Multinational tax avoidance: Is it all about profit shifting?

Christof Beuselinck, IESEG School of Management and LEM

Jochen Pierk, Erasmus University Rotterdam

ABSTRACT
The international tax debate is centered on the idea that multinational corporations (MNCs) are
saving taxes by shifting income from high-tax to low-tax jurisdictions. Nevertheless, recent
evidence finds that domestic-only firms are equally tax-efficient as MNCs, suggesting the existence
of important local (i.e., within-country) tax strategies. To gauge the relative importance of local
versus total tax avoidance, we study an international sample of parent and subsidiary-level data.
We find that subsidiary local tax avoidance explains between 14-29 percent of total MNCs tax
avoidance. Furthermore, the relative importance of subsidiary local tax avoidance has more than
doubled over the study period and the effect is largest in countries that introduced transfer pricing
documentation requirements. Finally, MNCs focus more on subsidiary local tax avoidance when
profit shifting costs are higher. Our results have important implications for tax research and public
policy debates on the complexity of global tax avoidance opportunities and behavior.

Keywords: Tax avoidance, profit shifting, local tax avoidance, multinational firms

Draft: March, 2018

This paper has benefited from comments by Kathleen Andries, Anna Alexander, Nico Lehmann, Benjamin Osswald,
Jennifer Glen, John Robinson and participants of the WHU Tax Readings Group. We thank participants of the
University of Illinois Symposium on Tax Research XV and Tom Neubig (discussant) and Steven Shay (discussant).
Furthermore, we thank workshop participants at University of Gothenburg (Sweden), University of Bristol (UK),
University of Goettingen (Germany), University of Paderborn (Germany), the Research Day in Accounting hosted by
the University of Antwerp (Belgium), the 1st ERIM Accounting Day at Erasmus University Rotterdam (Netherlands),
and conference participants at the 40th Annual Congress of the European Accounting Association in Valencia (Spain)
for their valuable comments. Corresponding author: Jochen Pierk, Burgemeester Oudlaan 50, 3062 PA Rotterdam,
Netherlands, E-mail: pierk@ese.eur.nl, Phone: +31 10 4082248

1
 1. Introduction

The interest in corporate tax avoidance has reached an all-time high level and both the

financial press and the academic perspective is dominated by the idea that cross-jurisdictional

income and debt shifting is the primary source of tax savings (e.g., Atwood et al. [2012],

Beuselinck, Deloof, and Vanstraelen [2015], Collins, Kemsley, and Lang [1998], Klassen, Lang,

and Wolfson [1993], Klassen and Laplante [2012], Markle [2015], Newberry and Dhaliwal

[2001], Rego [2003]). In line with the increasing demand for a fairer corporate taxation game for

global multinational corporations (MNCs) versus domestic-only corporations, where such

shifting opportunities are non-existing, the Base Erosion and Profit Shifting (BEPS) action plan

by the OECD (2013) is working on several proposals and guidelines to ensure that profits are

taxed where economic activities are generated. This attention seems warranted and is in line with

the common perception that excessive income shifting activities should no longer be part of

contemporary sustainable business strategies as is evidenced in the rise of the term “tax shaming”

(Barford and Hold [2013]).

However, recent academic evidence by Dyreng, Hanlon, Maydew, and Thornock [2017]

suggests that effective tax rates (ETRs) for U.S. corporations have declined for multinational

corporations as well as for domestic firms over the 25-year period 1988 to 2012. This finding

suggests that also for domestic firms a wide range of tax avoidance opportunities exist that can

give rise to lower tax bills. Examples of local tax avoidance comprise the use of intra-company

transactions between business group members within a specific jurisdiction (Beuselinck and

Deloof [2014], Gramlich, Limpaphayom, and Rhee [2004]), locally available tax planning

strategies such as investments in tax favored assets, usage of accelerated depreciation schemes,

tax credits, and allowances for corporate equity (Anning, Ravenscroft, and Zbogar [2015]),

2
optimizing tax schemes that are temporarily available within one specific tax jurisdiction

(Shevlin, Tang, and Wilson [2012]), or income shifting opportunities to lower-taxed states within

one federation (e.g., Dyreng, Lindsey, and Thornock [2013]). These observations seem to suggest

that the unilateral focus on income shifting to capture MNCs tax avoidance behavior is

potentially understating the full spectrum of tax avoidance strategies that international

corporations have at their disposal. This is particularly important because local tax planning

opportunities are not only available in the MNC home country, but also in all its affiliate

countries. Moreover, national governments have increasingly responded to tax base erosion by

strengthening transfer pricing regulations and increasing the capacity of tax audit staff

(Alexander, de Vito, and Jacob [2017], Lohse and Riedel [2013]) and this in turn may trigger

MNCs to trade-off the relatively more costly international profit shifting by local tax avoidance

strategies. However, although prior work recognizes and investigates examples of local tax

avoidance strategies, we are unaware of a study that directly quantifies the importance of local

tax avoidance strategies relative to total tax avoidance for a large sample of global MNCs. At

this stage, the current study steps in to shed light on the relative importance of subsidiary local

tax avoidance and how it contributes to MNC group total tax avoidance.

Anecdotal evidence also suggests that MNCs care about local tax avoidance over and above

international tax shifting strategies. Consider the Walmart example as an illustration of local (i.e.,

country, state or federal) tax minimization in conjoint with international planning activities.

According to a 2015 tax report by Clemente and Auerbach [2015], Wal-Mart Stores, which is the

ultimate owner of all Walmart subsidiaries, owns over $76 billion worth of assets in 78

subsidiaries that are located in 15 tax havens in which it has no retail stores. These haven

subsidiaries generated $2.4 billion of (low or zero taxed) foreign earnings and contribute to a

3
lower aggregate tax bill. At the same time, there is evidence that Walmart has been reducing its

local U.S. corporate taxes by $400 million annually (Lohman [2007], Mattera [2011]) over

several years and that such local tax rebates gave rise to an additional $1.2 billion tax savings.1

Conceptually, both across-country income shifting that is established by locating foreign entities

in low-tax countries as well as within-country tax avoidance that is realized via locally

engineered tax strategies contribute to Walmart’s lower tax bill. Empirically, however, it has

been very difficult, if not impossible, to differentiate between both tax avoidance components

because affiliate entity level data were typically not at hand.

We exploit the Orbis database ® from Bureau van Dijk and provide unique insights in the

relative importance of subsidiary local (or: within-country) tax avoidance to total group tax

avoidance.2 Our results are based on data between 2006 and 2014 for 7,660 European MNCs

(34,111 MNC group-year observations) and their 42,115 domestic and global-foreign affiliates

(158,749 subsidiary-year observations). Our empirical strategy is twofold.

First, we use the large pool of subsidiary-entity-year observations to gauge the relative

importance of MNC systematic group fixed effects that may help explaining subsidiary local tax

avoidance behavior. In other words, we investigate whether subsidiary local tax avoidance is

systematically related to the MNC fixed effects. We calculate abnormal GAAP ETRs, which we

1
Walmart was able to do so by engineering aggressive tax schemes such as (1) paying rent to itself via “captive” real
estate investment trusts (REITs) and deducting the rent payments from its state taxes, (2) extracting property tax
abatements, infrastructure improvements and economic development subsidies and (3) taking advantage of states that
fail to cap vendor discounts to large retailers.
2
Orbis contains financial statement and non-financial data at both the consolidated (group-level) and unconsolidated
(affiliate-level) and been used in various recent studies (e.g., Bloom e al. [2010], Shroff, Verdi, and Yu [2014],
Beuselinck, Deloof, and Vanstraelen [2015], Johannesen, Tørsløv, and Wier [2017]). We describe the features of the
database in more detail in Section 3.

