’ foreign shifted to low-tax countries each year. activities. 28 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40 By contrast, several other research 2. LITERATURE REVIEW explores the roles of offshore financial 2.1 Profit Shifting center (Picard & Pieretti, 2011; Foad & Lundberg, 2017; Chernykh & Mityakov, There are several definitions of profit shift- 2017). ing. OECD (2018) defines profit shifting as Empirical studies on profit shift- allocation of income and expenses ing mostly concentrated on how the between related corporations or branches profit shifting was affected by tax rate of the same legal entity (e.g., by using differential, commonly called as the transfer pricing) in order to reduce the semi-elasticity of profit shifting. Hines overall tax liability of the group or corpo- and Rice (1994), the pioneers of this ration. Similar objective is expressed by study, estimated the semi-elasticity of Huizinga and Laeven (2008) where profit 2.3, meaning a reduction in the tax rate shifting should reduce MNC profits by one percentage point will increase reported in high-tax countries. the reported profit by 2.3%. Dozens of There are two main ways to shift similar studies then followed Hines and profit: transfer pricing and financing struc- Rice. In the latest study by Beer, de ture (Maffini & Mokkas, 2011; Buettner, Mooij and Liu (2018) who reviewed all of Overesch & Wamser, 2017). Another way these empirical studies, it was found involves treaty shopping and strategic that one percentage point reduction in location of intellectual property (Beer et the tax rate increases the before tax al., 2018). profit by 1.5%. Transfer pricing is a neutral term. It In addition to the aforemen- is defined as a price set by a taxpayer tioned, empirical research studying the when selling to, buying from, or sharing connection between financial secrecy resource with a related person (Arnold & and profit shifting is still not well-devel- McIntyre, 2002). To minimize taxable oped in the literature. The study by profit, MNCs locating in high-tax country Akhtar, Akhtar, John and Wong (2017) will overstate the import price and/or might be the closest one, as they inves- understate its export price (Huizinga & tigated whether corporate governance Laeven, 2008). Moreover, transfer pricing affects the probability of tax evasion. is considered the dominant profit shifting This paper tries to fill the gap in the channel based on meta-database analysis literature by empirically studying the from 27 empirical studies (Heckemeyer & impact of the financial secrecy on profit Overesch, 2017). shifting. This paper also contributes to In the context of financing struc- the literature since it tries to extend the ture, reducing tax burden can be achieved determinants of profit shifting by by imposing high interest rate to affiliated including secrecy issue that was over- company located in high tax country looked in the previous research. (Huizinga & Laeven, 2008). The main reason is that interest is deductible mean- while dividends are not deductible hence 29 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40 debt financing is considered more fixed effect. Dharmapala and Riedel (2013) effective than equity financing (Arnold found that parents’ positive earning & McIntyre, 2002). shocks are associated with a significantly positive increase in pretax profits at 2.2 Determinant of Profit Shifting low-tax affiliates, relative to the effect on the pretax profits of high-tax affiliates. Most of the empirical research in profit In addition to the tax differential as shifting regards tax rate as the main one of the main important variables, the profit shifting determinant since the study about profit shifting cannot be sep- potential tax savings rely on the differ- arated from the existence of tax havens. In ence in the corporate tax rate. Grubert principle, tax haven is a location with a and Mutti (1991) and Hines and Rice very low tax rate and other tax-favorable (1994) are considered the pioneers in characteristics to attract foreign direct empirical profit shifting study. Their investment (Dharmapala & Hines, 2009). papers used cross-sectional regression Dyreng and Lindsey (2009) studied how analysis for 1982 country-level data, tax haven affect tax burden of US multina- resulted