Substitution Across Profit-Shifting Methods and the Impact on Thin Capitalization Rules

26 Pages Posted: 28 Jan 2020

See all articles by Wolfgang Eggert

Wolfgang Eggert

University of Freiburg - Institute of Public Finance; CESifo (Center for Economic Studies and Ifo Institute)

Gideon Goerdt

University of Freiburg

Date Written: 2020

Abstract

Thin capitalization rules limit firms' ability to deduct internal interest payments from taxable income, thereby restricting debt shifting activities of multinational firms. Since multinational firms can limit their tax liability in several ways, regulation of debt shifting may have an impact on other profit shifting methods. We therefore provide a model under which a multinational firm can shift profits out of a host country by issuing internal debt from an entity located in a tax haven and by manipulating transfer prices on internal goods and services. The focus of this paper is the analysis of regulatory incentives, (i) if a multinational firm treats debt shifting and transfer pricing as substitutes or (ii) if the methods are not directly connected. The results provide an explanation for why hybrid thin capitalization rules are used. These insights can add to the existing literature since the results explain why hybrid rules can result in improvements in welfare if multinational firms treat methods of profit shifting as substitutes.

Keywords: thin capitalization rules, profit shifting methods, substitution

JEL Classification: H700, H200, K300

Suggested Citation

Eggert, Wolfgang and Goerdt, Gideon, Substitution Across Profit-Shifting Methods and the Impact on Thin Capitalization Rules (2020). CESifo Working Paper No. 8046, Available at SSRN: https://ssrn.com/abstract=3526601 or http://dx.doi.org/10.2139/ssrn.3526601

Wolfgang Eggert (Contact Author)

University of Freiburg - Institute of Public Finance ( email )

D-79098 Freiburg
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Gideon Goerdt

University of Freiburg ( email )

Fahnenbergplatz
Freiburg, D-79085
Germany

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