4
define as deviations from country-industry-year averages. 3/4 Next, we apply a variance-

decomposition technique as developed by Abowd, Kramarz, and Margolis [1999] and show that

MNC time-invariant fixed effects explain close to 80% of the total explained variation in

subsidiary abnormal GAAP ETR, which is far above the 6% (27%) that stems from the MNC

parent country (parent-subsidiary country pairs) fixed effects. We interpret these results as

evidence that the MNC fixed effect (i.e., the “corporate style”) is largely responsible for the

design and orchestration of subsidiary local tax avoidance behavior.

Second, we identify the proportion of MNC group level tax avoidance (deviations from

country-industry-year average on the consolidated level) that stems from subsidiary-level local

tax avoidance. Empirically, we regress the abnormal group consolidated GAAP ETR on the (pre-

tax income) weighted abnormal GAAP ETR for the entirety of its subsidiaries. This approach is

appealing because it allows to distinguish between tax avoidance that is realized by entirely

focusing on local tax avoidance strategies (where the association is predicted to be equal to one)

and tax avoidance that originates entirely from income shifting (where the association is

predicted to be zero) or from a combination of both (where the association is predicted to be

between zero and one).5 After controlling for the standard GAAP ETR determinants identified in

prior tax research, we find that MNC group tax avoidance is positively associated to the weighted

subsidiary local tax avoidance. The observation of a significantly positive association between

group and subsidiary tax avoidance is consistent with the conjecture that MNCs’ tax avoidance is

not a result of international income shifting alone. More in particular, our base-line model

3
Note that we cannot use cash-based levels of ETR as cash-flow data is not available in unconsolidated (affiliate
level) data.
4
We find similar results in our robustness section (Section 6) when we define ‘abnormal’ as the deviation relative to
the statutory tax rate (ETR – STR).
5
Please refer to Sections 3.1 and 3.2 for more details about the research design.

5
suggests that for the average MNC, subsidiary local tax avoidance explains 14 percent of total

MNCs tax avoidance and even 29 percent for sub-samples where we observe fifty percent or

more of the consolidated group income.6

Next, we investigate potential time trends that may have occurred in local tax avoidance

relative to the total tax avoidance strategies. We do so because the international tax landscape has

changed significantly over the sample period and many countries have tightened documentation

requirements and started comprehensive tax investigations after continued pressure on

governments to close loopholes and curb tax-motivated profit shifting by large MNCs (Lohse and

Riedel [2013], Alexander, de Vito, and Jacob [2017]). Notorious examples are investigations of

so-called sweetheart deals between several EU governments and large global players like Apple,

Amazon, Starbucks or Fiat Chrysler (The Economist [2015]). Our findings suggest that these

actions in combination with the OECD Base Erosion and Profit Shifting (BEPS) initiatives may

indeed have led to an increased reliance on local tax avoidance over time. We find that the

relative contribution of subsidiary local tax avoidance to total tax avoidance has doubled to 18%

in the second half of the sample period compared to 9% in the first half of the sample period.

Moreover, we exploit intertemporal variations in profit shifting opportunities over the

observation period. Using a difference-in-difference research design, we find that the relative

increase of local tax avoidance is driven especially by subsidiary countries where the introduction

of transfer pricing documentation requirements made income shifting more difficult. This

evidence confirms the idea that MNCs rely increasingly more on local tax avoidance strategies

6
Note that we interpret the 14% association as a lower bound. Detailed statistics on the requirements and impact on
coefficients are discussed in Table 6 (full sample) and Table 10 (restricted samples).

6
when cross-border profit shifting became costlier following the implementation of stricter anti-

avoidance rules in the EU.

Finally, we study heterogeneous treatment effects and focus on within-group and across-

group sample partitions to identify the economic channel that may shape the MNC focus on local

versus across-country tax avoidance.7 Within-groups, we observe that the focus on local tax

avoidance is largest in domestic subsidiaries as compared to foreign subsidiaries, suggesting that

the familiarity with the headquarters’ local tax administration may give rise to larger local tax

avoidance opportunities. Also, the association between subsidiary local tax avoidance and MNC

group level tax avoidance is most pronounced in vertically integrated subsidiaries, i.e., where the

subsidiary operates in a different sector of activity than its parent. This evidence confirms the

idea that in cases when transfer prices can potentially be challenged more by tax authorities,

MNCs focus more on subsidiary local tax avoidance.

Across-groups, we identify whether MNCs are publicly listed versus privately held and

whether they are domiciled in Eastern EU countries versus Western EU countries. The rationale

for the public versus private split is motivated by findings that public MNCs may have different

incentives and opportunities compared to private MNCs in their tax avoidance behavior (Lin,

Mills, and Zhang [2014], Beuselinck, Deloof, and Vanstraelen [2015]). However, we find no

differences between publicly listed MNCs and privately-held MNCs. We finally partition the

sample of Eastern versus Western EU MNC origin because of the broader concern that MNCs in

developing countries (such as in Eastern EU countries) are potentially less strongly governed and

that sophisticated anti-avoidance rules may only successfully limit profit shifting in more mature

7
We run models on all observations and also repeat our estimations using propensity-score matched samples to
sharpen the analyses further.

7
economies (OECD [2014a]). Consistent with this idea, we find that the association between

subsidiary local tax avoidance and MNC tax avoidance is significantly less pronounced in

Eastern-EU MNCs compared to other-origin MNCs.

Our study contributes to the nascent literature that addresses international tax avoidance

behavior by observing MNC groups and subsidiary level data (e.g., Beuselinck, Deloof, and

Vanstraelen [2015], De Simone, Klassen, and Seidman [2017], Dharmapala and Riedel [2013],

Huizinga and Laeven [2008], Johannesen, Tørsløv, and Wier [2017], Kohlhase and Pierk [2017],

Markle [2015]). Our study also makes a methodological contribution in that it allows for the

identification of subsidiary local tax avoidance by MNCs both cross-sectionally and within-

groups. While prior work on within-country tax avoidance so far was mainly based on single-

country data (e.g., Beuselinck and Deloof [2014], Dyreng, Lindsey, and Thornock [2013],

Gramlich, Limpaphayom, and Rhee [2004]) or tackled specific features of the tax code within a

particular setting (e.g., Hebous and Ruf [2017], Shevlin, Tang, and Wilson [2012]), the current

study provides new large-sample international insights in the importance of local tax avoidance.

The combined evidence suggests that subsidiary local tax avoidance is a non-negligible

component of international MNC tax planning, and that this local tax avoidance has gained in

popularity in more recent years after the global financial crisis when income shifting has been

labelled more and more as an unethical tax avoidance strategy (Hazra [2014]). The fact that we

observe within-group differences in the importance of subsidiary local tax avoidance further

deepens our understanding of the tax avoidance behavior of MNCs.

Our findings therefore may be particularly interesting for policy makers who are debating on

how to curb tax base erosion and profit shifting (BEPS) (OECD [2013]) and also for public

economists who often consider tax avoidance mainly as outcomes of income shifting activities.

