Publications

Unprofitable affiliates and income shifting behavior

with Ken Klassen and Jeri Seidman

The Accounting Review 92(3): 113-136.

Does a common set of accounting standards affect tax-motivated income shifting for multinational firms?

2016, Journal of Accounting and Economics 61(1): 145-165.

American Taxation Association / PricewaterhouseCoopers Outstanding Tax Dissertation Award 2014

International Accounting Section Outstanding International Accounting Dissertation Award 2014

Book review of Developing a world tax organization: The way forward

with Lillian Mills

2010, Journal of the American Taxation Association 32(1): 84-86.

Working Papers

The effect of Innovation Box regimes on income shifting and real activity

with Shannon Chen, Michelle Hanlon, and Rebecca Lester

Presented at Stanford Accounting Summer Camp 2016, Summer School on Taxation and R&D at the University of Mannheim 2017.

We study whether innovation box tax incentives, which reduce tax rates on innovation-related income, are associated with tax-motivated income shifting and local investment in the countries that implement these regimes. Using a matched sample of European multinationals’ subsidiaries operating in Europe, we find evidence consistent with firms engaging in less tax-motivated income shifting out of the country following the implementation of innovation boxes that provide the greatest tax benefits. We also find that innovation box regimes are associated with higher levels of fixed asset investment. Our study contributes to the patent box literature by evaluating outcomes that the literature has not previously examined and by informing the ongoing policy debate regarding the economic effects of innovation box regimes.

R&D and the rising foreign profitability of U.S. multinational corporations

with Jing Huang and Linda Krull.

Presented at the University of Texas and the University of Waterloo Second Biennial Taxation Research Symposium 2016, the University of Iowa, Virginia Tech, and Michigan State University.

We investigate how R&D contributes to foreign profit margins in U.S. multinational corporations (MNCs) through wage savings and tax incentives. Our results suggest that although wage savings increase foreign profit margins attributable to foreign R&D activities, the shifting of income attributable to domestic R&D activities to lower-tax jurisdictions has a larger effect on foreign profit margins. However, additional tests suggest that wage savings are more important than tax incentives in explaining foreign profit margins when the wage discount substantially exceeds the tax differential. Our evidence sheds light on the importance of R&D locations in corporate intangible income shifting that separates the location of economic activity from the location of reported taxable income.

Are multinational companies "fooled" by their own tax planning?

with Ken Klassen and Jeri Seidman

Presented at the 3rd Berlin-Vallendar Conference on Tax Research 2017.

We investigate how R&D contributes to foreign profit margins in U.S. multinational corporations (MNCs) through wage savings and tax incentives. Our results suggest that although wage savings increase foreign profit margins attributable to foreign R&D activities, the shifting of income attributable to domestic R&D activities to lower-tax jurisdictions has a larger effect on foreign profit margins. However, additional tests suggest that wage savings are more important than tax incentives in explaining foreign profit margins when the wage discount substantially exceeds the tax differential. Our evidence sheds light on the importance of R&D locations in corporate intangible income shifting that separates the location of economic activity from the location of reported taxable income.

The effect of foreign cash holdings on internal capital markets and firm financing.

with Rebecca Lester

Presented at Stanford Accounting Summer Camp 2017, George Washington University Cherry Blossoms Conference 2017, University of Iowa.

Prior literature demonstrates that firms should first use internal capital before accessing costly external finance. However, the U.S. tax system imposes an internal capital market friction by taxing active foreign earnings repatriated from a U.S. multinational corporation’s (MNC) foreign operations. This repatriation tax motivates firms to retain cash offshore (Foley et al, 2007) and suggests that U.S. MNCs with large amounts of tax-induced foreign cash may be unable to inexpensively access their foreign capital. We test whether and to what extent U.S. MNCs use domestic financing rather than incur the repatriation tax to meet domestic cash needs. Consistent with prior literature on internal capital markets and the pecking order, we first show an overall negative relation between a firm’s foreign cash holdings and domestic liabilities – U.S. MNCs with more foreign cash on average borrow less than other MNCs. We then show that this negative relation is attenuated for U.S. MNCs that require domestic cash for the specific purpose of financing share repurchases. We also observe this result for MNCs with mobile income, as measured based on R&D activities. Additional tests suggest that these results are not driven by a differential cost of debt and that increased domestic liabilities are incremental worldwide liabilities, not offset by lower foreign borrowing. This paper adds to the literature on internal capital markets by showing how U.S. tax frictions impede the domestic use of internal capital held by foreign subsidiaries, thereby inducing firms to access domestic financing sources.

Transparency and the location of assets: Evidence from the Foreign Account Tax Compliance Act (FATCA).

with Rebecca Lester and Kevin Markle.

To be presented at the University of Illinois Symposium on Tax Research XV 2017, presented at the Stanford-Berkeley Joint Seminar 2017.

