International Tax Research

1. International Tax Research Stacie Laplante ATA Doctoral Consortium February 21, 2013

2. Outline • Motivation – why should I consider doing research in this area? • Research - what has been studied? • Framework • Investment decision • Profit decision • Opportunities (aka challenges) – what can I do to be successful in this area? • Conclusion

3. Motivation - Quiz What do the following individuals have in common? Rich and Famous? Rich? Famous?

4. Motivation - Quiz What do the following individuals have in common? Tax Planners?

5. Motivation - Quiz • Eduardo Saverin • Facebook founder • Gave up US citizenship before IPO in 2011 WHY? • Singapore: 20% tax on earnings • 0% tax on capital gains • Versus? In US (uncertainty) • Non-tax cost – can he come back to the U.S. to visit his family? TAX PLANNER

6. Motivation - Quiz • Gerard Depardieu • French actor • Gave up French citizenship WHY? • Russia: 13% flat tax on earnings • Versus 41% to 75% in France • Non-tax cost – living in Russia vs. living in France TAX PLANNER

7. Motivation - Quiz • Terry Shevlin • Academic extraordinaire • Washington to California – WHY? • WA: No income tax • CA: 13.3% rate on “top earners” • Non-tax benefit – SUNSHINE! • Point – taxes (often) matter and people engage in tax planning using multiple jurisdictions, trading off tax and non-tax costs. Companies do it to. TAX PLANNER?

8. Motivation Why should I do research in this area? • Researchers care – setting enhances power • Variation in tax rates, base, enforcement, etc. • Data keeps improving • Accountants understand complex rules

9. Accountants understand complex rules • Understand complex tax rules & how they are utilized by companies in crafting actual investing and profit allocation decisions • Understand important non-tax cost = financial reporting implications

10. Motivation Why should I do research in this area? • Researchers care – setting enhances power • Variation in tax rates, base, enforcement, etc. • Data keeps improving • Accountants understand complex rules • Stakeholders care – especially now! • Investors care – maximize after-tax returns • MNC’s important to the economy • Policymakers care – collect taxes • Other stakeholders care – good corporate citizens

11. MNC’s important to the economy • US MNCs account for • $2.5 trillion or 24.9% of 2009 private sector output • 31.3% of all capital investment purchases • 48% of all US exports • 19.1% of all private sector payroll • US MNCs pay workers well • Avg MNC worker $62,784 vs. $50,621 in private sector (24% more)

12. Motivation Why should I do research in this area? • Researchers care – setting enhances power • Variation in tax rates, base, enforcement, etc. • Data keeps improving • Accountants understand complex rules • Stakeholders care – especially now! • Investors care – maximize after-tax returns • MNC’s important to the economy • Policymakers care – collect taxes • Other stakeholders care – good corporate citizens

13. Motivation – Policymakers care “There is a growing perception that governments lose substantial corporate tax revenue because of planning aimed at shifting profits in ways that erode the taxable base to locations where they are subject to a more favourable tax treatment.” OECD Addressing Base Erosion and Profit ShiftingFeb. 2013 • Some small jurisdictions receive disproportionately large FDI • Rules do not reflect economic integration across borders, the value of intellectual property, or new communication technologies • Tax rule gaps between countries allow MNCs to reduce taxes • MNCs more aggressive in last decade

14. Motivation Why should I do research in this area? • Researchers care – setting enhances power • Variation in tax rates, base, enforcement, etc. • Data keeps improving • Accountants understand complex rules • Stakeholders care – especially now! • Investors care – maximize after-tax returns • MNC’s important to the economy • Policymakers care – collect taxes • Other stakeholders care – good corporate citizens

15. Motivation – Other stakeholders care • “British Lawmakers Accuse Multinationals of ‘Immorally’ Avoiding Taxes” New York Times 3 Dec 2012 • “Starbucks Offers to Pay More British Tax Than Required” New York Times 6 Dec 2012 • “Starbucks row over tax and staff contracts could squeeze sales by 24%” Guardian 7 Dec 2012 • “UK Uncut protesters shut down Starbucks shops – US coffee chain targeted in row over ‘rubbish’ corporation tax payments” Guardian 8 Dec 2012 • “Starbucks threatens Cameron after “unfair” tax attacks” The Telegraph 26 Jan 2013 • “Forget Starbucks – what UK companies are doing to avoid tax is far worse” Guardian 10 Feb 2013

16. Motivation • Researchers care – setting enhances power • Variation in tax rates, base, enforcement, etc. • Accountants understand complex rules • Data keeps improving • Stakeholders care – especially now! • MNC’s important to the economy • Policymakers care – collect taxes • Investor’s care – maximize after-tax-returns • Other stakeholders care – good corporate citizens  Relevant & interesting area  Editors & reviewers like relevant & interesting research!

17. Research - Framework (see Devereux & Maffini 2007) Choices firms make in an international context: 1st: Produce at home & export, or produce abroad? 2nd: If abroad, where to locate production? 3rd: Conditional on location, must choose level of investment? 4th: Where to locate profits? Repatriate? 1, 2 & 3 – investment decisions 4 – profit decisions

18. Research • Caveat – providing brief overview • KEY – note the progression • Initial studies documenting investing and profit decisions • Recent studies – more powerful data, better theory

19. Where to locate investment? – Early work • Do taxes affect decision? • Host country taxes affect location decision • Estimate 1% in tax rates FDI by 3.3% (de Mooij and Ederveen 2003) • Data issues (see Devereux & Maffini 2007 for detailed summary) • Aggregate FDI flows  taxes consistently have significant impact • Aggregate affiliate data within specific countries  results mixed • Firm specific data  able to review specific decisions and show taxes matter (e.g., Kemsley 1998 examines decision to export or produce abroad) • Tax considerations important when non-tax costs are low (Wilson 1993) • Interviews with key employees in nine companies