8
For the BEPS action plan to be effective, it is crucial to know to what extent multinationals rely

on within-country tax avoidance and perhaps use this as a substitute for cross-country income

shifting, especially so in more recent years. Our findings also provide input for policy makers

who recently have exerted significant pressure on foreign tax havens to abandon secrecy laws

(Toplensky [2017]). Our findings suggest that political decision-makers should not neglect the

importance of local tax avoidance opportunities when debating fair tax rules at the international

scene. Finally, these results should interest lobbying groups and the financial press as it is one of

the first studies showing that MNC tax avoidance behavior may go beyond income shifting and

that MNCs seem to rebalance their tax avoidance behavior after profit shifting has become

costlier and harder following the implementation of stricter anti-avoidance rules in recent years.

The remainder of the paper is as follows. In Section 2, we elaborate hypotheses based upon

related literature and theoretical predictions. We discuss the research design in Section 3. Section

4 presents the sample and results while section 5 discusses within-group variation. Section 6

presents robustness tests and we conclude in Section 7.

2. Hypotheses Development

2.1 Multinationals and Income Shifting Costs

The tax debate has centered on the idea that multinational firms are saving on their tax bill

because they can shift income from high-tax to low-tax jurisdictions, including tax havens (e.g.,

Dharmapala and Riedel [2013], Dyreng and Markle [2016], Dharmapala [2014]). This may be

especially true for MNCs that can arrange their cross-border transactions on intangible assets

which are by nature more difficult to value and can be more flexibly relocated de jure across

borders (Grubert [2003], De Simone, Mills, and Stomberg [2014]). However, recent U.S. based

9
evidence suggests that also purely domestic firms, just like MNCs, seem to have reduced their

effective tax rates (ETRs) with similar speed and magnitude (Dyreng et al. [2017]). Such an

observation raises the question whether recent international tax reform guidance like the Base

Erosion and Profit Shifting (BEPS) initiative at the OECD (OECD [2013]) that has focused

mainly on profit shifting opportunities in MNCs is potentially underestimating the broader pallet

of tax avoidance opportunities for corporations.

While Dyreng et al. [2017] document comparable trends of decreasing ETRs for domestic

and multinational firms, they do not investigate the relative importance of domestic (i.e. local) tax

avoidance versus international profit shifting when firms have both opportunities at their

disposal. Therefore, our study relates to the relative importance of local tax reducing

opportunities in MNC tax strategies and its proportional contribution to total group avoidance,

including income shifting.

This is relevant because decisions to shift income may not only cause the tax bill to go down,

they can also bear non-negligible costs that may restrain firms from shifting profits. First, income

shifting decisions create administrative and compliance costs because profit shifting can only be

realized by the creation of the well-developed professional tax support system, documentation

system and the hiring of tax experts. Moreover, income shifting can evoke potential court

penalties and reputation costs when contested by minority shareholders or regulators (Desai and

Dharmapala [2006]).8

8
According to a study by the President’s Council on Jobs and Competitiveness [2012], administrative and
compliance costs by U.S. firms were estimated to exceed $40 billion per year or 14% of total taxes collected. In
earlier studies (e.g., Slemrod and Sorum [1984]), they have been estimated at 10% of the collected tax in the US, of
which 1% represents the administrative costs. This estimate is comparable to similar studies that find administrative
costs of 1.16% for the UK (Godwin [1995]) and 1.1% for Australia (Pope [1995]).

10
 Second, income shifting may bear important agency costs if profitable assets and business

functions are managed by a geographically separated subsidiary abroad (O’Donnell [2000],

Kostova, Nell, and Hoenen [2016], Beuselinck and Du [2017]). Consistent with this claim,

Dischinger, Knoll, and Riedel [2014] show that MNCs are reluctant to shift profits away from

their headquarters even if these are located in high tax rate countries.

Third, profit shifting to lower-tax regions may result in important tax repatriation costs upon

the decision to repatriate (Desai, Foley, and Hines [2001], Foley et al. [2007]). Therefore, it is

argued that large portions of shifted income can be trapped abroad, especially in contexts of

worldwide tax regimes where MNCs may decide to leave the cash in their foreign subsidiaries to

avoid the marginal tax cost upon dividend repatriation (Graham, Hanlon, and Shevlin [2011],

Markle [2015]). In line with the agency costs of foreign trapped cash, Edwards, Kravet, and

Wilson [2016] find that U.S. firms with high levels of trapped cash make less profitable

acquisitions of foreign target firms using cash considerations.

The non-negligible costs that accompany income shifting decisions lead to the conjecture that

MNCs alternatively may prefer to reside to tax-bill reducing techniques via focusing on

provisions in local tax laws. Such provisions typically reduce the tax base and are designed to

decrease ETRs on locally reported income and are available for domestic firms in their local

subsidiaries as well as for domestic and foreign subsidiaries of MNCs. While a thorough

description of all country-specific tax-base reducing schemes is beyond the scope of this paper,

we summarize some existing practices to better understand the affinities of how MNCs can

realize local tax avoidance strategies.

2.2 Institutional Knowledge and Local Tax Avoidance

11
 Most EU countries apply tax depreciation rules on equipment and tools that are mainly used

for Research and Development (R&D) operations that deviate from financial reporting (GAAP)

depreciation rules. In France, for instance, R&D depreciation for tax expense purposes is

increased by specific coefficients that can mount to 2.5 times the GAAP depreciation rate,

depending on the standard duration of amortization (EY [2016]). In fact, France is known to offer

one of the largest R&D tax credits in the world – the Credit Impôt Recherche – that benefits

foreign companies operating in France by over 5 billion Euro per year (OECD [2014b]). In the

Netherlands, Dutch tax law provides for various facilities such as accelerated depreciation of

several specific assets, like investments in assets that are in the interest of the protection of the

local environment and that appear on the so-called VAMIL (Vervroegde Afschrijving Milieu

Investeringen) list. In Portugal, companies can apply for a special tax regime to support

investment (RFAI) as a form of tax credit that is granted to companies that invest in fixed assets.

This tax incentive is granted to companies that are based in Portugal, either foreign or domestic

firms, that have no obligations to tax authorities and allows firms to recover 25% of the eligible

regarding the investment amount of €5m and 10% regarding the investment amount exceeding

€5m, up to a limit of 50% of the tax liability.

However, local tax avoidance can also take form in even more specific schemes. Belgium, for

instance, has a relatively high corporate statutory tax rate of 33.99% but at the same time has

multiple exception rules that allow to reduce the tax base. One exception that is particular to

Belgium is the allowance for corporate equity (ACE) provision that allows firms to deduct a

fictitious (i.e., notional) interest on corporate equity. While such a scheme makes economic sense

as it treats both debt and equity tax neutral, the observation is that especially wealthy capital-

intensive groups often benefit from it and the economic rents merely flow to shareholders in the

12
form of higher dividends rather than help creating new jobs (Zangari [2014]). At the same time,

Belgium is one of the countries in Europe allowing for so-called patent boxes, where patent

income deduction grants allow for an 80 percent tax deduction, allowing for an ETR to be

reduced to a maximum of 6.8 percent. The use of patent boxes takes different forms but exists in

other EU countries as well such as France, Hungary, Ireland, Italy, Luxembourg, the Netherlands,

Spain, and the United Kingdom.

The combination of non-negligible costs that are associated with income shifting as well as

the large pool of tax-base reducing provisions that are available in local tax laws lead to the

conjecture that MNCs avoid taxes in aggregate partly by subsidiary local tax planning activities.

This results in the first hypothesis (H1) stating that there is positive association between

subsidiary local tax avoidance and MNC aggregate tax avoidance:

H1: Subsidiary local tax avoidance is positively associated with MNCs tax avoidance.

