Country-by-Country Reporting may shift profit shifting towards high-tax countries

Country-by-Country Reporting (CbCR) was introduced in 2016 to give tax authorities greater insight into the worldwide activities of multinational companies and help tackle international tax avoidance. However, the measure can have unintended consequences.  

Profit shifting changes direction 

The researchers developed a theoretical model in which CbCR increases the costs of tax planning and tax audits for multinational companies. As tax authorities gain more information about a company’s global activities, shifting profits to tax havens becomes more costly. This creates what the researchers call a substitution effect. For multinationals, it becomes relatively more attractive to shift remaining profits from high-tax countries, where the potential tax savings are greater. At the same time, profit shifting from low-tax countries decreases. 

As a result, the overall amount of profit shifted to tax havens may decline, but high-tax countries can still lose part of their tax base. Low-tax countries, by contrast, may benefit from the resulting redistribution of profit shifting. 

Explaining mixed evidence 

The researchers also find empirical support for these predictions. Their analysis indicates that profit shifting from high-tax countries increased after multinationals became subject to CbCR, while profit shifting from low-tax countries decreased. 

This pattern may help explain why previous studies have failed to find clear evidence that CbCR has become the expected ‘game changer’ in tax enforcement. While the measure can reduce overall profit shifting, it can also redirect the remaining activity towards different countries and parts of multinational groups. 

Transparency is not enough 

The findings have implications for how tax authorities use CbCR information. The reports reveal the amount of profit a multinational holds in tax havens, but do not directly identify the affiliates or countries from which those profits were shifted. The researchers therefore argue that tax authorities should combine CbCR-based risk indicators with targeted audits that trace the corresponding deductions in high-tax affiliates. 

The study demonstrates more broadly that greater transparency does not necessarily eliminate the behaviour being targeted. Group-level policies can reduce an activity overall while simultaneously encouraging companies to reallocate the remaining activity to the parts of the organisation where the financial gains are greatest.