Economic Substance in Tax Havens: A Human Capital Measure of Haven Operations

Abstract

Under international tax regulations, multinational corporations must increasingly demonstrate economic substance in tax havens to justify reported profits in these locations. However, due to data limitations, prior research focuses on legal presence rather than the substance of haven operations. We address this gap by introducing Haven Substance, a novel proxy for economic substance within tax havens. Unlike subsidiary-based haven indicators, Haven Substance is based on the proportion of employees located in tax havens using data from employees' online professional profiles. Consistent with capturing a distinct tax-motivated dimension of haven operations, Haven Substance has significantly stronger associations with tax avoidance and income shifting than traditional haven indicators. Further validating the measure, we find that economic substance mitigates the tax settlement risk associated with tax avoidance. Overall, we develop and validate a novel proxy for economic substance in tax havens, offering insights into how multinationals leverage haven jurisdictions for better tax outcomes.

Keywords: Economic substance, tax havens, tax avoidance, income shifting

JEL Classification: H25, H26, M41