OECD Action 13: Country-by-Country Reporting – is it working as intended?
The OECD initiative on base erosion and profit shifting (BEPS) is an ambitious effort to inhibit multinational corporations from avoiding taxes. One of the most important components of the initiative is OECD Action 13, which mandates country-by-country reporting by multinationals of important financial information about their subsidiaries in the countries in which they operate.
The parent company is required to collect information like:
- The number of employees working in each country
- Where the subsidiary has its “permanent establishment”
- Profit before tax
- Tax paid
- Amount of capital is employed
- Value of tangible assets
The information is then sent to the tax jurisdiction in which the parent company is headquartered. The intent was to have a record of the amount of tax paid by multinationals, because it was widely assumed the effective tax they were paying was lower than the statutory requirements. The thinking was that companies would not want to be seen as being tax avoiders and would change their behavior to pay taxes closer to what was required.
This reporting requirement was initially met with trepidation, if not alarm. Country-by-country reporting (CbCR) has been substantially in place for two years now. Has it had the effect that was intended on effective tax rates paid by multinationals?
What Do CbCR Impact Studies Say?
We reviewed the academic literature available on the subject and found that there was an effect, but not a very big effect. One study from June 2019 by Felix Hugger of the Center for Economic Studies at the University of Munich found multinationals’ effective tax rates increased by less than a percentage point after the reporting requirement was implemented.
“While the effective tax rates of multinational groups with a reporting requirement increase by about 0.8 percentage points as compared to companies in the control group, the growth rate of total tax payments is unaffected. This seems to be due to a reduction of the tax base which is also due to a rise in leverage and resulting tax-deductible interest payments. At the same time, shifting of profits out of high tax jurisdictions is reduced by CbCR, but not at the expense of low tax OECD countries. CbCR therefore seems to primarily reduce profits located in tax haven affiliates of multinational groups.”
Another paper, “Does Public Country-by-Country Reporting Deter Tax Avoidance and Income-Shifting? Evidence from Capital Requirements Directive IV” looked at an EU directive that required public reporting of financial data. Did increased public scrutiny have an effect on parent company behavior?
“Treating the introduction of public country-by-country reporting under the Capital Directive IV (CRD IV) as an exogenous shock to disclosure requirements and using affiliate-level data of European banks, we document a significant decrease in the income shifting activities by the financial affiliates in the post-adoption period. Concurrently, we find evidence of an increase in income shifting activities by these banks’ industrial affiliates, which are not subject to reporting and disclosure requirements under CRD IV.
“Our findings suggest that public tax transparency can act as a deterrent for tax-motivated income shifting, but the tax avoidance behavior likely will not change if firms are able to increase income shifting activities among the less transparent affiliates.” (Preetika Joshi Schulich School of Business York University, Edmund Outslay Broad College of Business Michigan State University, Anh Persson Broad College of Business Michigan State University August 2018.)
In conclusion, one study indicates modest, but still measurable and admirable, effects of CbCR. The other study found that adding public disclosure into the mix did make CbCR more effective, but multinationals found ways to minimize effects by shifting profits to industrial subsidiaries that do not have reporting requirements.
A case of “the more things change, the more they stay the same?”