Monday, December 21, 2020

Nash Bargaining, Splitting Factor, and Ex-Post Outcome Testing

A research that produces know-how or other intangibles often involve highly skilled personnel, and vary in terms of importance and success. If the parties involved are independent from each other, a combination of market force, bargaining power, self-interest and profit maximizing behaviour of both parties will result in return and remuneration that are at arm’s length.

If the parties are affiliated, pricing could be distorted by other factors. One of which is tax-motivated profit shifting. If the tax rates governing the parent and the subsidiary differ, taxpayer may be tempted to apportion income beyond what is arm’s length to the entity in low-tax jurisdiction. As enterprises become globalized, and capitals increasingly morphed into intangibles (Haskel and Westlake, 2017) this problem has grown in size and complexity (Borkowski and Gaffney, 2012).

The arm’s length principle purports that if conditions are made or imposed between affiliated enterprises that differ from those that would be made between independent enterprises negotiating at arm’s length, that difference must be included in the profits of that enterprise and taxed accordingly. Further, Para 1.40 of OECD Transfer Pricing Guideline 2017 states that “All methods that apply the arm’s length principle can be tied to the concept that independent enterprises consider the options realistically available to them.”

“Options Realistically Available”

“Options realistically available” implies that independent, economically-rational enterprises would strive for Pareto optimality, i.e. only enter into a transaction if it is not expected to make them worse off than their next best option. They will only enter into the transaction if they see no alternative that offers a clearly more attractive opportunity to meet their commercial objectives.

One example of the adoption of options realistically available in domestic regulation is the US Treasury Regulation Section 482, which cites “alternatives available” to the taxpayer in determining whether the terms of the controlled transaction would be acceptable to an uncontrolled taxpayer faced with the same alternatives and operating under comparable circumstances. The changes to Section 482 by the Tax Cuts and Jobs Act (TCJA) 2017 also stipulates “realistic alternatives” as a basis of valuation of intangible property transfer.

In the Indonesian tax regulation, the Minister of Finance Regulation no. 22/PMK.03/2020 concerning Advance Pricing Agreement also contains similar clause in its transfer pricing provision. Article 14 of PMK-22/2020 considers transactions involving service, use/the rights to use intangibles, cost of debt, transfer of property, business restructuring, and cost contribution arrangement (CCA) to be special transactions that warrant a preliminary step. For the transaction involving transfer of property and business restructuring, the regulation mandates that taxpayer must demonstrate that such transaction is “the best option out of other available options”. This clause also reiterates the ex-ante application of arm’s length principle in the Indonesian transfer pricing regime.

Parekh (2015) and Amici (2020) proposed various approach to identify, value, and determining options realistically available, inter alia:

  • Capital budgeting, using internal calculation to value a project based on its internal rate of return or its net present value or its payback periods, or a combination of these methods ;
  • Opportunity cost, using explanation of why the other options are not realistically available, e.g. due to being incompatible with the business of taxpayer as such, commercially unattractive, not available at the time of transaction, not acceptable by the other party, or not in accordance with the regulation
  • Best alternative to a negotiated agreement (BATNA), using reservation point and alternatives if negotiation fails
  • Risk simulation, using the expected value of the investment (weighted average sum of all the probabilities of the possible outcomes of an investment) and the variance (deviation of possible outcomes). Other techniques such as Monte Carlo simulation could also be used.
  • Bargaining power theory and game theory, using hypothetical negotiation that can be simulated based on the bargaining power, the contributions made to the marginal benefit of the transaction, and the strategy of the other party to the negotiation
In the context of bargaining power theory and game theory, Sattertwaithe (2019) highlights the similarity of “bargaining problem” (where two players negotiating over the apportionment of something desirable) to the provision of “options realistically available”. Applying John Nash’s bargaining theory, Sattertwaithe propose that seeking a Nash equilibrium strategy will maximize the utility for the player regardless of what strategy the other player adopts. This Pareto optimality will imply the most efficient allocation of utility relative to the bidding parties’ respective alternatives to entering into the transaction – hence, an arm’s length condition.