20. Where to locate investment? – Recent work • Does financial accounting affect decision? • Real decisions that increase flexibility in book and/or tax reporting are valuable (Shackelford, Slemrod, Sallee 2011) • Financial accounting expense deferral is as important as cash tax deferral when deciding where to locate (Graham, Hanlon and Shevlin 2011) • 64 question survey sent to 2,806 firms (N = 595) • 31% rate APB 23 expense deferral important in location decision • % higher if publicly traded, have foreign assets, and have high R&D spending • Also examine repatriation decision

21. Where to locate investment? – Recent work • Foreign ownership varies across firms (Lewellen and Robinson 2013) • Firms choose their ownership structures in response to legal and tax rules imposed by host countries • Taxes only one of several considerations • Multiple sources of data • BEA data: Includes financial data on domestic & foreign ops • GDP from Worldbank • Investment treaty data from UNCTAD & Worldbank • Trade agreement data from NSF-Kellogg Institute • Tax data from Comtax, Worldscope, Deloitte, KPMG and E&Y

22. Where to locate profits? • Income Shifting (e.g., location of debt/intangibles, transfer pricing, entity selection) • Early papers document shifting patterns of firms moving income from high to low tax pocket • 1980s in response to tax rate changes (e.g., Klassen, Lang and Wolfson 1993; Harris 1993) • 1988-1992 U.S. MNCs shift into, but not out of U.S. (Collins, Kemsley and Lang 1998 ) • In general, show shifting is a viable tax planning technique but some results puzzling

23. Where to locate profits? • Income Shifting: Modifications • Klassen and Laplante (2012) – revisit/extend CKL • Measurement error in proxy for incentive to shift income • Incentive = AvgFOR – StatutoryUS • Income shifting = multi-period exercise • Replicate CKL, then modify using multi-period proxies & I.V. • Estimate income shifting by regressing foreign pre-tax RoS on Worldwide pre-tax RoS + tax measures • Show income shifting both into and out of U.S. • Extend analysis to show income shifting changes • Changes in tax rates, transfer pricing rules/enforcement, • Estimate $10 billion more shifted out of US during 2005-2009 annually relative to 1988 – 1992 for our sample of 380 companies

24. Where to locate profits? • Income Shifting:Modifications - specific techniques • Location of debt mechanism for tax-motivated income shifting • 1987-1997 US MNC bond offerings (Newberry & Dhaliwal 2001) • 1987 – 1996 US income tax data on Foreign Controlled Corporations (Mills and Newberry 2004) • Transfer pricing - U.S. exporters set smaller prices for related parties (Bernard, Jensen, and Schott 2006) • Data – includes every U.S. export transaction from 1993- 2000 • Average arm’s length price 43% higher than related party price (8% for commodities; 66.7% for differentiated goods) • Transfer pricing – differences in practices and strategies across firms (Klassen, Lisowsky and Mescall 2013) • Survey evidence – 219 MNCs • Saturday at 3:30

25. Where to locate profits? • Permanently Reinvested Earnings • Financial reporting incentives – deferral of tax expense important to firms • e.g., Krull (2004), Graham, Hanlon and Shevlin (2011), Blouin, Krull and Robinson (2012) • American Jobs Creation Act (2004) – temporary tax holiday • Valuation effects (e.g., De Waegenaere and Sansing 2008; Oler, Shevlin and Wilson 2007) • Characteristics of firms that repatriate and use of funds (Blouin and Krull 2009) • Location of PRE (Blouin, Krull and Robinson 2012) • Effect of PRE held as cash on foreign acquisitions (Edwards, Kravet and Wilson 2012)

26. Where to locate investment/profits? • International operations & tax planning • Effect of multinational operations on worldwide effective tax rates • Rego (2003) – US MNCs scale of operations related to ETRs • Markle and Shackelford (2009) – Domicile of parent related to ww ETRs • Effect of the location of US MNC’s foreign operations on worldwide, federal and foreign tax rates (Dyreng and Lindsey 2009)

27. Research Summary • Take away from research review • Early studies document taxes matter for investment and profit location • Studies generally incorporate SWEMS framework • Recent studies refine theory and data • Proliferation of data sources • Theory advancement more measured • Pretty convincing evidence that financial accounting is important

28. Opportunities (aka Challenges) What can I do to be successful in this area? • Knowledge – continue exploiting strengths • Tax & accounting rules in multiple countries • Understanding business environment to generate interesting questions • READ: e.g., WSJ, Economist • Research in public economics & finance • Creative use of new & existing data sources

29. Opportunities – Suggested Readings • Klassen and Laplante (wp 2013) • Example of theoretical advancement • Incorporates income shifting into models of investment • Optimal shifting relates to the interplay of costs and tax rate differential • Suggests hypotheses refinement for recent income shifting and PRE studies • Example of new data on e-commerce • Markle (wp 2012) - Examines Income shifting in territorial vs. worldwide systems • Example of data advancement (Orbis database)

30. Opportunities – Suggested Readings • Graham, Hanlon & Shevlin (JAR 2011) • Explicitly incorporates predictions from Shackelford, et al. (2011) regarding financial accounting • Looks separately at investing & profit decision • Example of data advancement • Any feedback for KL (2013) or Markle (2012) greatly appreciated!

31. Conclusion • Motivation • Interesting and important area of research • Research – lots of it, but room for more! • Investment & profit decision: Taxes matter, but nontax considerations like financial accounting matter too • Advances in theory and data helping us move forward • Opportunities • Accountants bring valuable skills to the table – exploit! • Big world – learn about what businesses are doing • Editors like to publish interesting research!

32. Thank you!