However, MNC tax avoidance strategies may also have changed over time. This may be

particularly true because of the changing public opinion about tax bill reducing decisions. One

example is the negative reputational effects that were recently evidenced in the high-profile cases

of Amazon, Facebook, Google UK and Starbucks against the UK appeals court and where the

corporate press often blames large corporations of “…shifting profits around the world and

paying small tax bills.” (Goodley, Bowers, and Rogers [2012]).9 Discussions on the ethics of tax

9
An example of how corporate tax strategy decisions may ultimately impact customer behavior is evidenced in the
following example, mentioned on the BBC news article entitled, “Google, Amazon, Starbucks: The rise of 'tax
shaming'” (accessible on: http://www.bbc.com/news/magazine-20560359): “Another impact of tax shaming is that
some people, such as 45-year-old self-employed businessman Mike Buckhurst, from Manchester, boycott brands.
"I've uninstalled Google Chrome and changed my search engine on all my home computers. If I want a coffee I am
now going to go to Costa, despite Starbucks being nearer to me, and even though I buy a lot of things online, I am
not using Amazon. "I'm sick of the 'change the law' comments, I can vote with my feet. I feel very passionate about
this because at one point in my life I was a top rate tax payer and I paid my tax in full," he says.”

13
avoidance are now observed on different layers of society while a few years ago, it was more a

gathering of activists and campaign groups that were protesting against MNC tax avoiding

behavior.10 For instance, Ortiz et al.[2013] show that out of 488 identified protests in the world,

133 (27%) had ‘tax justice’ as one of their main motivations. In line with the increasing demand

about a fairer corporate taxation game, the Base Erosion and Profit Shifting (BEPS) action plan

by the OECD [2013] has also been working on several proposals and guidelines to ensure that

profits are taxed where economic activities are generated. More and more, the common

perception that excessive income shifting activities should no longer be part of contemporary

sustainable business strategies as evidenced in the rise to the term “tax shaming” (Barford and

Hold [2013]).

This increasing cost of international tax avoidance over time is evidenced in Dyreng, Hoopes,

and Wilde [2016], who investigate the consequences of the ActionAid public pressure campaign

in 2010 to spur U.K. listed firms to comply with the requirements stipulated in the United

Kingdom’s Companies Act of 2006 to disclose the name and location of all subsidiaries. Non-

compliant firms after the public pressure campaign not only report higher than expected ETRs

but also effectively reduced the proportion of subsidiaries located in tax havens. In addition,

Dyreng, Hoopes, and Wilde [2016] find that non-compliant firms experience a significantly more

negative short-window market returns around a well-publicized ActionAid report on profit

shifting to tax havens than firms that initially disclosed. In support of these result, recent survey

10
Examples of sprouting protests in the public opinion arise right after the global financial crisis as in the small-scale
student protests mentioned in the corporate press against tax avoiding behavior from the corporations of Sir Philip
Green, efficiency adviser of the UK government. (https://www.theguardian.com/world/2010/nov/29/philip-green-
protest-alleged-tax-avoidance) and the creation of the protest group called UK UnCut, mobilizing its protesters via
the hastag #taxmeet (https://www.theguardian.com/business/2011/jan/19/tax-avoidance-uk-uncut-boots).

14
evidence reports that 89% of the CEOs of large MNCs are concerned about the media coverage

of corporate tax avoidance, up by almost 50% since 2011 (EY [2014]).

Because of the increasing attention on income shifting, and especially so after the global

financial crisis as a tax-aggressive strategy (e.g., Anning, Ravenscroft, and Zbogar [2015]),

MNCs may see local tax avoidance strategies progressively as the more cost-efficient tax strategy

compared to income shifting. However, besides public scrutiny, also tightened anti-avoidance

rules may cause a redesigning of the corporate tax planning spectrum (Lohse and Riedel [2013]).

Consistent with this idea, Alexander, de Vito, and Jacob [2017] report that profit-shifting

activities have declined by over 50% over the period 2003-2013 and Beer and Loeprick [2015]

identified important mitigation effects as a consequence of the introduction of transfer pricing

documentation requirements.11 Consequently, we conjecture that MNCs in their continuous

search for tax-minimizing planning may have substituted income shifting by local tax avoidance

strategies in more recent years to avoid the negative media attention associated with profit shifts

and because of stronger anti-avoidance rules making shifting profits more difficult to establish ex

ante. Therefore, we hypothesize that the association between subsidiary local tax avoidance and

MNC group tax avoidance has increased in more recent years compared to early observation

years. This results in hypothesis H2:

H2: The positive association between subsidiary local tax avoidance and MNC group tax
avoidance has increased over time.

11
In particular, Alexander, de Vito, and Jacob [2017] show for a large sample of EU multinationals that the semi-
elasticity of reported profits to the corporate statutory tax rate dropped from 0.66 over the 2003–2006 period to 0.38
in the final years of their sample period (2011–2013). Beer and Loeprick [2015] estimate that profit shifting is
reduced by more than 50 percent after the introduction of documentation requirements.

15
 3. Research Method

The traditional view in most MNC tax avoidance studies is that shifting income from high-tax

affiliates to low-tax affiliates reduces worldwide taxes. The current study suggests that the ex-

post observed MNC tax avoidance is not necessarily uniquely explained by cross-jurisdictional

profit shifts and that subsidiary local tax avoidance is a potentially important element which can

contribute to the MNC group tax avoidance strategy. One key conceptual contribution of our

paper therefore lies in the identification of local tax avoidance versus total tax avoidance.

However, empirically isolating local tax avoidance is both conceptually and empirically

challenging without oversimplifying this distinction. In the following Section 3.1 below we

provide a numerical example to illustrate the logic of how the relative importance of local

(within-country) tax avoidance can be gauged from observing subsidiary local tax avoidance

patterns and relating these to MNC group tax avoidance behavior. Section 3.2 then provides an

overview of the empirical model specifications.

3.1. Local Tax Avoidance versus Income Shifting

To illustrate the rationale applied for our empirical tests and model specifications, consider an

observation where a specific 3-digit SIC industry (e.g., 345: Fabricated Structural Metal

Products) in a specific country (e.g., Germany) has N country-industry rivals that face an average

effective tax rate (ETR) of 20 percent for any given year. Also assume that within SIC 345, we

observe 2 German-origin MNCs Alpha (A) and Beta (B) that have an identical aggregate taxable

income (100,000) and both have two equal-sized subsidiaries (proxied by Sales) spread over 2

affiliate countries, C1 and C2, and where the subsidiaries are labelled as follows: SubA_C1 and

SubA_C2 (both fully-owned and incorporated for tax reasons by Alpha) versus SubB_C1 and

SubB_C2 (both fully-owned and incorporated for tax reasons by Beta). Also, assume that the

16
peers’ effective tax rates in country C1 and C2 are 10 percent and 30 percent, respectively. For

simplicity, we assume that the peers’ effective tax rate equals the statutory tax rate.

