taxes and transfer pricing: income shifting

7/22/2019 Taxes and Transfer Pricing: Income Shifting

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toin-iiii ot ..Recounting Researc.-V O L.34 No. 2Autimii i19vmf rnUfd i> :i .S..-i.

TaxesandTransfer Pricing: Inc om eShifting and theV o lume of IntrafirmTransfersJ O H N J .4 CO B *

i. IntroductionThis paper extends Harris [1993] by linking the level of taxes paid b\

firms and tb.e profits thev report in various geographic areas to the volumeof iotergcographie area transacticm.s wiuiin iiriTiS. If firmsuse theprices,for goods t ransferred in te rna i iona l lv to minjiriize th eir g lobal taxe s, itseems reasonable -hat thegrea test op port tu i i t ies and incentives for suchmanipula t ion exis tfor firms with large am ou ntsof in te rna t iona l in t raf i rmsales and wwh.large difl 'erenees in tax rates beftveen reg ion s. FollowingHarris [1993]. tliese firn'is constitute the ''flexibility partition" "vviih thegreatest incentives and oppoi ' tuni t ies for tr ansfe r p r i ce m anag em en t . ' \* Uiiivcrsitv oi C o l o r a d o at Denver. This paper js based ov.mydisserta t ion at Xort i i -

wesrei'n I'riiversitv. Iwoi;id Uke to iha iik m emb ers of niv dissestatioi; con" mittee. Thom isLvs U'hair ' ; . BaSa Baiachandraii . Carla ilaMi. Robert McDonald, anfi Ramu Thiagarajau, 1also tl iank Ernest /Vud and Scotv McSliaiie oi lutemat ioriaL Business Services at Er-,\stJcYo ung aiic (i.arv Coi'Dert for usehii discussions. T nep a p e r hasbeiie fiied fron-s c inri nien tsfrom seminar part ic ipants at Nortlnvesterii I ' lsi^ersity, SLN'S'at B-cffalo. Bartic'n (.'.c:illegr.University of Coioradt / at Denver , the 1,995auntsal m eet ing of Ihe .Inieric an .Accounti g, \ssociatiori (held in O r l a n d o ) , a ri d ,a;anot ivmous re fe ree .

' Harr is defines his ilexibiiitv purution as firms with h igli levels of interes t . RirD.. ren t ,adver t i s ing , and i n t a n g i b l e s . Th t g ioba in t e res t a l loca t ion rec iu i red bvTRASband il e


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302 jc>URN-\L OF ACC:C>L;NTINC;RE,,SEARCH, AUTUMN1996necessary conditionfortax-motivated income shifting through manipu-lationoftransfer pricesis theexistenceofintrafirm ii'tternationai trans-fers.Using dataonthese transfers, 1 attempttodiscriminate betweentheuseofoperational methods to decide the locationofincome and the ac-counting rrianipulationoftransfer prices.-My results suggest that tax-moti\'ated income shifiiiig through transferprices was prevalent both beforeandaft,er theTax: Reform -A,ctof 1986(TRA86).Themagnitudeof theincome shifting appearsto berelated,tothevolumecsf intrafirm international transfersofgoodsandservicesand regional differences in taxrates. These resuits suggest thai transferpricesare themechanismfor income shifting.'^Section 2summarizes prior researchin thearea. Section3describesthe sample selection, while section4containsthe research designandempirieai res'alts. Section 5examines tberole of firms' location deci-sionsas apossible confounding itifSuenceandsection6summarizesthecoiiclixsions..2, Related Research

-A, numberofpapers addre,ss geographic income shifting. Prominentamong theni are Grubert an,d Mutti [1991 ] .Harris eia l. [1993], Grubert,Good.speed,and,Sweason, [1993],Klassen, i.ang, and Wolfson [1993],andHarris [1993], Harris [1993] studiesmeresponseofMNGstoTRA86.TIi-A,86 reduced thecorporate taxrate from 46%;to34%andsimulia-neoush' decreased, investment incentives. Harris .hypothesizes that thesechange, ,increased tlie incentives forMNG-ito shift income into the UniiedStalesandcied'uctionsout of theU.S.TheresulLsfor arandom, sampleweakly support ihis hypothesis,andthosefor asubsampie identifieciasmore sensitivetoT'R,A.,S6's changes (the flexibility sample) are consistentwith the hypothesis. The flexibility sample is composedoffirms with highinterest, R E).,advertising, and rent expensesorhigh intangible assets.The papers cited abo'i'e examine nieasure.s such, as reported, profitabil-ityinvarious regionsorU.S. taxes paidforevidenceofincome shifting,Thev find that firms report higher incomein low-tax countriesorthatsubsequent to a changeintax rates, ihe geographic distributionoffirms'inc(,)me andtaxes) changes in, line withthechanged iiicenti'ves. WTiile