We examine how increased reporting requirements for U.S. individuals with offshore assets affect the location of investment assets. Specifically, we study the Foreign Account Tax Compliance Act (FATCA), which requires foreign financial institutions to provide information to the United States regarding U.S. account holders for the purpose of reducing offshore tax evasion. Using annual country-level data on investments in U.S. securities by foreign account holders from 2006 to 2015, we document a significant decrease in foreign portfolio investment to the U.S. from tax haven countries after FATCA. However, we also observe an increase in the amount of investment out of tax haven countries that did not agree to exchange information. These results suggest that some U.S. investors with hidden offshore assets moved the assets to other countries that provide secrecy, thus enabling these investors to continue to avoid U.S. tax liabilities. Our study contributes to both the academic literature on tax evasion as well as the analysis of similar yet controversial regulation being contemplated by numerous countries around the world.

Using IRS data to identify income shifting to foreign affiliates

with Lillian Mills and Bridget Stomberg

Presented at Stanford Accounting Summer Camp 2015, National Tax Association Annual Meeting 2014, Oxford University Centre for Business Taxation Doctoral Meeting 2012, the 2012 AAA Annual Meeting, the 2012 EIASM 2nd Workshop on Current Research in Taxation, and the University of Texas at Austin.

We use confidential Internal Revenue Service (IRS) data on the magnitude of U.S.-foreign intercompany transactions to develop a financial statement-based measure of the likelihood that U.S. multinational entities (MNEs) make net intercompany payments out of the U.S. Descriptive analysis shows that although sample firms report net inbound intercompany payments on average, high tech firms and small firms report average net outbound payments. The determinants of net outbound payments vary with size, but the likelihood that a firm reports net outbound payments is positively related to high tech operations and income tax incentives across all firms. Supplemental analyses show that firms with net outbound payments have historically not been more likely to be audited or assessed additional taxes upon IRS audit. Our study provides a validated measure based on publicly available data that researchers, investors, and policymakers can use to infer a substantial form of income shifting.

How reliably do empirical tests identify tax avoidance?

with Jordan Nickerson, Jeri Seidman and Bridget Stomberg

Can common empirical tests reliably identify tax avoidance? This is an important question because our understanding of the determinants of tax avoidance largely depends on results generated using such tests. We address this question by using a controlled environment to examine the effectiveness of empirical tests that use effective tax rates (ETR) and book-tax differences (BTD) as tax avoidance proxies. We seed Compustat data with three tax avoidance strategies and examine how reliably empirical tests identify this incremental simulated tax avoidance, all else equal. We find that power varies with the proxy and the type of tax avoidance. Thus, we offer guidance to researchers in matching specific types of tax avoidance with the most powerful proxy to detect it. We further offer evidence on how research design choices affect power. Results suggest researchers can increase power by eliminating observations with both negative pre-tax book income and negative tax expense, and by using robust regression to address data outliers. In contrast, power is impaired when truncating ETR proxies and when using Execucomp data. We also provide evidence that tests have less power to detect tax avoidance when multi-year ETR proxies are used.

Repatriation taxes and foreign cash holdings: The impact of anticipated tax policy.

with Joseph Piotroski and Rimmy Tomy.

Presented at Presented at the London Business School Accounting Symposium 2017, Carnegie Mellon University, MIT, University of Southern California, University of Oregon.

We examine whether anticipation of Congress enacting a reduction in repatriation taxes affects the amount of cash U.S. multinational corporations (MNCs) hold overseas. Prior papers have focused on which U.S. MNCs repatriated foreign cash and how they deployed these funds following the repatriation tax holiday in 2004. We build on this literature and examine whether MNCs were willing to incur the costs of holding excess cash in response to proposed, but uncertain tax legislation. We find that U.S. MNCs most likely to benefit from this legislation began accumulating significant cash holdings once Congress initially proposed and began deliberating a second repatriation tax holiday. Further tests reveal that this cash accumulation was accompanied by two complementary activities designed to maximize expected tax benefits: tax-motivated income shifting and increases in permanently reinvested foreign earnings. The documentation of such preemptive behavior by corporations contributes to the literature on how firms respond to tax-induced incentives, provides a new explanation for the dramatic growth in cash holdings by U.S. MNCs over the last decade, and raises important questions about the long-run consequences of enacting temporary tax regulation.

Income shifting using a cost sharing arrangement

with Richard Sansing

Presented at Journal of the American Taxation Association Conference 2015.

This study investigates the use of a cost sharing arrangement (CSA) by a multinational corporation (MNC) to shift the income attributable to valuable intellectual property (IP) to low-tax foreign jurisdictions. Using a strategic tax compliance model, we identify three major effects that determine whether an MNC will use a CSA to develop the IP rather than develop the IP domestically: a marketing intangible effect, an undervaluation effect, and an enforcement effect. First, we find that the MNC is more likely to use a CSA to develop the IP when the MNC has valuable domestic marketing intangibles, such as a global brand. Second, the MNC is more likely to use a CSA if the nature of the IP development project allows the MNC to understate the fair market value of the IP. Third, the MNC is less likely to use a CSA if the tax authority can cost effectively challenge the position and impose retroactive revaluations of the IP. We also compare the effects of the rules in the U.S. to the OECD transfer pricing guidelines used in most other countries.