Probably owing to its mechanistic and mathematical foundation, Nash’s theory rarely enters the legal world. Even its admissibility in patent infringement case is somewhat inconsistent and vary from judge to judge, depending on its ties to the facts of the case (e.g. Compare Robocast Inc. v. Microsoft Corp. (2014), Gen-Probe Inc. v. Becton Dickinson & Co. (2012)).

Economists, on the other hand, have noted the applicability of Nash’s bargaining in transfer pricing, for instance in interdivision negotiated price (Clempner and Poznyak, 2017) or vertically integrated supply-chain (Rosenthal, 2008). There have also been studies of game theory’s application for specific taxation purpose such as in applying profit-split method (Pogorelova, 2015; Voegele, Gonnet, and Gottschling, 2008) or a BEPS-related reporting game (Dorey, 2015). Indeed, Sattertwaithe noted at least 6 elements of similarity between Nash bargaining problem with transfer pricing in general: 1) players and subject of bargaining, 2) alternatives and rationality, 3) surplus utility maximization, 4) zero-sum competing interest, 5) utility value, and 6) allocation.

Sattertwaithe further notes that the profit-split method is readily applied to intangible property primarily because it offers a solution when each party provides unique and valuable contributions but comparable data are lacking, and that an allocation of value (e.g. residual profit) should be calculated anyway under profit-split. For a tax authority’s perspective, profit-split also overcomes the deficiency of one-sided methods where they automatically assume that the residual profit earned by the “untested party” as arm’s length, even though it is literally untested (Wells and Lowell, 2014). This opens up an avenue for abuse. In the case of intangibles, an MNE group can easily designate its intellectual property holder in low-tax jurisdiction, reducing its overall tax liability on royalty income and shielding it from adjustment.

We thus borrow some parts of profit-split into our calculation.

Nash Bargaining

Nash solution for bargaining problem is:


\(\max x_{P}^{S}=(U(x_P)-V_P)(U(x_S)-V_S)\)

where U denotes utility; subscript P denotes Player P; subscript S denotes Player S; and V denotes fall-back utility, which would be gained if the player chose the second-best option to bargaining that is realistically available to her. X is possible bargaining outcome, for which if U(X) > V implies a surplus utility.

This section is again motivated by Sattertwaithe’s paper. However, we differ in the sense that we use a tax administration’s perspective in doing arm’s length outcome testing (ex post) approach when doing the audit. We thus do not assume the existence of third party firm to value the (ex ante) price of intangible. At the very least, this could serve as a sanity check in intangible transfer pricing analysis. Para. 6.113 of OECD TPG 2017 is relevant here, as transferor would not be expected to accept a price for the transfer of either all or part of its rights in an intangible that is less advantageous to the transferor than its other realistically available options which includes making no transfer at all. In a similar vein, Para. 6.79 of OECD TPG 2017 noted that “Compensation based on a reimbursement of costs plus a modest mark-up will not reflect the anticipated value of, and the arm’s length price for the contribution of the research team in all cases.”

The Setup

Assume a parent company P and subsidiary S, where – besides doing its routine functions – also conducts R&D activity to enhance P’s intangibles. (Despite its “contract research” features, Para. 7.41 OECD TPG 2017 note that the consideration of options realistically available may also prove useful in this situation.) Assume that the R&D results in a material, identifiable structural advantage in the market (thus valuable). This synergistic benefit increases the combined profit of P and S, either via increased sales and/or reduction of costs.

Following the residual approach for profit split, we first calculate the residual income of P and S after deducting the remunerations for their respective routine functions, hereinafter denoted as Π, such that:

\(\Pi=(Y_P-C_P-r_P)+(Y_S-C_S-r_S)\)

where rP and rS denote the routine function of P and S, respectively. Suppose S is remunerated for its R&D function using a cost-plus method, where some mark-up µ is added to R&D costs borne by S (denoted Cr). The Pareto-optimum fall-back positions of P and S are thus
\(V_P=\frac{(1+\mu)C_r}{\Pi}\)

and
\(V_S=\frac{C_r}{\Pi}\)

where there are additional profits of (1 + µ) Cr for P for not having to remunerate S; and Cr for S for not having to bear the R&D costs. The Nash bargaining problem is thus used to solve:

\(\max x_{P}^{S}=(X-V_P)-((1-X)-V_S)\)

which is done by first taking the derivative with respect to X,

\(\frac{d}{dx}(X-(\frac{(1+\mu)C_r}{\Pi})((1-X)-\frac{C_R}{\Pi})\)

then setting it to zero. Resulting in:

\(2X=1-\frac{C_r}{\Pi}+\frac{(1+\mu)C_r}{\Pi}\)

which then could be solved for X, the proportion of Π for P; and (1 – X), which is the proportion of Π for S.

