Does Private Country‐by‐Country Reporting Deter Tax Avoidance and Income Shifting? Evidence from BEPS Action Item 13

• DOI: http://doi.org/10.1111/1475-679X.12304
• Published date: 01 May 2020
• Date: 01 May 2020
• Author: PREETIKA JOSHI

DOI: 10.1111/1475-679X.12304

Journal of Accounting Research

Vol. 58 No. 2 May 2020

Printed in U.S.A.

Does Private Country-by-Country

Reporting Deter Tax Avoidance

and Income Shifting? Evidence

from BEPS Action Item 13

PREETIKA JOSHI

∗

Received 1 December 2018; accepted 25 February 2020

ABSTRACT

To combat tax avoidance by multinational corporations, the Organisation for

Economic Co-operation and Development introduced country-by-country re-

porting (CbCr), requiring firms to provide tax authorities with a geographic

breakdown of their profitability and activities. Treating the introduction of

CbCr in the European Union as a shock to private disclosure requirements,

this study examines the effect on corporate tax outcomes. Exploiting the

∗Desautels Faculty of Management, McGill University, 1001 Sherbrooke St W, Montreal,

Quebec, H3A 1G5, Canada.

Accepted by Douglas J. Skinner. I appreciate the insightful comments and construc-

tive suggestions of two anonymous referees. This paper is based on my dissertation and

I received invaluable guidance from my dissertation committee members: Amin Mawani,

Ambrus Kecskes, and Albert Tsang. I also thank Michelle Hanlon, Kenneth Klassen, Rebecca

Lester, Kevin Markle, Devan Mescal, Marcel Olbert, participants at the 2019 Journal of

Accounting Research Conference, 2019 American Taxation Association Mid-Year Meeting,

2019 Canadian Accounting Academic Association Annual Conference, and seminars at

York University, London Business School, Ohio State University, University of Texas at

Dallas, and McGill University. A special thanks goes to Lisa DeSimone for her valuable

feedback. I gratefully acknowledge financial support from the Schulich School of Busi-

ness at York University and the Ted Rogers School of Management at Ryerson University.

All errors remain my own. An online appendix to this paper can be downloaded at

http://research.chicagobooth.edu/arc/journal-of-accounting-research/online-supplements.

333

CUniversity of Chicago on behalf of the Accounting Research Center, 2020

334 P.JOSHI

€750 million revenue threshold for disclosure and employing regression-

discontinuity and difference-in-differences designs, I document a 1–2 per-

centage point increase in consolidated GAAP effective tax rates among

affected firms. I also find evidence consistent with a decline in tax-motivated

income shifting, starting in 2018. These results suggest that, although private

geographic disclosures can deter corporate tax avoidance, so far, the regula-

tions have had a limited effect on tax-motivated income shifting. My findings

have policy implications for the global implementation of private CbCr and

extend the debate on public versus private disclosure of tax information.

JEL codes: G38; G39; H20; H25; H26

Keywords: tax transparency; private tax disclosure regulations; corporate

taxation; tax avoidance; income shifting; reputation cost

1. Introduction

Tax transparency and exchange of information are at the heart of a

global effort to tackle aggressive tax planning of multinational corpora-

tions (MNCs). Policymakers worldwide, including the Organisation for

Economic Co-operation and Development (OECD), the G20 nations, the

European Union (EU), the Financial Accounting Standard Board (FASB),

and the United Nations, have introduced initiatives aimed at enhancing

tax disclosures. Even with this push for global tax transparency, evidence is

lacking about whether regulations achieve desired effects. This study exam-

ines the corporate tax avoidance and income shifting of EU MNCs follow-

ing the introduction of one of the most widely implemented transparency

rules: private country-by-country reporting (CbCr) under Action Item 13 of

OECD’s base erosion and profit-shifting project.1

At the firm level, I find robust evidence of an increase in effective tax

rates (ETRs) of EU MNCs subject to CbCr, in the three-year postadoption

period.2In examining the affiliate-level response, I document no signifi-

cant difference in the profits reported by low tax affiliates of EU MNCs,

over the same period. I do however find some evidence consistent with

a decline in profit shifting starting in 2018. Overall, these results suggest

that, although the introduction of CbCr led to a significant decline in firm-

level tax avoidance, the impact on affiliate-level income shifting has been

limited.