"earnings stripping" rtiies have constrained l;,,S,MNCs use of interest to shaft ineonie.Trai'isfer pricingofintangibleshasaiso faced sigtiitieant restrictions after TEL'lSd, Thus.JIarris' fiexibilitv sample may nothavehad much discretion in transfer pricing in tiiepost-TR-A,86 period, Firm,s with sizable ititangibie assets i'stsch aspharinaccuticai firms),however,arelikeh'to bef exil->ieintheir loeation decisions" Examplesofoperating decisions that infitience where income i,s reported are locatingmore profitable ,operationsinIciv-tax jurisdictionsandre.sporiding tc; changesin taxratesby aiterhig the locationorvoJunieofbtisiriesscs,''Alternatives to transfer pricesasmeans tomanage thelocation of reported incomeinclude managingtheiocationofdebt and expenses.


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LA.XF,S \ND TR^NSFFR PRICING :}i,i,H

this isconsistent with tax-motivated incom e shifting through tran-,ferprices,it is aiso consistent with firms respondingto tax incentives usingoperational methods suchaslocating more profitable opera tionsin hnx-tax cotmtriesor alteringthe geographic distribution c>f their operatioiisin responseto a changein tax rates, This paper attemptsto discriminatebetween tbese competing explanations using the volumeof intraiirmin-ternaiionai transfersas a proxyfor income-shifting opportunities,3. Sample Selection

The samplewaschosen random lv from I .S. firms on ompustatforfiscal year 1988 that reported pretax earnings figures separately for tl:eirU.S.and foreign operations. Disclosing both domesticand foreign m-ponentsof incomewastaken to indicate multinatioiialnv, unde r SfASNo If. Attention wasrestricted to L .S.M.XCs to avoid the incen-i'iediilerences induced bv varying tax .systems, A sample was used insteadofthe populationof irmsonCow />u.v/nf because dataon the volumeof mtei-geographic area transfers were hand collected from annual reports,'Iwohundred six firmsin the 19.82-84 periodand 289 firmsin the 1988-9('iperiod constituted,thefinal sample.*Two time period s were exam ined, fiscal years 19S2-84 and fsscal vear.s1988-90.The periods were chosen so that the intervening years coverthe period whenthe greatest chan gesin the tax and transfei-pricingr-=-G-ulations occurred.Univariate tests (not reported) revealed that theproportion of iiura-firm intergeograpljic area transfers to total sates iTItlN.S]bas increasedbetween pericds (from a medianof .5.4%to one of7.?' )as has the pro-portionof foreign salesto total sales(MN, from 28.0%to 34,3%), RothsheU.S,stauUorv and theaverage foreign tax rate declined between periods,F-Iowever, the L .S. tax rate is greater than the average foreign tax rate d.ir-lug ihe 1982-84 period andless than this rate d urin gthe1988-90 period,implying different incentivesfor income shifting in the two periods,4. Research Designand .Empirical Results4.1 IMI>:T OF IR. VNSFER.S ON GLOB.\L TAXES PAID BY FIRNLN

If firms tise the pricesfor interge ograp hic area transfers to shiftin-cometo minimize taxes, then firms with large volumesof tliese transferssho'ald, cetcris paribtis.pay lower global taxes. Ib examine this hypob-esis,the following regression isestimated:GIJAX, ,= a f>'.GEPROE,, +

'' Th e differetice in sample sizes betweeti the two p e r i o d sisbeca use several firms tf .alreported fore ign t ipera tionsin t'fie later perioddid not do so in thf ear l ier per iod.