The usage of Nash bargaining as “splitting factor” indeed differs from the usual asset/capital/cost-based allocation keys. We note that while R&D expense may be suitable for manufacturers, it may be insufficient given that: 1) it is only independently born by S, and 2) it may not be a reliable measure of the relative value of the transaction, taking into account options realistically available.

Illustration:

P is the parent of S, a contract manufacturing companies which sources raw material from third party suppliers. S manufactures, and subsequently sells the finished goods to P. P then sells the product to third party customers. S’s cost of goods sold and P’s sales are of independent transactions.

Assume that 100% of P’s inventory comes from S, and 100% of S’s sales are sold to P. S also conducts research for improving the products. P will remunerate S by S’s costs of doing research with a mark-up of 10%. P will also remunerate S for its contract manufacturing function with a full-cost mark-up of 10%.

Suppose the cost of research is 2, thus remuneration from P to S related to research is 2.2. The combined profit of P and S, after remunerating their respective routine functions is 16. Suppose it is sufficiently established that there is simply no justification from the taxpayer as for why the residual profit should all be automatically attributed to P, in the absence of their internal arrangement. (For example, P neither performs nor controls the research.) Hence the relative bargaining position is:


\(2X=1-\frac{2}{16}+\frac{2.2}{16},X=\frac{81}{160}\)

Therefore, out of profit of 16, 8.1 could be attributable to P, while 7.9 could be attributable to S. (This is almost similar to if the taxpayer use profit-split with 50:50 splitting factor). Nevertheless, this shows that S is inadequately remunerated since – viewed in totality – it is doing functions beyond mere contract manufacturer-contract research service provider.

A Partial Contribution Approach

The above-mentioned residual approach necessitates tax administration to calculate the routine function of P and S. We note that this does not take into account a marketing function done by P that may be similarly valuable. One obvious approach is to take into account marketing expense in calculating the relative bargaining position, which results indeed in higher proportion for P. Alternatively, we may calculate both parties’ contributions simultaneously.

Consider that the P’s sales is affected by S’s contributions in the form of R&D, or further development or enhancement of manufacturing know-how (which is accounted in S’s cost of goods sold or costs of employee). These contribution enables P to either increases price or maintains a desired profit margin given a determined price (via reduced costs). We thus propose – combining P’s effort to market the products – that a log-log function of:


\(\ln(Y_P)=\alpha+\beta_1\ln(C_r)+\beta_2\ln(C_m)+\epsilon\)

where Cm is P’s marketing expense and ε is error term, may be appropriate. The model could of course be expanded to include other costs, or to use profit in lieu of sales. The error term, which may reflect the residual, “non-routine” profit, may also be employed. (These alternatives warrant further explorations, which is the limitation of this post.)

Exploiting approximation that (1 + x)a ≈ 1 + ax for small a, then % Δ YP ≈ β1% Δ Cr, i.e. a 1% change in S’s R&D cost result in β1% change in P’s sales. Π is then obtained by approximation of β1% * YP, and the Nash bargaining as mentioned above will follow.

Second alternative, considering that not every R&D could be expected to always increase sales – especially if the research is “blue-sky” – we may instead be interested in R&D expense variability in relation to the variability of sales. Using variability instead of correlational direction may also alleviate the drawback that using historical data would arguably constitute a hindsight.

