Page 6 - Working Paper (Multinational Firms Losses and Profit Shifting Behavior in Indonesia: Some Comments)

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along with the gap of tax rate between the Today, more than 70 countries in the world
domestic and the country where their related have mentioned ALP on their tax law. There are
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party operates. This is also supported by the tendencies that transfer pricing regulations in
idea of optimal value cost of capital which can various countries are getting stricter, exposed
be measured through weighted average of cost by the obligation for multinational enterprise
of debt and cost of equity (weighted cost of to submit transfer pricing documentation.
capital), where cost of debt considers after tax Before 2001, only 14 countries that have
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cost of debt. As a result, firms would prefer transfer pricing documentation requirement
debt in their capital structure, particularly in for affiliated transactions. In 10 years (2011),
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the context of cross-border financing. the figures quadruple to 58 countries. Several
countries had also armoured themselves with
Comparing between those two, there penalty and other re-characterizing clauses.
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is a general consensus that transfer price
manipulation is the main technique to shifting Many countries today also apply domestic
profit. From meta-data analysis based on rules to prevent intra-group excessive debt,
various previous studies on profit shifting, which refers to thin capitalization measures.
transfer price manipulation is a dominant The most common approach to test whether
profit shifting strategy accounted for 72% of the firms have reasonable financial structure
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all cases , while in developing countries this and interest payment is rely on a fixed ratio of
figure is higher. debt to equity (DER). Limit of the appropriate
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debt to equity ratio is quite intriguing. The
3.3. The Cures
mark between the ‘appropriate’ and ‘excessive’
debt is hard to measure. From government’s
It should be emphasized that decision to
perspective, efforts to take into account all
have profit shifting strategies can be reduced
business model and economic sectors will
by creating anti avoidance rules. There is an
result in numerous ratio, which indeed will
increasing trend among countries to set specific
create more administrative inconveniences,
anti avoidance rules (SAAR) and general anti
especially when assessing complex business
avoidance rules (GAAR). SAAR is meant to
model. Therefore, many countries only set up
focus on specific (individual) tax avoidance
one single debt to equity ratio, mostly around
practice, such as transfer pricing rules, thin
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3:1.
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capitalization rules , and others. With regards
to the dominant schemes of profit shifting, this How about the effectiveness of these rules?
article only deals with transfer pricing and thin Lohse and Riedel estimate that transfer price
capitalization rules. manipulation channel could be reduced up to
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50% with stricter transfer pricing legislation.
Concerned with the possibility for
Studies on foreign affiliates of US multinationals
manipulation of internal group transactions,
in 54 countries during 1982 – 2004 also showed
there is a tremendous growth of transfer
that thin capitalization regimes restrict the ratio
pricing rule across countries. The fundamental
of an affiliate’s total debt to assets up to 43% of
basis for transfer pricing rule is the arm’s
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the case. Moreover, in developing countries
length principle (ALP), which mainly refers
context, application of transfer pricing and thin
to the Article 9 of either OECD or UN Model
capitalization rules simultaneously can reduce
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Tax Convention about associated enterprise.
22. John R. Graham, “Taxes and Corporate Finance: A Review,” The
Review of Financial Studies, Vol. 16, No. 4 (2003): 1101.
23. Peter H. Blessing, “The Debt-Equity Conundrum – A Prequel,” 28. UN, United Nations Practical Manual on Transfer Pricing for
Bulletin for International Taxation, Vol. 66, No. 4/5 (2012): 200. Developing Countries (New York: UN, 2013), 264.
24. See Jost H. Heckemeyer and Michael Overesch, “Multinational’s 29. See Theresa Lohse, Nadine Riedel, and Christoph Spengel, “The
Profit Response to Tax Differentials: Effect Size and Shifting Channels,” Increasing Importance of Transfer Pricing Regulations – A Worldwide
ZEW Discussion Paper No. 13-045, (2013). Overview,” Oxford Centre for Business Taxation Working Paper WP
12/27 (2012).
25. See B. Bawono Kristiaji, “The Incentives and Disincentives of
Profit Shifting Strategies in Developing Countries” (Master Thesis, 30. Please note that thin capitalization rules have many variations, such
Tilburg University, 2015). Available online at: https://arno.uvt.nl/show. as: fixed interest to EBITDA ratio, targeted rules, worldwide debt, interest
cgi?fid=137341. to assets ratio, and others.
26. The term thin capitalization rules referring to rules which restrict 31. It is ranging to 6:1 for normal firms. See Jennifer Blouin, et al.,
interest deductions. This rule commonly associated to a debt-to-capital “Thin Capitalization Rules and Multinational Firm Capital Structure,” IMF
ratio, an interest to-profit ratio (earning stripping), or an application Working Paper WP/14/12 (2014): 23-24.
of arm’s length principle. See Chloe Burnett, “Intra-Group Debt at the 32. Theresa Lohse and Nadine Riedel, “Do Transfer Pricing Laws Limit
Crossroads: Stand-Alone versus Worldwide Approach,” World Tax International Income Shifting? Evidence from European Multinationals,”
Journal, Vol. 6, No.1 (2014): 43. CESifo Working Paper, No. 4404 (2013).
27. Article 9 (1) of OECD Model Tax Convention consist the concepts 33. Jennifer Blouin, et al., “Thin capitalization Rules and Multinational
of associated enterprise and arm’s length principle, while Article 9 (2) Firm Capital Structure, CEPR Discussion Paper, No. 9830 (2014): 29-
concern on corresponding adjustment to avoid economic double taxation. 30.