Tax transparency initiatives aim to either increase the amount of in-

formation available to taxing authorities (private disclosures) or improve

1In the remainder of the paper, “CbCr” refers to private country-by-country reporting un-

der OECD’s BEPS Action Item 13. This paper also refers to other CbCr rules, which will be

referred to as public CbCr. Fifty-eight countries (including EU nations) adopted CbCr starting

January 1, 2016. As of September 2019, more than 90 countries (including most tax havens)

had implemented CbCr (KPMG [2019]).

2“Pre-implementation period” refers to 2010–2015 and “post-implementation period”

refers to 2016–2018.

DOES PRIVATE COUNTRY-BY-COUNTRY REPORTING 335

accountability and compliance via mandatory tax disclosure to the public

(public disclosures; Hoopes, Robinson, and Slemrod [2018]). Despite

ample research on regulations that improve accountability and compliance

via mandatory tax disclosure to the public (Hope, Ma, and Thomas [2013],

Dyreng, Hoopes, and Wilde [2016], Hoopes et al. [2018]), research on

how firms respond to private disclosures that could allow increased scrutiny

of MNC tax affairs by tax authorities is limited and, as Hanlon [2018, p.

3] states, “not always on point.” Furthermore, these studies provide mixed

evidence (Hoopes, Mescall, and Pitman [2012], Towery [2017]). This gap

in extant literature is one of the main motivations for my study. Under-

standing the impact of private tax disclosures is crucial because the most

widely adopted transparency initiative is private (CbCr under Action Item

13). This paper evaluates the impact of CbCr on corporate tax outcomes.

The OECD’s Action Item 13 aims at closing ambiguities in tax laws legally

exploited by MNCs to reduce their global tax burdens. Under Action Item

13, MNCs increase disclosures to tax administrations by submitting an an-

nual CbC report to each tax jurisdiction in which they do business. The

report must include revenue (split between related and nonrelated enti-

ties), profit or loss before income tax, income tax paid and accrued, stated

capital, retained earnings, the number of employees, and tangible assets

(OECD [2013a]). To ensure that all tax authorities receive the same dis-

closures, the OECD developed an agreement to facilitate the secure and

confidential exchange of CbC reports between tax authorities across juris-

dictions. The OECD intended this kind of reporting to enhance tax en-

forcement, and thus to deter aggressive tax planning (OECD [2016]).

CbCr can change MNC tax behavior by altering the actual or perceived

net benefit of tax planning. First, country-level disclosures can increase

enforcement by providing useful new information to tax authorities on a

firm’s global activities and the associated tax costs, especially in nonres-

ident jurisdictions.3For example, CbCr provides the local tax authority

with new and consistently calculated information, such as a geographic

breakdown of cash taxes paid. Moreover, CbCr provides this information

to all relevant tax authorities, whereas such information sharing between

tax authorities was limited before the implementation of Action Item 13.

Second, CbCr can increase the perceived cost of reporting income in

low-tax countries, due to the risk that this information may be leaked and

published.4However, it is uncertain whether CbCr provides additional

insights to tax authorities because the disclosures are unrelated to the

specific transfer-pricing methodologies used by firms to substantiate their

3In the rest of the paper, “resident or local jurisdiction” refers to the jurisdiction in which

the parent entity is headquartered, and “non-resident or other jurisdiction” refers to other

countries where the entity has business operations.

4For example, in the 2014 Luxembourg tax leaks, private tax rulings between taxpayers

and Luxembourg tax authorities were leaked to media outlets, which resulted in an outcry

and criticism from numerous stakeholders.