Following Shorrocks (1982), the proportional contribution of factor Cr to the decomposition of the variance of YP could be computed as:


\(s_{C_r}^{*}=\frac {Cov(C_r,Y_P)}{\sigma^2(Y_P)}\)

where cov(Cr, YP) is the joint variability of Cr and YP, and σ­2(YP) is the variance of YP. While this is not intuitively easy to associate, via Scherrer (1984), coefficient of determination R­2 could be computed as:


\(R^2=\sum\limits_{j=1}^{k}a_jr_{xy_j}\)

where aj is standardized regression coefficient of j-th explanatory variable, and ry,xj is the Pearson correlation coefficient of y and xj. Assuming we regress Cr and other variables mentioned above to YP, then the contribution of Cr to the variance of YP equals to:

\(a_{C_r}r_{{Y_P}{C_r}}=a_{C_r}\frac {Cov(C_r,Y_P)}{\sigma^2(Y_P)}\)
which sums to unity.

It should be noted that this function is not monotonic. A more exact approach would be to use Shapley-Owen decomposition. But for k parameters this requires k! combinations, hence 2k possible models to be calculated, and this is computationally expensive.

Illustration:

Assume P as the parent of a contract manufacturing subsidiary S similar to the illustration above. The table below gives the sales of P, R&D expense of S, and marketing expense of P, all in natural log, for the last 10 fiscal years:

The log-log regression gives result:
So even though the coefficient of R&D expense is higher than marketing, given that marketing expense is more statistically significant than R&D in explaining P’s sales, the contribution of R&D is lower than marketing expense. In this case, 33% and 62% of P’s variability of sales may be approximately contributed by S’s R&D activity and P's own marketing activity, respectively (5% of sales variability is due to other factors). Subsequently, the current pricing policy could be tested against 35:65 split  (0.33:0.95 = 0.35 and 0.62:0.95 = 0.65) similar to the Nash bargaining problem as outlined above, and see if their ex-ante testing is appropriate.


Conclusion

Nash bargaining could be used in ex-post outcome testing whether a transaction involving research resulting in valuable intangibles would have been entered into by independent parties, taking into account options realistically available. It should be noted that this analysis is presumptive, and should not be taken as prima facie proof of transfer mispricing. OECD cautions that better-than-expected result may not be reasonably foreseeable ex-ante by taxpayers. Indeed, assuming taxpayers do not provide adequate justification of ex-ante pricing, insofar as the remuneration for transferor and the actual outcome do not deviate by 20% from the projection, Para. 6.194 OECD TPG 2017 discourages the usage of ex-post facto rationalization, as it is considered as hindsight.

Reference

Minister of Finance Regulation no. PMK-22/PMK.03/2020

OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, 2017 Edition

Amici, D. (2020) In-Depth Analysis of the Concept of Options Realistically Available in Transfer Pricing. 27 Intl. Transfer Pricing J. 2, pp. 112-122

Borkowski, S. and M. A. Gaffney (2012) “Uncertainty and Transfer Pricing:(Im)Perfect Together?” J. Int’l Acct. Auditing & Taxation Vol. 32 (2012). IBFD Journal Articles & Papers

Brealey, R. A., S.C. Myers, and F. Allen. (2019) Principles of Corporate Finance ch. 5 (13th ed.). McGraw-Hill

Bullen, A. (2011) Arm’s Length Transaction Structures: Recognizing and Restructuring Controlled Transactions in Transfer Pricing. IBFD

Clempner, J. B. and A. S. Poznyak (2017) “Negotiating Transfer Pricing Using the Nash Bargaining Solution,” 27 Int’l J. Applied Mathematics & Comput. Sci. 853

Dorey, M. (2015) “To Audit or Not to Audit: Applying Game Theory to a Post-BEPS World,” 24 Transfer Pricing Rep. 404 (Aug. 6, 2015)

Haskel, J. and S. Westlake. (2017) Capitalism Without Capital: The Rise of Intangible Economy. Princeton University Press

Hafkenscheid, R. P. F. M. (2011) De bepaling van een zakelijke risicoallocatie in een business restructuring, Weekblad voor Fiscaal Recht 2011/660 (12 May 2011), at 660-668

Fisher, R. & W. Ury (1981) Getting to Yes: Negotiating Without Giving In. Penguin Group