On the surface, it is clear from a tax planning perspective that both groups have incentives to

record higher taxable income in C1 as this affiliate country has the lowest statutory tax rate

among the two affiliate countries. In line with a tax-minimizing planning strategy, Group Alpha

records taxable income of 60,000 in country C1 and 40,000 in country C2, leading to a combined

tax burden of 18,000 (=60k*0.10+40k*0.30). This makes Group Alpha tax aggressive relative to

its industry-country-year peer group as its realized ETR equals 18 percent, which is 2 percentage

points below that of its peers. Group Beta, however, also realizes an ETR of 18 percent but

achieves this via exploiting local tax advantages bringing its affiliate ETR under the statutory tax

rate and by locating its taxable income equally (i.e., 50-50) across-country C1 and C2. Beta

achieved this via affiliate-country local tax planning strategies (e.g., local tax loopholes

exploitation), leading to a reduction by 10 percent in ETR compared to the STR in C1 (9%

instead of 10%) as well as C2 (27% instead of 30%). The combined tax burden for Beta is also

18,000 (=50k*0.09+50k*0.27). In other words, while both groups Alpha and Beta achieved an

identically lower group ETR compared to their peers, Alpha realized this via income location

decisions consistent with a tax-efficient shifting strategy (income shifting), while Beta realized

this via a focus on subsidiary country local tax avoidance.

When we summarize these opposite tax planning strategies in the example below, we observe

that the abnormal group ETR (AETRg) relative to the country/industry/year SIC 345 peer group is

minus 2 percent in both cases. The difference between the groups is apparent in the abnormal

ETR across the subsidiaries (AETRs). While Alpha has a zero deviation from the affiliate country

STR in its local ETR realizations, Beta realizes a 1 percentage point deviation (SubB-C1: [9%-

17
10%] = -0.01) and a 3 percentage points deviation (SubB-C2: [27%-30%] = -0.03). By weighting

local (within-country) tax avoidance by the respective taxable income, one can calculate the

weighted abnormal ETR combined over all affiliate countries (wAETRs) for Group Alpha

(60k*[10%-10%] + 40k*[30%-30%] = 0) and Group Beta (50k*[9%-10%] + 50k*[27%-30%] = -

0.2). In the case of Alpha – who is realizing the lower tax bill via income shifts – the group ETR

differential (AETRg, -0.02) is unrelated to the weighted subsidiary ETR differential (wAETRs,

0.00). For Beta – who is realizing the lower tax bill via local tax avoidance – the group ETR

differential (AETRg, -0.02) is identical to the weighted subsidiary ETR differential (wAETRs, -

0.02).

Exhibit 1: Numerical Example of Local (Within-country) vs. Across-Country (Income Shifting)

Tax Avoidance
Group Alpha Group Beta
Consolidated SubA-C1 SubA-C2 Consolidated SubB-C1 SubB-C2
PTI 100,000 60,000 40,000 100,000 50,000 50,000
Tax expense 18,000 6,000 12,000 18,000 4,500 13,500
ETRg (group) 0.18 0.18
AETRg (group) -0.02 -0.02
ETRs (subs) 0.10 0.30 0.09 0.27
AETRs (subs) 0.00 0.00 -0.01 -0.03
wAETRs (subs) 0.00 -0.02
PTI is pretax income. ETR(group) is the groups’ effective tax rate as documented in the consolidated statement.
AETR(group) is the groups abnormal effective tax rate defined as ETR(group) minus the country-industry-year
average of 20%. STR is the statutory tax rate of the respective subsidiary country (which is assumed to be equal
to the peers’ effective tax rate). ETR(subs) is the subsidiaries’ effective tax rate as documented in the
unconsolidated (individual) statement. AETR(subs) is the subsidiaries’ abnormal effective tax rate defined as
ETR(subs) minus the country-industry-year average. wAETR(subs) is the by pretax income weighted average of
abnormal effective tax rates of the groups’ subsidiaries (AETR(subs)).

From the example, it becomes apparent that no matter how much income is located in low tax

jurisdictions, the association between AETRg and wAETRs will always remain zero (0.00) if group

Alpha is not able to deviate its affiliate ETR from the local STR in one of its subsidiary countries.

One the other hand, the perfect correlation of one (1.00) that is observed for group Beta is only

18
 true for those cases where group tax avoidance is perfectly correlated with the (pre-tax income-

weighted) local subsidiary tax avoidance. In reality, one can expect intermediate cases where

groups do shift income for tax purposes to lower STR countries yet are also locally tax-

aggressive in their affiliate countries. Under these scenarios, the association between AETRg and

wAETRs will be positive and between zero and one. In our empirical analyses, we are interested

to observe whether MNCs do apply within-country tax planning strategies. Second, we aim to

identify cross-sectional variations in AETRg and wAETRs based upon characteristics that may

explain why groups rely more on income shifting (zero or low correlation between parent and

weighted subsidiary abnormal ETRs) versus within-country tax avoidance (correlation closer to

one between parent and weighted subsidiary abnormal ETRs).

3.2. Empirical Model – Correlation of Subsidiary and Group Tax Avoidance

To identify the proportion of tax avoidance that originates from subsidiary local tax

avoidance versus total MNC (group) tax avoidance, we analyze the relationship between the

MNC consolidated abnormal effective tax rate (AETRg) and the pre-tax income weighted AETR

of their domestic and foreign subsidiaries based on unconsolidated data (wAETRs). First, the

effective tax rate (ETR) is calculated as GAAP tax expense divided by GAAP pretax income. In

our empirical quantification, we start by computing the abnormal effective tax rate for each group

and each subsidiary, which is the deviation from the respective country-industry-year average.

We use “t” as a year subscript, “j” as an industry subscript, “c” as a country subscript, “s” as a

subsidiary subscript, and the subscript “g” relates to the respective group. The AETR for the

subsidiaries are computed as follows.

19
 1 n (1)
AETRs ,t = ETRs ,t − * ∑ ETR j ,c ,t
n i =1

AETRs,t can be interpreted as the subsidiary-specific ETR deviation from the country-

industry-year average. In other words, this measure captures the relative tax-avoidance for each

MNC subsidiary entity, relative to its subsidiary country-industry-year peer group. We interpret

positive values as observations with below country-industry-year tax avoidance while negative

values represent observations with above country-industry-year tax avoidance. An AETR of zero

is expected to correspond to a subsidiary of which the ETR is identical to the country-industry-

year average ETR.

We are able to perform this type of analysis, since our dataset (as described in more detail

below: see Section 4.1) allows us to observe unconsolidated (subsidiary-entity) financial

statements of domestic and foreign affiliates that are majority-owned by global MNCs. The

pretax income that is reported in unconsolidated financial statements is the source-country

income that is subject to local tax. Notably, this is the income that is reported in a country after

potential profit shifting activities into or out of that specific country. Next, we compute the

weighted average (by pretax income, PTI) of the AETR for all subsidiaries (s) of a given

multinational to obtain one measure of tax avoidance of all its subsidiaries in year t. This measure

can be interpreted as the weighted local tax avoidance within jurisdictions where the subsidiaries

are located (wAETRs) and where the weight is formed by the level of the subsidiary taxable

income.

20
 1 m
wAETRs ,t = * ∑ AETRs ,t * PTI s ,t
m
s =1 (2)
∑ PTI
s =1
s ,t

Next, we define the abnormal effective tax rate of the group based on consolidated

statements. The calculation is the same as for subsidiaries as shown in Formula 1 with the

exception the data is based on the groups’ consolidated statement.