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30 4 JOHN JACX>Bwhere for firin j and year r:

GLTAXj, is cu rre ntl y paya ble gioba l taxes scaled bv globa l asscLs,GLPRO j f is giobal pretax profits of the firm scaled by global assets,TRANSjf is the dollar am ou nt of intr aS rm intergeogra.ph ic area iraris-fers for the firm scaled by giobal sales.MNj, is a proxy for the deg]-ee of m ujtin atio nal i ty of the firm,defined as the ratio of foreign sales to global sales ,SlZFCj, is the na tur al log arith m of global assets , a s ize proxy,

I is a vecto r of ind ustry du inn iies ,] j is a vec tor of year dum m ies , and

is the residual.A profitability measure is included since the ie^'cl of taxes paid is ex-pected to depend on profitabil i ty. AlV, the proxy for the degree of multi-nationality oi the firm, controls for the possibilit.) ' that the average taxrate abroad for firms could .systematically difler from the correspondingU.S. figure; i.e., global taxes might depend on the extent of ff>reign op-e ra t ions . SIZE co ntr ols fc)r the influ enc e of firm size on taxe s pai d. T heindustry dummies are controls for industry influences on the level oftaxes paid and the year dummies control for factors sucb. as changes intax rates, ' 'As a proxy for the am ou nt of intrafirm int ern atio na l transfers ofgoods and services, TRANS.,the ra t io of in t ra f i rm in terg eog raph ic a reasales to tota] sales revenue of the firm is used. SFASNo. 14 req uire s firmsto disclose the amount of intrafirm sales between geographic areas and

to account for them on ihe basis used by the ftrrri to price the intrafirmtransfers.^'The results of e .s t imating (i) , reported in tabie J , suggest that firmswith s izable intrafirm international transfers pay lower taxes than other-wise smiilar firm:s.' ' The coefficient on TRJ\NS. which proxies ior the vcil-ume of transfers, is negative and .significant at the 5% level or better inboth periods. Using the coefficients from^ the regression, the mean an-nu al tax savings pe r firm is $18.9 mill ion (95%' confid ence inierva l , $ 7 .1 -30.8 mill ion) in the 1982-84 period. The correspcmding figures icjr the

'For exatapie, I ' lc vurying inspact of ciepreciatiori deduction'^ ov , different m dusaics;could resuii in ditlereace.' ; across industries''It is possi'fiie liiat. firni.'. ;ise difle reiit tran sfe r pri ces foi fin aac ia re po rt in g and taxpurposes. However. corsyersation.s witli practitiot.


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3 0 6 JO HN J-ACOBT LE 2

Regression Eiesults for U.S. Tdxe-i PaidModel: USlAX,t =t: -f 51 ftLPROF,,-I-f 2HMA?? ,,-t-

0 0 1 7(0,65)0.345(iO.g2)-0 .045(-LG2)-0 ,020( -L2 9 )-O.OOOOS

( -0 .01)0,64437 7

0,015(1 .40)0,286(22.88)

0,033 2,6i)-0,023(-2,56)O,OSi]

(1.2S'i0,57751 6

Pre dic ted Prc-T'RASo Period '' Post-TR.'\,8(i Pe riod''Variable'' Sign (1982-84 ) (1988-90 )intercept rGLPROE ^TRANSMN

Adjus t ed *N o , of O b s e r v a t i o n sH,'O('fficiei;t^ and f-statislics for industr)' liiid year riiiiiinry ^'aria Jies are not reported,^7,,stati?,tic,s are ir,, pare:;d:ieses. St and ard err ors a rt co m pu ted iisir,g Whit e's }ieterosccda,stir;tv-coris:sten'. covariaiiccs in cases where tiie itUil of -^joniosceriastjcity was rejeotci.Variable dei ini t io i is ,U.ST. iiK ,- U,,S, taxes curre riti) ' payable scalet; bv l, ' .S. assets,GLPROf g i Sb^)pre tax hicetm r scaie.: bv gio't)al total a ssets.TliAjWS - i rs lergeograp 'u ic area sa les scaled b\ g lobal saies revenue ,A'lV - :ati (; oi foreig n sales to tota, saies rev enu e,S'//X' = na tu ra l iogai Jth n; oi U.S, asset,s (ir, $ niiliion s': of tfve tiriB,I-\ D = a vector of industry ciuir-inies 'based on two-digit 5/C codes,YE. - i.h: - a vector of year cun inii es which take Ihe vaiu e ] when year - , ' arid 0 o herv,'ise.

