Detecting profit shifting in Indonesia using the Hines and Rice approach

Prior studies suggest that profit shifting by multinational enterprises (MNEs) occurs not only in developed countries but also in developing ones. However, the knowledge of profit shifting in developing countries is very limited, because the findings of most of the prior studies are difficult to interpret due to problems about reliability of data and method used to measure profit shifting (Fuest & Riedel, 2012). This article investigates whether foreign-owned Indonesian companies (FOICs) shift profits out of Indonesia by following an approach introduced by Hines and Rice (1994) (hereafter HRA) with some modifications. HRA has been widely cited in the literature of international tax avoidance. We examine both the accounting profit and taxable income reported by FOICs in their Indonesian tax returns using confidential data supplied by the Indonesian tax authority. After analysing a final sample of over 3,000 observations from 2009 to 2015, we find that on average a one percentage point lower statutory tax rate in the residence country of an FOIC’s parent is associated with a reduction of 2.6% and 2.9%, respectively, in the pre-tax accounting profit and taxable income reported by the FOIC in its Indonesian tax return.