Parekh, S. (2015) The Concept of “Options Realistically Available” under the OECD Transfer Pricing Guidelines. 22 Intl. Transfer Pricing J. 5, pp. 297-307 (2015). IBFD Journal Articles & Papers

Pogorelova, L. (2015) “Transfer-Pricing and Game Theory,” 43 Intertax 395

Rosenthal, E. C. (2008) “A Game-Theoretic Approach to Transfer Pricing in a Vertically Integrated Supply Chain,” 115 Int’l J. Production Econ. Oct. 2008

Sattertwaithe, B. M. (2019) Nash Bargaining Theory and Intangible Property Transfer Pricing. Tax Notes Federal, September 30 2019 Issue

Scherrer, B. (1984) Biostatistique. Quebec, Canada: Gaetan Morin

Shorrocks, A. F. (1982) “Inequality Decomposition by Factor Components”. Econometrica. Vol. 50 No. 1 (Jan. 1982)

Voegele A., S. Gonnet, and B. Gottschling. (2008) “Transfer Prices Determined by Game Theory,” Tax Planning Int’l Transfer Pricing

Wells, B and C. Lowell (2014) “Tax Base Erosion: Reformation of Section 482’s Arm’s Length Standard”. Florida Tax Review. Vol. 15 no. 10


Monday, September 28, 2020

An Ode to the Little Giant

There is not so much changes with you, with us.

We’re still the same, weather-beaten, rain-sodden us. We’re red dwarfs awaiting supernova implosion, burning through our last hydrogen atoms. We sigh into the onslaught by identical days. Far too exhausted for tomorrow morning stroll, just enough for waking up. Bound by tyranny of boredom and the confinement forced into us from some foreign, voracious, microscopic agents of chaos.

We are tired and sullen, the skeletal, spectral us.

As we get older, we drag our feet more. We started losing sight. A bleary vision. Stanzas of worry etched on our foreheads. The wound from ramshackle dreams latched onto our shoulders. Fragmented plans, shredded like the Oxyrhyncian trash heap.

The sun goes up and down like the most despicable clockwork. Older you be and you doubt more. (We all do, holding to that frail strand of hope that made thinner by day.)

Yet while I started giving up, you were always a snowdrop flowering at the first day of spring. Frigid wind above you, the small giant, adorable in your fortitude. Dawn gives you rain and you unfurl your petals, forever my raincoat for the storm.

Amidst all this cacophony you endure, you always manage to find some notes of symphony.

Today is the day when you get one year older, and us a year older. These days are dark, and there is no candle on the cake (there is no cake at all).

So come, let’s try be human once more. This I can offer you. Let’s sit together on the floor, imagining foreign places. Our banters be like fireworks. Let’s stay away from the edges of our bed. Let’s always fight for blanket, our nightly annexation game. Let’s exchange stories before dreams, before the day is done. Let’s eat badly, raw fish and third-rate rice wine and all.

Let’s cry, let’s curse, let’s... grow up together.

Let’s embrace senescence like an old friend. Let’s create a makeshift compass and a dim torch that guide us to each other.

For the day is dark, and there is no candle.

But you, you are always the only light that matter.

Tuesday, July 14, 2020

Through the CbCR Looking-Glass, and the Profit Shifting Found There

Last week, the OECD published for the first time its aggregated and anonymised Country-by-country Reporting (CbCR) data. Despite its limitation, CbCR is quite a significant move in the fight against corporate tax abuse, as a part of Action Plan on Base Erosion and Profit Shifting (BEPS).

Information asymmetry has always been the bane of tax authority, especially in dealing with multinational enterprise. Prior to transfer pricing documentation regime, tax authority relies much on domestic tax return and financial statements in order to understand MNE's structure.

Those aforementioned sources, understandably, do not paint a complete picture of the functions performed, assets used, and risks assumed by each of MNE's constituent entities. The closest analogy that we often use is "blind men and elephant". A group of blind men heard that a strange animal, called an elephant, had been brought to the town, but none of them were aware of its shape and form. The first person, who touched the trunk, said, "This animal is like a snake". Another one whose hand reached its ear, it seemed like a kind of fan. Another person, whose hand was upon its leg, said that the elephant is like a tree-trunk, or a pillar. They are not entirely incorrect, of course, but they are missing the big picture.