Glob al profitability is u,sed as the c on tro l for profitab ility since tlieU.S, taxes global income of U.S.MNGs. .MN.the prox y for th e ciegree ofn^ultinationaiity of the firm, controls for' the tleferral of U.S. taxes on in-com e ea rned ab road .Table 2 contains the resuits of est imating equation (2). Tlse resultsindicate that firms m the pre-TR-A-SG period with sizable intrafirm trans-fers appear to have paici less U.S. tax tlian comparable flrnis without thesetransfers. The coefficient on TPi^ANS is negative and statistically sigrii-ficani at the 10:% levei . In t i ie post-TR.\86 period, however, the s i tuaiionreverses. Finns v^'ith substantial inira,firm iniern?ttic>nal transfers appearto pay hi gh er Ll,S, ta,xes than firms w ith ou t these tra nsfer s. Th e co -efficient on IJtiNS is positive and statistically significant at the 1%' level.Th ese resu l ts a re cons is teot wi th TR, \86 red ucin g the ma rgina l cos t of re -porting income in Ihe United States relative to foreign countries ."

The coefficient on MN, {he proxy fbr the niult inaiionaUiy of the firm,is negativ e in bot h p erio ds, probably beca use of the deferral provisioi; inth e U..S. tax h'rtvs for taxe s on fo reig n in co m e. Th e m or e m ultinatio nal:

"''N(,>te that thoriph TR/\86 increased L'.S, taxe.s for U.,S,MNds(due to changes in the in-'vestnien tax credit and dep reciatio n j'ules), ii is likeiv to hsve reciuccd the uiarginai costof income shifted into the United States (due to reductions in, the statutorv tax rate'.


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AND I'R.-VNSFLR PRICING 3('>7T.AELE 3

prediction, , forCoefficients under Atternativi ScenariosM(idei:DIEEPROE:,^. a -^ b-ft,,, ^j - If.,) xTTMAiS' ; ,- rP;(f,,,,

Prc'dicteriSig i ofCoefficientsScenario Descripnoti of vScenario j>; p-> {V;

A No income slnfiing U '* r>i^ income shifted but ij.oi through transfer prices -J - Incorrje shifted via transfer prices only - * +; -

^ariable defiiutior" s:DIFFPROF~differe ice m profitabinry idehried as rario of estiriiarcd taxable incv-uji to as' e ;

between ihe I'.S. and foreign operadons.i . = sratutorv torpoMitt= tax ratt= in the Usiited States, m the periuti ; ;.'.S. ci:rre; L i"3

ex'jrnse li. positive, se; to missing otiienvise.tf = ra t ioof currej i t roreigr; taxestoestiiiiaied iVn'eign. taNabie -h uon ie.M A =ra i ioof foreitj:"; saiestoto:a ; saiiesot f i rm.TFiWS =rat io ol'" int eig eo gra ph ir area salestototal saiesofhrn-i./ A 7 > = 'ectorof industrv di inimie^ basesion two-tUgi;S IC coties-VE. xR Vir.fiorof vear dinrinue? which take the I 'aJue ; v/ ien year ='ar.J'0c-lhefvase

the firm, the larger the proportionofIIS . tax-deferred foreign incomeis likely to be.The restilts reported m table 3 are con.sistent with the results for Har-r i s [1993] flexibility sample but they differ from those reported in Klas-sen, Lang, and V\T)lfson [19931forthe post-TRA86 period . T hev reportincome shifting out of the United States in 1987-88 and insignificant re -suits for 1988-89 and 1989-90. The results in the pre-TR-\86 period arenot strictly comparable because both Harris [1993] and Klassen. Lain,.and \^^:)lfson [1993] use 1984-85 whileIuse 1982-84.4.3 IMPACT OF 'I'R.\NSFLRS ON FIRMS' REPORl'ED PROFITABILITY

The greater the difference in tax rates among regions, the largerar:the tax savings achievable bv locating incomein the lower-tax jurisdic-tion. Since tax authorities monitor transfer prices, the opportunities forincome shifting appear to be greatest for firms with sizable transfers be-tween regions. For these firms, a smali change in the transfer price co'aldhave a significant impact on profitability and tax(;s paid. Ceteris paribu:^.tax-motivated manipulation of tran.sfer prices wovild result inreported:profitability; in the U . S . and abroad, deviating from the industry normtothe greatest extentin firms which have large amountsof internationalintrafirm sales and large differences in tax rates between regions.This hypothesis is tested bv examirdng the ditlerenceinthe reportedprofitabiiitv of firms between their operationsin the U.,S,andabroad.The following regression is estimated:

D I E E P R O I y =a P i { ^ w j . f - fjj) >^ T R A N S . j + ^ i t u , , , ; - i r , : j


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308 JOHN J.ACOBwhere for firm / and )'ear t,DIFFPROF,fproxies for the clifrererice in thefirm's profitability in the U.S. and foreign locations. This proxy isdefined as:

77 . . T7,.,,DIFFPROF,, = ,.^.'1': :' -FFTFASSF/FS,,,^ , , ASSETSf ,

where for region i= wi, /"(oreign). firm. ; and year i:TL ;jI =estinrated taxable income,"''ASSETS,; j - identifiable assets from the geographic segment fooLiJoie..

t'; ,fproxies fc;r firms' tax rate m region ifor ? us,/'(oreig;:). and othervariables are as defined earlier.

The operations of firms are segregated irno two regions, the U.S. andforeign. Using an average tax rate for the foreign region captures theincome-shifting incentives in cases where foreign operations of firms arein one country or m countries with similar tax rates. This is not as appro-priate when the foreign operaticins are in countries with widely differinglax rates.'^

The marginal tax rate faced in the United Stales is estimated as thetop U.S. corporate statutory rate (0.46 m 1982-84 and 0.34 in 1988-90)in the years that the U.S. current tax expense is positive. Observationsfor years in w'hich these taxes are negative or zeio are exclud.ed from thesample due to uncertainty about this marginal tax rate. The tax ratefaced abrc>a.d is estima.ted as tlie ratio of foreia n current tax expense toestimated taxable income a.broad for the year.

The estimas.ed tax rate in tlie foreign region is an a .'eragc rather thana marginal tax rate. This is used because of the ciifHculty m estimating amarginal foreign tax rate. Since the tax rates ai'e likely to be ineasured witherror, the sensitivity of the results to six clistirict estimates for the difTer-ence in tax rates between, regions was te.sted.. 'ilie results vicrc essentia )'unchanged. The differences in tax rates betwreei regions were trans-formed irno four portfolio ranks to reduce the influence of outliers.''

The difference in profi'tability between regions is used as the depen-dent variable because any income that is shifted out of one region is

' The estimates- of the l.'..S and foreign taxable inconrje arc .roniputcd a.s:BtT. .

where for region t - VS. or .foreign, firm / and i ear j :j Rf DiX,., - pretax incoirie.DEF jj - deierred incon :e tax. expense.T;, ; - estinialed tax rate set to the statutory rate in the U.S. and the ratio of

mcc me tax expense to pretax inc,:.>rt'e abroad.'"Howeyer, to the extent that the foreig;n tax credit pc sitior? iniiuences the. preferred,

location of income, the average foreign tax rate could iiave a bearnig on income-shiftingincentives.

--Three of the proxies for tax rate diilerences 'betvs'een regicTis used iirtn-specific esti-mates oi' the U.S. at'id foreign tax rates. The results were very similar wher: the pc>rtf;.'liomean or median was used, instead of tfie portfo'io ranlc.


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TAXE.S .\N D TRANSFE R PRICIN G .'3('9presumably shifted into the other. Using the difference in profitabiliiybefvveen region s increases th e power of tests to detect income shifting. Us-ing this difference also purg es frcui the de pe nd en t varia'Die firm-specificinfluences on profitability that are common to both regions.

The interactive variable between the diflerence in tax rates, /,-,',-.and the proportion of international intrafirm sales.ER^\NS attempts tocapture tax-motivated income shifting. The clifTerence in tax rates andthe proportion of international intrafirm sales are introduced indiviclu-ally as explanatory variables to control for any effects thev have on thedependent variable, independent of their interaction.MN the proxy for tlie degree of multinationalitv of the firm, attemptsto explain any of the difFerential profitability between regions 'vvhichstems from the degree to which the firm is involved in foreign operations.Industry dummies serve as controls for industry-.specific influences and