1 n
AETRg ,t = ETRg ,t − * ∑ ETR j ,c ,t (3)
n i =1

We then regress the abnormal ETR of the group (AETRg,t) on the pre-tax income weighted tax

avoidance of the subsidiaries (wAETRs,t) to investigate how the parent’s tax avoidance is

associated with the subsidiaries tax avoidance. A coefficient of zero would indicate that there is

no association between the ex post realized MNC tax avoidance and the local tax avoidance in

subsidiaries. This result of a zero correlation in the case of a tax-aggressive MNC group is

indicative of tax avoidance that is realized via income shifting as it is not related to any

subsidiary country tax avoidance. A coefficient of one in the case of a tax-aggressive MNC group

would indicate that the parent’s tax avoidance is fully explained by the subsidiaries’ local tax

avoidance strategies. A significantly positive coefficient of x (with x ranging between 0 and +1)

is indicative of subsidiary local tax avoidance contributing to x % of MNC total tax avoidance.12

The model of interest goes as follows:

AETR g ,t = β 0 + β 1 * wAETR s ,t + controls g ,t + ε i ,t (4)

12
Note that while our model allows for investigations of the relative importance of subsidiary local tax avoidance
contributing to total tax avoidance, we do not make any statement about the magnitude of local tax avoidance.

21
 We insert determinants that prior research has identified to be important drivers of tax

avoidance and tax sheltering (e.g., Gupta and Newberry [1997], Chen, Chen, Cheng, and Shevlin

[2010], Desai and Dharmapala [2009]). First, we control for a firm’s size (SIZE) proxied by the

natural logarithm of firm assets. In line with Mills, Erickson, and Maydew [1998] and Rego

[2003], we expect SIZE to be negatively related to ETRs since large firms are expected to do

more effective tax planning. However, in line with the political cost argument as in Zimmerman

[1982], SIZE may also be positively related to ETRs. Second, we control for a firm’s pretax

profitability. Following the arguments in Gupta and Newberry [1997], we expect that under the

condition of stable tax preferences and for a given level of total assets, ETR is negatively related

to ROA. This result is also predicted from the perspective that MNCs with higher levels of pre-tax

income have more opportunities to reduce their overall tax burdens through tax-planning

activities (e.g., Rego [2003]). Third, we control for the level of capital intensity (PPE) and

interpret this variable as a proxy for a firm’s asset mix. In line with the idea that tax benefits are

associated with capital investments, we expect that capital-intensive firms should face lower

ETRs (see e.g., Gupta and Newberry [1997]). Fourth, we control for the level of capitalized

intangibles (INTANG) as more intangible firms can benefit from favorable tax treatments for

research and development (e.g., Patent Boxes).13

Fifth, we include LEV to control for a firm’s financing policy. The tax codes generally accord

differential treatment to the capital structure of firms because interest expenses are deductible for

tax purposes, whereas dividends are not, leading to the expectation that firms with higher

leverage would have lower ETRs. However, a positive relation between ETRs and leverage is

13
Note that if R&D is expensed rather than capitalized like is the case in many GAAP worldwide then we do not
expect to observe a significant relationship between capitalized intangible assets and ETR as the true intangibility
then is not reliably represented on the firm’s balance sheet.

22
possible if firms with high marginal tax rates are more likely the ones that can attract and use

debt financing (Gupta and Newberry [1997]). Sixth, we include a dummy which is coded one if

the respective group had a loss in the previous years (LAGLOSS). As tax-loss carryforwards are

not observable but apply in most of the observed institutional settings under study, LAGLOSS

captures these to some extent. Seventh, we include #SUBS which is the number of subsidiaries

that belong to the respective group to control for the number of available options for avoiding

taxes locally. Eighth, to control for the tax attractiveness we include ∆TAXINDEX, which is the

difference between the tax attractiveness index of the location of the headquarters as proposed by

Keller and Schanz [2013] and the average tax attractiveness indices of the respective subsidiaries.

MNCs with subsidiaries located in more tax attractive subsidiaries relative to their peer firms are

expected to benefit from these tax features via a lower ETR resulting in a predicted positive

coefficient for ∆TAXINDEX. Ninth, we include PUBLIC which is a dummy variable equal one if

the group is publicly listed, and zero otherwise. Prior research has shown that private and public

firms have different costs and benefits associated with tax planning leading to the expectation

that public firms may be more tax-efficient (e.g. Beatty and Harris [1998], Beuselinck, Deloof,

and Vanstraelen [2015]).

Because the variables AETRg and wAETRs are both demeaned at the country-year-industry

level, there are no separate country-industry-year dummies included in the model. However, we

do additionally include subsidiary-country fixed effects to further control for differences in profit

shifting opportunities. These fixed effects are a battery of dummies that take on the value of one

for all countries the respective MNC operates in.

23
 4. Sample and Results

4.1. Sample

The sample is based on non-financial groups from 27 EU Member States and their global

subsidiaries.14 The data is gathered from Bureau van Dijk © Orbis database covering the period

2006 to 2014. This database contains information on the (most recent) ultimate owner of each

corporation, which we use to construct corporate groups.15 We consider groups in our sample

when they have at least one foreign subsidiary. We do not consider purely domestic (i.e., single-

jurisdictional) groups since these firms can only avoid taxes locally and therefore cannot trade-off

local tax avoidance with cross-jurisdictional income shifting. For each EU Member State, we

download the consolidated parent financial data and the unconsolidated subsidiary level data to

calculate the group-level ETR, respectively affiliate-level ETR. Subsidiaries are defined as such

if the parent company directly or indirectly owns at least 50% of the shares. This search strategy

allows us to combine all unique subsidiary observations to their ultimate parent. We exclude

14
The sample does not include Italian groups as Italy has a regional tax that is based on the value of all produced
goods. In this case, the standard proxies for tax avoidance, e.g. the effective tax rate, cannot be interpreted. However,
the results remain qualitatively the same if we include Italian observations.
15
Note that the use of Orbis database which has information on accounting data to study tax avoidance poses some
challenges that all other studies using this dataset also suffer from. We explain the three most important limitations
and the way how we address these. First, accounting profits are not identical to taxable profits and book-tax
differences may vary systematically over time and across countries. However, the use of country-time fixed effects
that we introduce in our empirical design capture country/time-varying book-tax differences. Moreover, since we
focus on EU multinationals of which we observe domestic and foreign subsidiary observations, the 4th and 7th EU
Directive apply in the large majority of our sample cases. In most EU Member States, taxable income is based on
reported accounting income and is adjusted with specific tax law regulations. Second, our study could suffer from
measurement error in the tax avoidance measurement due to imperfect coverage of the Orbis database. If the
database coverage is particularly low in specific countries because of the low level of local disclosure, like is the case
in tax havens, our results may be biased. However, Johannson et al. [2016] show that Orbis scores relatively well in
the coverage of tax haven presence, and correctly identifies tax haven presence in 70 percent of the cases. Third,
since we cover 69 countries, it is hard to identify country-specific tax treatments that may be put in place at one point
in time and that explain the relative weight that specific MNCs may want to place on within- versus across-country
tax avoidance strategies. To the extent that the treatments are available for all MNCs operating in the specific
jurisdiction, the subsidiary-country-year demeaning again is capturing this effect. In all other cases where only
specific MNCs are able to negotiate tax deals locally (for instance, only very large MNCs are able to negotiate
advance pricing agreements (APSs) with local authorities or can set up structures to take advantage of tax loopholes),
the empirical tests are expected to capture the cross-sectional variation.

24
observations with missing data on pretax income and total assets and for which we have missing

data on control variables; for firm-years with a negative pretax income, firm-years with a

negative tax expense; firm-years with a tax rate above 100% of pre-tax income; and subsidiaries

with net income of exactly zero (in this case firms have a profit transfer agreement). The final

subsidiary-level dataset consists of 158,749 subsidiary-year observations from 69 different

countries from both within as from outside the European Union. This sample also corresponds to

34,111 MNC group-year observations headquartered in the European Union. Table 1 shows

country-level details on the location of subsidiaries (rows) and the origin of the respective group

(columns).