CbCR attempts to bridge this asymmetry by requiring MNE to report its economic activities in each jurisdiction it operates. CbCR's first main forms, CbC-1, lists MNE's financial information (revenues, profit/loss, taxes, assets, capital, and employees) in per country basis. The second form, CbC-2, lists MNE's entities alongside its functions (e.g. manufactures, procurement, distribution/marketing, R&D, service, financing, etc.)

CbC-1 and CbC-2

Nevertheless, this trove of information comes with a trade off.

Firstly, CbCR's functions are limited to transfer pricing and other BEPS-related risks assessment, as well as for statistical purposes. It cannot be used as conclusive proof that there exists incorrect transfer pricing. It also cannot be used for global formulary apportionment purpose. In short, it cannot be used directly for transfer pricing correction in tax audit, but only to initiate further inquiries.

Lastly, CbCR is not public, rendering its use for public accountability limited. (Some MNEs voluntarily made their CbCR public, however, but this is not a requirement.) For the purpose of measuring BEPS risks, OECD collects aggregated and anonymised CbCR from many jurisdictions. By aggregating and anonymising the CbCRs, it make them difficult to trace back to certain MNEs, which once again serve CbCR's private characteristic. The part of OECD's report on Indonesia serves as the basis for our profit shifting measure here.

Global Profit Shifting and Revenue Loss Measures

Profit shifting to country, \(i\), denoted \(S_i\), is measured from the profit booked \(\pi_i\), and theoretical profit \(P_i\), i.e.

\(S_i = \pi_i - P_i\)

The profit booked is taken from profit (loss) before tax in CbC-1.

We employ 2 estimation strategies. First, we follow Tax Justice Network (TJN)'s formula in measuring share of economic activity.

\(P_i\) is calculated by multiplying the total profits by the share of economic activity. The share of economic activity is calculated on the basis of unrelated party sales, \(R_i\), and number of employees, \(E_i\), i.e.

\(P_i = \sum\limits_{i}{\pi_i}\cdot (\frac{\frac{1}{2}\cdot R_i}{\Sigma_i R_i}+\frac{\frac{1}{2} \cdot E_i}{\Sigma_i E_i})\)

We also employ the so-called "Massachusetts formula", where instead of using half-revenue half-employee as weights, we use weighting from unrelated party revenue, employees, and tangible assets \(A_i\), each with a third of weight.


\(P_i = \sum\limits_{i}{\pi_i}\cdot (\frac{\frac{1}{3}\cdot R_i}{\Sigma_i R_i}+\frac{\frac{1}{3}\cdot E_i}{\Sigma_i E_i}+\frac{\frac{1}{3} \cdot A_i}{\Sigma_i A_i})\)
Massachusetts formula is used in US to apportion income or cost of a corporation among US states, by placing equal weights on sales, payrolls, and assets.

TJN’s choice of two weights – revenues and employees only, but not tangible assets – follows their rationale that tangible assets are biased by profit shifting. On their analysis, tangible assets in Luxembourg are greater than Germany, France, and African countries combined, despite the former is not renowned for their real sector economy compared to the latter.

Arguably, the same reasoning could be used to suspect that revenues might be biased. For example, if the MNEs employ third party to act as distribution hub in Singapore to perform sales in Asia-Pacific region and consequently books massive unrelated party revenues in Singapore. We thus include Massachusetts formula that incorporate tangible assets to still account for MNEs that have real economic activities that have low level of labour but significant capital investment in properties, plants, or equipments.


To obtain estimates of profit shifting, \(S^c\)is then defined as the sum of positive values of \(S_i\) for countries where the effective tax rate is below 15%, such that


\(S^c = \sum\limits_{i}{S'^c_i} - P_i\), where
\[
S'^c_i =
\begin{cases}
S^c_i & \text{if } S^c_i > 0 \text{ and } ETR^c_i < 15\%\\ 0 & \text{otherwise } \end{cases} \] TJN argues that this correction allows us to remove some resource-rich countries with large profits and high tax rates, therefore obtaining a more conservative estimate of profit shifting.