year dumm ies are inclu ded to control for m acroecono mic factors such since if. in equ -librium, after-tax rates of return m the two regions are to be equal, themore highl) taxeci area should have the higher pretax return. - .Scei.-ario iJpredicts a negative (or ie.ss positive) pg becau.se if incomei shiftedthrough means other than transfer prices, the lower-taxed area shouldexhibit higher than expecied profitability, btu this should be unrelatedto the volume of transfers.Under scenarios Aan d Bon e wouid expect a coefficient ciose to z,er >on 3^. If transfers are fairlv priced, they should not aflect the differenti;;profitability between region s. Unde r scena rio C, a significant coefficienton ^-i is expe cted if incom e is shifted,, in anv one dire ction , ind epe nd entof tax rates the firm faces in the regions.^'*The results of estimating (3). reported in table 4. indicate that trans-fer prices have been used to shift income to low-tax jurisdictions. T'n ?

- Schofes and Woifson :1992. p. 2.53j argue tjiat competition shouid leaci to li-jt- benefitsof lower taxe.s being diluted so that, in cq'dilibrsum, aftei-tax rates of return are eqisa'i acrossccitiritries,''"Reasons for sticb iiicotne shifting cotild be political instability or restriction.^ on repa-triation of profits in foreign countries.


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310 JC>HNJAC;OBT LE 4

Regi'ession ofDifference in profdalriiity between RegionsModel: DIFFPROF), - a -r jJ-. t-^ ,, - tf ,,, ) x TRANS., - Bj (, ., - tjj . )

eriod '' Post,-TRA86 Pe riod''Variable'^ , (J982-84) (1988-90)" Intercept o lS 0.043',,(3.56) (0.64)(t^,- tf] XTRANS -0,:;61 -0.S36 t-] .85) 1-4,61)

,- ff ) -0.010 -0,002(-0,89) (-0.25)IELANS O,iOi 0,619(0.46) (3 90)M N -0.152 -0,111(-1,891 (-1.56)Acliu,sted R-- 0,279 0.225No of Observation,- ^ 242 407

^CoeiFicieiits, ari,d f-statistics fo iriciu,strv a n dvear dum my var i ab l es a r e no t r e p o r t e d ,'^7-statisticb are in parent 'tyeses, ,StaDclard errors art^ {-oinputcd us;i it^ W hi te 's hetero scet iast ici ty -cor i -,sistent covar iance s in cases K'here t h e n u l l of h o m o s c e d a s t i c i i y was r e jec t ed ,^'The differing sasrvpse sizes arc due to difference.s in data availubilitv a nd f he l a r g e r n u m b e r off i rms with internat ional , : iperat i t>ns in the later per ioi i .Var iable def ; i i i r ions:DIFFPROF di ercncc in profita bility {(iefiued as r a t i o of e s t m i a t e d t a x a b i e i n c o m e to assets)b e t w e e n tb e t ' ,S , and for ei g i i op era t io ns .*, = s t a tu tory co rpora t e tax r a t e i n t he Uni tet i States in the p e r i o d if U,S, c u r r e n t tax,e x p e n s e i,spos i t h 'e , set to mi ss ing o therwi se ,.V :- rat io of cur r ent f or e i gn t axes to es t imated for e i gn t axable i nco m e,,'VI\' = ratiC of foreign sales to total sales oi f i rm,TPJ'iNS '-'r a t i o of i u t ergeographic a r ea sa l es fo t'he total sales of f i rm,/-VX' -' ^'ect,or of iridiistry du trm ne s baseci crit wo digit S-'^Ccocies,YEAR = vec tor of year dummies which t ake t h t va lue 1w,-hen vear - ianci 0 o t h e n v i s e .

interactive variable, (t ^ - ii) xTRANS is negative, as predicted, and sta-tisticaiiv significant (at the 10% level in the pre-TR-A.SG period and atthe 1% level in the post-TR:\86 period).The coefficient on ERANS is positi'^'e and significani in the 1988-90period, indicating some income shifting into the United States indepen-dent of tax rates. The coefficient on it^- tr) is negative but not statisti-cally significant in both periods, suggesting that income shifting throughinean.s other ihan transfer prices may not be pervasive.^'''5. L ocation D ecisions as a Possible Confoun ding Influence inthe Data

It is likely th at firms which ope rate in loiv-tax jurisdic tions to m inimiz etaxes have large amounts of intrafirin international transfers, either be-cause of the geographic dispersion, of these firms' activities or because' Results of siniilar regressions using the profitabilit)' of U,,S,and foreign operations in-divichaa )' as t-f e de pe nd en t variable in (3) supported these conc iusions. In, atio the r test,did not find a diilerential impact of the foreign tax credit position of firms on the extentof inco m e shifting-.