***INSERT TABLE 1 HERE***

For expositional purposes, we separately show the MNC parent/subsidiary observations only

for these countries where we observe more than 1,000 subsidiary-year observations. The

countries for which this is the case are Austria, Belgium, Germany, Denmark, Spain, Finland,

France, United Kingdom, Ireland, Luxembourg, the Netherlands, Poland, Portugal and Sweden.

In the interest of readability, the observations of all other countries (N=12) are pooled in the final

column (Other). As shown in Table 1, we observe most subsidiary-locations (rows) in the United

Kingdom (GB, 19,049), followed by Spain (ES, 17,011) and France (FR, 15,624). In terms of the

MNC parent-origin (column), we observe that MNCs from Germany (DE) have the highest

number of subsidiaries (41,252), followed by Great Britain (GB, 22,210) and Spain (IT, 15,042),

respectively. Further, a large fraction of the observed subsidiaries is located domestically. For

example, the highest fraction of local subsidiaries is observed in Great Britain (GB/GB: 10,807).

Thus, our sample includes 10,807 subsidiary observations for subsidiaries located in Great

Britain majority owned by British-origin MNCs.

25
4.2. Descriptive Statistics and Results – Subsidiary Level

In Table 2, we observe that the mean (median) subsidiary-level ETR is 24.7% (25.1%) and

the interquartile range lies between 17.1% and 30.6%. While average and median ETRs are

consistent with rates reported in prior research in a U.S. setting (e.g., Dyreng et al. [2017]), the

top quartile of observed ETRs are substantially higher. One potential explanation for some

extreme ETRs may lie in the fact that we have some countries in our sample that had high tax

rates during our sample period (e.g. Germany above 38% before 2008). By definition, the mean

abnormal effective tax rate (AETRs) of subsidiaries is zero. The median is also zero indicating

that approximately half of the subsidiary observations sample is labelled as avoiding tax (left-tail

of the distribution) and the other half is labelled as not avoiding tax (right tail).

***INSERT TABLE 2 HERE***

As a preliminary analysis, we investigate whether and to what extent subsidiary local tax

avoidance is determined by the group. This is relevant because subsidiary decisions cannot be

treated independently from strategic impulses by corporate headquarters and also tax strategies

are likely to be designed at the top level. We test for the MNC corporate style by inserting time-

invariant MNC (group) fixed effects in a model that predicts subsidiary-level tax avoidance

behavior and develop our tests in a similar vein as Bertrand and Schoar [2003]. The proportion of

subsidiary local tax avoidance variation explained by MNC time-invariant components can be

interpreted as the MNC corporate headquarters’ ‘style’ that manifests into the local subsidiary tax

avoidance behavior. To empirically quantify this MNC tax avoidance style that manifests across

the subsidiary chain, we utilize an approach similar to the one developed in Abowd, Kramarz,

and Margolis [1999] and applied in Graham, Li, and Qiu [2012] and Law and Mills [2017]. The

approach provides a relatively simple to interpret calculation technique that allows capturing the

26
relative contribution of each set of fixed effects (FEk) to the respective model R2 by summing up

the ratio cov(AETRs, FEk)/var(AETRs) for all fixed effects. In other words, this ratio effectively

captures the fraction of the model R2 that is attributable to each set of fixed effects. Results in

Table 3 summarize the main findings. The dependent variable is the abnormal effective tax rate

of subsidiaries (deviation from the respective country-year-industry average): AETRs.

In a first estimation, we do not include any additional fixed effects and observe an R2 of

around 3.3%. Next, we want to know whether the origin of the parent has additional explanatory

power and we include parent-country fixed effects (26 fixed effects). The parent-country fixed

effects account for 0.2 % of the total R2 (row: cov(AETRs, FEgroup) / var(AETRs)). In Column (3),

we include fixed effects for each parent-country/subsidiary-country combination (787 fixed

effects). These fixed effects account for 1.2 % of the total R2. Lastly, we include fixed effects for

each group (7,659 fixed effects). The group fixed effects account for 10.9 % increase in R2. Also

the adjusted R2 has increased from 3.2 % to 9.5 %. The 10.9 % increase in R2 in Column (4) is

equivalent to 78.9% of the total explained variation, which is far above the 5.8% (26.7%) that

stems from the MNC parent-country (parent-country/subsidiary-country pairs) fixed effect. We

interpret these results as evidence suggesting that MNC origin and MNC-affiliate country

bilateral relationships only capture a portion of the subsidiary tax avoidance and that rather the

MNC fixed effect (i.e., the “corporate style”) is largely responsible for the design and

orchestration of subsidiary local tax avoidance behavior. After having established this group style

effect that cascades down into the subsidiary tax avoidance, we now move to more formal tests

on the average association and time-series evolutions in the association between subsidiary local

tax avoidance and aggregate MNC tax avoidance.

***INSERT TABLE 3 HERE***

27
4.3. Descriptive Statistics and Results – Group Level

Table 4 includes the summary statistics of the groups. We observe that the average ETR (tax

expense/pre-tax income) is 28.4%. The median ETR is slightly lower (27.0%). Interestingly, only

25% of the MNC groups realized an ETR below 20.7%. By design, the abnormal effective tax

rates of groups (AETRg) is zero. With respect to wAETRs, the pretax income-weighted abnormal

ETR of the groups’ subsidiaries, we find that the average group displays a slightly tax aggressive

strategy in its subsidiaries (p50: – 0.004).16 The average (median) group has 4.7 (20.) subsidiaries

(#SUBSg) in the final sample. In terms of profitability (ROAg), groups are on average highly

profitable (mean=9.7%; median=7.4%). The average group has 9.1% of its balance sheet total in

capitalized intangibles and the maximum level of intangibility is 67.2%. Mean (median) level of

PPE is 24.4% (20.9%). The average group has a balance sheet total of about € 128.8 million and

a financial leverage (including short and long-term debt) of 57.7%. Finally, 6.5% of the

observations had a negative income in the pre-observation year and 24.5% of all observations

relate to publicly listed groups.

***INSERT TABLE 4 HERE***

The correlation table (Table 5) provides first evidence that the group-level tax avoidance,

measured as abnormal effective tax rates (AETRg), is positively correlated with the tax avoidance

of its subsidiaries (wAETRs): The Pearson correlation between AETRg and wAETRs is 0.11 and

the Spearman rank correlation is 0.12 (both statistically significant at the 1% level). Furthermore,

the Table 5 suggest that the consolidated ETR is positively related to INTANGg (0.08; p<0.01)

16
The mean of wAETRs is not equal to zero due to the pretax weighting.

28
and LEVg (0.12; p<0.01). At the same time, ETRg is significantly negatively related to ROAg (-

0.20; p<0.01), and negatively to SIZEg (-0.02; p<0.01).

***INSERT TABLE 5 HERE***

Table 6 reports the regression results for the variables of interest. The columns quantify the

association between the group tax avoidance (AETRg) and the pretax income-weighted abnormal

effective tax rate (wAETRs) within subsidiary affiliate countries. Recall that a zero correlation is

expected to arise if parents realize tax savings that are totally independent from the subsidiary

within-country tax avoidance and that a significantly positive correlation indicates that groups

realize tax savings that are explained to a specific extent by the subsidiary within-country tax

avoidance. In all specifications, we find that group tax avoidance is positively related to the

subsidiary within-country tax avoidance. More in particular, we observe in the base-line model,

controlling for various GAAP ETR determinants, that a one percent change in subsidiary tax

avoidance contributes to a 13.9 basis points change in MNC tax avoidance (column 4: 0.139;

p<0.01) and even 28.2 basis points for the sub-sample where we require to observe fifty percent

or more of the consolidated group income (column 4: 0.282; p<0.01). These findings allow us to

reject the null hypothesis of no within-country tax avoidance (confirming H1).

