Taxation and the Allocation of Risk Inside the Multinational Firm

44 Pages Posted: 16 Jul 2018

See all articles by Johannes Becker

Johannes Becker

University of Muenster

Niels Johannesen

University of Copenhagen

Nadine Riedel

Oxford University CBT; University of Hohenheim

Date Written: May 14, 2018

Abstract

This paper provides the first theoretical and empirical analysis of how taxation shapes the joint allocation of risk and profits inside the multinational firm. Theoretically, we show that unconstrained firms optimally allocate all their risk to high-tax countries to maximize risk sharing with governments and all their profits to low-tax countries to minimize expected tax payments. However, transfer pricing rules requiring risk to be compensated with a higher expected return introduce a trade-off: the risk sharing motive to allocate risk to high-tax countries must be balanced against a pro.t shifting motive to allocate risk to low-tax countries. Empirically, we consistently find that multinational firms disproportionately allocate risk to low-tax countries. This suggests that the intra-firm allocation of risk and profits is effectively constrained by transfer pricing rules and that the profit shifting motive dominates the risk sharing motive. Finally, we show that within-firm differences in risk can account for a significant fraction of the well-established correlation between profits and tax rates suggesting that risk shifting is a quantitatively important channel for profit shifting.

JEL Classification: H200

Suggested Citation

Becker, Johannes and Johannesen, Niels and Riedel, Nadine, Taxation and the Allocation of Risk Inside the Multinational Firm (May 14, 2018). CESifo Working Paper Series No. 7033. Available at SSRN: https://ssrn.com/abstract=3206613

Johannes Becker

University of Muenster

Schlossplatz 2
Muenster, D-48149
Germany

Niels Johannesen (Contact Author)

University of Copenhagen ( email )

Nørregade 10
Copenhagen, København DK-1165
Denmark

Nadine Riedel

Oxford University CBT ( email )

Park End Street
Oxford, Oxfordshire OX1 1HP
United Kingdom

University of Hohenheim ( email )

Stuttgart
Germany

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