The choice of break-out threshold in 15% follows TJN's methodology, based on their finding that every country with an effective tax rate above 15% loses tax revenue through profit shifting.

The global tax revenue loss, \(TRL^c\) is calculated by multiplying shifted profit \(S^c\) with the average effective tax rate in countries that is higher than 15%, weighted by the measures of real economic activities, i.e.


\(TRL^c = S^c \cdot \widehat{ETR^c}\)

Effective tax rate (ETR) is calculated as follows:

\(\widehat{ETR^c}=\sum\limits_{i\in{\{N-c\colon ETR_i \geq 15\%\}}}ETR_i(\frac{\frac{1}{2}\cdot R_i}{\Sigma_i R_i}+\frac{\frac{1}{2} \cdot E_i}{\Sigma_i E_i})\) , for TJN weight, and

\(\widehat{ETR^c}=\sum\limits_{i\in{\{N-c\colon ETR_i \geq 15\%\}}}ETR_i(\frac{\frac{1}{3}\cdot R_i}{\Sigma_i R_i}+\frac{\frac{1}{3}\cdot R_i}{\Sigma_i R_i}+\frac{\frac{1}{3} \cdot A_i}{\Sigma_i A_i})\) , for Massachusetts formula weight.

However, their definition of effective tax rate is taxes paid divided by profit before tax, which is closer to the definition of cash ETR in tax avoidance literature. We supplement this analysis with our measure of effective tax rate which is taxes accrued divided by profit before tax. From this point on, CETR will be used to denote TJN's measure, and ETR to denote "traditional" ETR.

Results

We estimate around 1-3 trillion IDR of shifting out, depending on the measure used.



To these following countries.



Plotting the distribution into box plot, there are significant variants if cash ETR is used.



How much revenue is lost? Depending on the measure of ETR and weighting, this translates to 200-600 billion IDR of global tax revenue loss.



NOTE: Due to its aggregated nature, this is not the tax revenue lost of Indonesia only, but collective tax revenue lost for some countries where Indonesian MNEs operate.


Conclusion and Further Remarks

Based on the aggregated and anonymised CbCR, there are indications that MNEs engage in global profit shifting, resulting in significant revenue loss.

Aggregated and anonymised CbC Report released by OECD is a neat tool to monitor global profit shifting lost. This type of analysis could even be conducted on MNE level, and with the indicators outlined in the OECD Handbook of Effective Tax Risk Assessment, this may be used to complement current compliance risk management analysis. Incorporating the information of CbC-2 as weights and employing different ETR threshold (e.g. using MNE's own group ETR) could also improve future analysis. It may be even useful for the purpose of Pillar 2, Global Anti-Base Erosion proposal to address digital economy and other economy of scale without mass.

Reference

INFINITE (2020), Comments on Public Consultation Document: Review of Country-by-Country Reporting (BEPS Action 13) https://www.infinite-tax.org/2020/05/19/comments-on-public-consultation-document-review-of-country-by-country-reporting-beps-action-13/ (Accessed 13 July 2020)

OECD (2020), New corporate tax statistics provide fresh insights into the activities of multinational enterprises http://www.oecd.org/tax/new-corporate-tax-statistics-provide-fresh-insights-into-the-activities-of-multinational-enterprises.htm (Accessed 13 July 2020)

OECD (2017), Country-by-Country Reporting: Handbook on Effective Tax Risk Assessment, OECD, Paris.
www.oecd.org/tax/beps/country-by-country-reporting-handbook-on-effective-tax-risk-assessment.pdf (Accessed 13 July 2020)

Tax Justice Network (2020), Watershed data indicates more than a trillion dollars of corporate profit smuggled into tax havens, https://www.taxjustice.net/2020/07/08/watershed-data-indicates-more-than-a-trillion-dollars-of-corporate-profit-smuggled-into-tax-havens/ (Accessed 13 July 2020)

Tax Justice Network (2020), Methodology: Analysis of OECD country by country reporting data, https://www.taxjustice.net/wp-content/uploads/2020/07/Methodology-Analysis-of-OECD-country-by-country-reporting-data-July-2020.pdf (Accessed 13 July 2020)