Page 4 - Working Paper (Multinational Firms Losses and Profit Shifting Behavior in Indonesia: Some Comments)

DDTC Working Paper 1215
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a higher risk is assumed. Therefore, multinational From business perspective, corruption is
firms with simple FAR, such as commission agent sometimes considered as informal tax to the
or toll manufacturer should have a normal profit government. Stable political environment and good
but have less probability of financial loss. governance influences business decision making
and discourages multinational firms to allocate
Secondly, the impact of business cycle and profits abroad.
strategy should be considered. Every industry
sector have their own particular business cycle Based on the above arguments, it could be
patterns, for instance: the tourism section is observed that losses could have been driven
greatly influence by seasonal demand. Even within by non-tax factors. However, the next question
a sector each firm have own particular life-cycle, would be: for how long, could a multinational
starting from start-up phase, growing phase, firm, from economic rationale perspective, suffer
matured company, decline phase, and finally when such losses? Two, five, ten years or even longer?
the enterprise is shut-down. Business life cycle also Again, it depends on the whether such losses could
have an impact on how firms design and formulate be tolerated thereby taking into consideration
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their business strategy. For instance, a firm that is remuneration from future profits. From economic
contemplating to enter into a new market (start-up rationale perspective, when multinational firms
phase) would probably interested in implementing continue to operate their business, while most
a market penetration strategy, either by offering of independent firms are not; this could be an
products to the customers with significant lower indication of profit shifting strategy (tax motive).
prices than existing products from competitors or
to offer significant discount. Such strategy could 3. Financial Loss as Profit Shifting
Strategy
create a financial loss for the firm.
Thirdly, the impact of extraordinary market
conditions should be considered. In their When multinational firms suffer losses, they
operations, firms would always anticipate their may not be receiving adequate compensation
future operations by making market projections from the multinational group of which it is a
based on most recent economic conditions, for part in relation to the benefits derived from its
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instance, when setting their pricing policy. However, activities. Multinational firms’ losses can therefore
in the case of market volatility (disequilibrium) be associated with profit shifting strategy. Profit
projections might fail and lead into financial loss. shifting is a strategy to minimize the multinational
The global financial crisis during 2008-09 could be firm’s global corporate tax burden by placing or
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robust illustration. Both multinational firms and allocating profit to the entity that operates in
independent firms are impacted by the probability the country that provides the most favorable tax
of unexpected risk in abnormal situation. There regime. As a result, profit shifting can erode a
are three different sources of abnormal situations: country’s tax base. From basic economic model
(i) internally from the company (e.g. fraud or of profit shifting, multinational firms’ reported
inefficiencies); (ii) industry or sector (volatility of profit was a result between ‘true profits’ minus the
price for raw material); and (iii) macroeconomic shifted profit. Thus, financial loss (negative profit)
condition. 7 might be the outcome of excessive profit shifting
strategy. Discussion on such issue in the context of
Fourthly, non-economic conditions should be Indonesia, need further understanding on why and
considered. For multinational firms, political risk how profit shifting can be occurred, beforehand.
could also create uncertainties to their business.
Furthermore, there is a negative relationship 3.1. The Causes
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between corruption and corporate tax payment.
Interdependency of the world economy
marked by global value chain and free movement
4. See Romi Irawan, “Analisis Fungsional” in Transfer Pricing: Ide, of products and production input has brought
Strategi, dan Panduan Praktis dalam Perspektif Pajak Internasional,
eds. Darussalam, Danny Septriadi, and B. Bawono Kristiaji (Jakarta: more concern on international aspect of public
Danny Darussalam Tax Center, 2013), 107-135. finance. Tax policy is extended from local to
5. Robert Feinschreiber, “Life-Cycle Analysis and Transfer Pricing,” global, from national to international. It is
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in Transfer Pricing Handbook, 3rd Edition: Volume 1, ed. Robert
Feinschreiber (New Jersey: John Wiley & Sons, Inc., 2001), 37.9-37.10. merely concern that any country’s corporate
6. Christian M. Scholz, “Recession Transfer Pricing Returns,” in Transfer
Pricing in Recession. Tax Planning: Special Report, ed. Lilian Adams Compliance?” Beiträge zur Jahrestagung des Vereins für Socialpolitik
(Washington D.C.: BNA International Inc., 2009). No. A17-V1 (2010): Ökonomie der Familie - Session: Corporate Taxation,
7. Deloris R. Wright, “Extraordinary Market Condition,” in Transfer Pricing No. A17-V1.
Handbook, 3rd Edition: Volume 1, ed. Robert Feinschreiber (New Jersey: 9. OECD Transfer Pricing Guidelines 2010, Paragraph 1.71.
John Wiley & Sons, Inc., 2001), 16.3-16.4. 10. Richard A. Musgrave and Peggy B. Musgrave, Public Finance in
8. See Clemens Fuest, Giorgia Maffini, and Nadine Riedel, “How Does Thory and Practice: 4 edition (New York: McGraw-Hill, 1984), 759-
th
Corruption in Developing Countries Affect Corporate Investment and Tax 760.