A study of profit shifting using the Hines and Rice approach

Adopting and adapting the widely cited approach introduced by Hines and Rice, we investigate the extent of cross-border profit shifting activities by foreignowned Australian companies (FOACs) and evaluate the effectiveness of the measures implemented by the Australian Parliament to combat base erosion and profit shifting (BEPS) by foreign multinational enterprises (MNEs). Specifically, we measure the sensitivity of profit before tax reported by FOACs in Australia to the tax rate differentials between Australia and other countries where the related foreign-based MNE groups operate as an indicator of BEPS. We further examine whether the estimated tax rate sensitivity has decreased since the implementation of Australian BEPS countermeasures. Overall, we find that profit shifting from Australia to lower tax countries occurred throughout the 14-year study period from 2007 to 2020. The higher the Australian corporate tax rate relative to the tax rates of a FOAC’s immediate parent entity and ultimate parent entity, and the higher the ranking of the Australian tax rate relative to those of other countries where a foreign MNE operates, the lower is the profit reported in Australia. In general, cross-border profit shifting from Australia to lower tax countries has not reduced in the post-BEPS period from 2013 to 2020 after the implementation of BEPS countermeasures in Australia. Although there is some evidence from breaking down the post-BEPS period by year that shows that profit shifting might have reduced in 2019, this reduction was not sustained in 2020. Perhaps it takes time for the effects of these measures to be reflected in the financial reports of FOACs due to law enforcement or administrative time lags.