The impact of tax planning on forward-looking effective tax rates

[Introduction] The tax planning strategies of multinational corporations have been a key issue on the international policy agenda for some years now. Both the European Commission and the OECD are currently working on anti-avoidance measures to curb international profit shifting of multinational companies. These initiatives against so-called aggressive tax planning have mainly been pushed by anecdotal evidence on tax avoidance strategies of some of the currently most valuable and fast growing multinational companies such as Google, Apple, and Ikea. These companies use tax planning structures reducing the effective tax burden on foreign income to close to zero. In addition to this anecdotal evidence, there is empirical evidence on profit shifting activities of multinational companies. Several studies suggest that both pre-tax profits and leverage are sensitive to statutory tax rate differentials. The purpose of this study is to provide a more general insight into the impact of representative tax planning strategies on forward-looking effective tax rates considering cross-border investments between the EU member states and the US. We thereby complement the report on aggressive tax planning structures by Ramboll Management Consulting and Corit Advisory prepared for the European Commission with information on the actual tax saving effects of typical tax planning strategies. As in the annually updated report on effective tax rates conducted by ZEW, we apply the Devereux/Griffith model to calculate cost of capital (CoC) and effective average tax rates (EATR). This allows us to compare the results for different tax planning structures to the results for direct cross-border investments known from the annual updates. The report is structured as follows: In Section 2, we briefly describe the Devereux/Griffith model applied in this study to compute CoC and EATR. We also list the underlying economic assumptions of the model. Section 3 explains the design of the study. It gives an overview of the different tax planning strategies and countries considered in this report and summarizes relevant tax parameters. In Section 4, we explain which adaptions to the basic cross-border formula of the Devereux/Griffith model have been made to arrive at the results for CoC and EATR for the different tax planning strategies. Section 5 summarizes the baseline results that present the most tax-efficient way for a multinational parent company to directly finance an investment in a wholly-owned foreign subsidiary. Section 6 discusses the effective tax levels computed for all considered tax planning strategies and compares them to the baseline results. In Section 7, we refer to potential effects of anti-avoidance measures on our results. Finally, Section 8 concludes.