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TAXES AND TR^ NSFER PRICING 31 1the ge og rap hic dispersion is used to red uce taxes thro ug h creative trans-fer pricing. Under the firs t of these alternatives, some of the results inthe previous sections couid be due to a positive correlation betweenfirms tax-driven loca tion dec isions and t he vo lume of intrafirirt inte: -national transfers .

Tc> investigate this possibility, I first c om pu te the co rre lati on s b etw eenthe volum e of in terg eog rap hic area transfe rs (77?.4A 5) and the absoluievah,ie of the d ifferen ce in tax rate s firms face b etw een thei r U.S. and fo: -eign o per atio ns (?; - if . Tbis co rre lati on is positive and significant inboth time periods, indicating that firms with large differences in tax rat-sbetw een tbeir U.S. and foreign op era tion s also tend to have large intra-firm international transfers .To examine whether this correlation is driving tbe results , I reestimateequations si) and (2) for both periods using a fixed effects dummy vari-

able model. This model involves introducing firm-specific dummy var,-ables into the regressions. Thi.s procedure is equivalent to regressing thedeviation of the de pe nd en t variable from its firm- and period-specifics:imple means on the deviations of the independent variables from theircorresponding sampie mea: is . This approach e l iminates the impact cfmissing firm- a nd period-spe cific factors , such as location de cisions thatcould affect the dep en de nt variable. Th e assump tion involved is that the.firm does not make m;\jor location changes within each of the three-year sample periods and thus each firm acts as its own conti-oLTh e results of the fixed effects m od els (no t reported ; confirm theessential results reported in earlier sections. The results of estimating

equation (i) in both periods inc{ica,te that transfers are associated witilower global tux pa>ineB,ts. T h e coefficien t on TKiN^S snegat ive , as pre -dicted, ili both periocis and significant at conventional levels in the pre-TR.486 period.\\T:icn the fixed efFects model is estimated for equation (2), i.e., th fregr essio n of U.S. taxes paid on, the a m ot m t of transfers , the sign onthe TRANS variable is consistent wth the minimization of global tax,esthro ug h transfer prices in both per iod s. Th is variable is negative and sta-tistically significant at conventional levels in the pre-TRA86 period and isinsignificantly positive in the post-TKAS6 period. The levels of signifi-cance of the variables are reduced from those observed in the regressionwithout firm-specific dummie.s. This is not surprising, given that thefixed effects modei suppresses considerable information.Overall , these results suggest that while location decisions may be par-tially respon sible for the earlier findings, th ere a ppe ars to be a noth e:effect which is in de pe nd en t of loca tion d ecisions. This effect is mostlikely due to the man ip alation of transfer prices for tax reasons.6. Conclusion

Harris [1993] observed patterns in the U.S. taxes paid and the geo-gra phi c disti ibinion of u icom e re po rte d bv U.S, AlNd consistent witb


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3 1 2 JOHN JACOBt ax -mot i va t ed i i icome shi f t ing. I use data on the vo lume of in t raf i rm.i n t e r n a t i o n a l t ransfers to inves t igate wb et l ie r these pat ter ns are du e too p e r a t i o n a l fac to rs o r t o t he m ani pu la t ion o f p r ices fo r i n t e r na t i ona lintrafi rm t ransfers .

T he resul t s ind ica te that fi rms wi th subs tant ia l in te rna t ion al in t raf i rmsales pay lower global taxes than o therwise s imi lar f i rms in bo th the pre-an d the pos t. -T RA86 pe rio ds , bu t these same f irms ap pe ar to have paidlower U .S . taxes than o therw ise s imi lar f irms in the pre-T RA 86 pe rio d an dh i g h e r L^S . taxe s in th e post-T R.4.86 pe rio d. T his re.suJt is con sisten t withg loba l t ax m in im iza t ion th rou gh t rans fe r p r i ces in bo th per iod s . Fur th er -m o r e , p ro f i t ab i li t y d i f fe rences be tween U .S . and fo re ign op era t ion s a recons i s t en t wi th the management of t ransfer pr ices for tax reasons in bo thp e r i o d s .

REFERENCE.S


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taxes and transfer pricing: income shifting

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