***INSERT TABLE 6 HERE***

5. Time Trends and Difference-in-Difference Analysis

In this section, we first investigate whether there is a general time trend in within-country tax

avoidance. Second, we employ a difference-in-difference methodology that exploits

intertemporal variations in transfer pricing documentation, i.e. requirements that are assumed to

mitigate tax-induced profit shifting opportunities.

29
 Time trend: Table 7, Panel A includes graphical evidence of the general time trend. The left-

hand side graph shows the yearly coefficient when regression AETRg on wAETRs. The graph

indicates an overall time trend and suggests that within-country tax avoidance is getting more

important over time. The right-hand side shows this general time trend, based on a regression of

wAETRs on a time trend. Panel B includes the respective regression results and controls for the

traditional ETR determinants and group-specific variables as identified above. Moreover, we

control for subsidiary-country fixed effects to capture any potential time trends that are

potentially caused by varying macro-economic states across subsidiary countries. In line with our

second hypothesis, we find preliminary evidence that the association between AETRg and

wAETRs increases steadily with about one percent per year, suggesting that MNCs have

increasingly relied more on local (within-country) tax avoidance in more recent years.

***INSERT TABLE 7 HERE***

Difference-in-difference: Several countries introduced increased documentation

requirements which are expected to mitigate profit shifting by multinationals. Documentation

requirement details are taken from Beer and Loeprick [2015] and Appendix A.1 reports more

details of affected affiliate countries in our study.

To reduce the concern that firms in the treated group and control differ along other

dimensions than the change in documentation requirements, we first plot the pretreatment trends

between treated and control firms around the documentation requirement introduction year in

Panel C of Table 7. More specifically, the graph shows the intertemporal shift in relative

importance of firm-specific demeaned local tax avoidance for treated firms (straight line)

30
compared to control firms (dotted line).17 We observe a very similar time trend pre-passage of the

documentation requirements for both treated and control firms. We do find, however, a

differential effect across both groups from the time of documentation requirements introduction.

Panel D of Table 7 shows results for this difference-in-difference analyses for the

association between group and subsidiary tax avoidance for an analysis of firm-specific

demeaned AETRs after the insertion of firm specific controls, subsidiary country fixed effects.

The interaction term of interest wAETRs*TREAT is significantly positive, suggesting that affiliate

observations from countries where documentation requirements are introduced start relying more

on local tax avoidance compared to control firms in countries where no such concurrent shock is

observed. While these tests admittedly only capture the relative importance of local tax avoidance

to total tax avoidance, they do suggest that after documentation requirements are introduced,

MNC tax strategies rely about 40 percent more (=0.063/0.0161) on local tax avoidance compared

to control observations.

6. Cross-Sectional and Within-Group Variation in Local Tax Avoidance

After having established causal evidence on the contribution of subsidiary local tax avoidance

to MNC tax avoidance and finding that this association has increased over time and especially so

after the introduction of countermeasures to base erosion and profit shifting, we next turn to

analyses where we exploit variation across and within MNCs. Because the economic effect in

local tax avoidance decisions may vary both across MNC types as well as across different

17
Note that firm-specific demeaning allows to observe within-firm intertemporal variation in the correlation
coefficient between group and subsidiary weighted abnormal ETR and is equivalent to introducing firm fixed effects.
Also, because control firms have no identified ‘event’ year, we perform a bootstrap analysis (1,000 iterations) on
randomly assigned event years from the control sample observation to obtain the annual coefficient.

31
subsidiaries belonging to one group, these additional analyses serve to further corroborate our

findings.

First, the trade-off between local tax avoidance and income shifting may depend upon a

group’s listing status. Profit shifting from high to low-tax country countries may lead to negative

reputational effects for the companies that received tax investigations (Anning, Ravenscroft, and

Zbogar [2015]). This concern may be particularly valid for listed (i.e., public) companies since

minority investors can have value-based concerns about tax avoidance strategies which may

negatively impact long-term value. This negative value impact can come from direct tax

settlement lawsuits or from pure reputational costs (Hazra [2014]).18 As such, it may be expected

that public MNCs are more concerned about the negative image that are associated with profit

shifting and therefore may see local tax avoidance as the more cost-efficient tax avoidance

strategy. Evidence that indirectly supports such as claim is found in Lin, Mills, and Zhang [2012]

and Beuselinck, Deloof, and Vanstraelen [2015] who document that public firms are less likely to

shift income from high to low-tax countries compared to private firms. Empirically, we split the

sample in public versus private groups and expect to observe a larger coefficient on local tax

avoidance in subsidiaries pertaining to listed groups.

Another important MNC characteristic that may give a different impetus for the choice to

avoid taxes locally rather than via income shifting techniques may be related to the MNC origin.

Recent evidence shows that sophisticated anti-avoidance rules targeting multinational firms

18
Examples of tax-related lawsuits and settlements for the sample of corporations we analyze are manifold,
including Glaxosmith-Kline/GSK ($3.4bn settlement; U.S. lawsuit in 2006), AstraZeneca (US$1.1bn: U.S. in 2010)
and £550m (UK in 2010), or Vodafone (£1.25bn: UK in 2010). More details of these cases are available at:
https://www.wsj.com/articles/SB115798715531459461 (GSK, 2006),
https://www.theguardian.com/business/2010/feb/23/astrazeneca-tax-uk-pharmaceuticals (AstraZeneca 2010) and
http://www.telegraph.co.uk/news/politics/8875360/Taxman-accused-of-letting-Vodafone-off-8-billion.html
(Vodafone in 2010).

32
successfully helps limiting profit shifting (Ruf and Weichenrieder [2012], Lohse and Riedel

[2013]). However, because such rules rarely exist in developing countries (OECD [2014]) and

because the regulatory and bureaucratic capacity often is limited, Johannesen, Tørsløv, and Wier

[2017] conjecture and find that the sensitivity of reported profits to profit shifting incentives is

higher in developing countries compared to developed economies. Consequently, it may also be

expected that local tax avoidance explains a larger fraction of total tax avoidance if the MNC

origin has more developed anti-avoidance rules in place. To test this conjecture, we exploit cross-

sectional variation in the regulatory and bureaucratic capacity across our sample firms and expect

to observe that the relative importance of local tax avoidance is more important when the home

country’s tax apparatus has more sophistical anti-avoidance rules. Empirically, we split the

sample in Eastern versus Western EU MNC home-country origin and expect to observe a lower

coefficient on local tax avoidance in subsidiaries pertaining to Eastern EU groups.

***INSERT TABLE 8 HERE***

Table 8 reports results for the association coefficients between the group tax avoidance

(AETRg) and the pretax income-weighted abnormal effective tax rate (wAETRs) within

subsidiaries separately for publicly listed groups compared to private groups. Our model includes

the same controls and fixed effects as in the main model. First, we observe in Column (1) of

Panel A that public firms, on average, do employ less within-country tax avoidance compared to

private firms (coefficient of the interaction of wAETRs and PUBLICg: -0.017). The coefficient,

however, is not statistically significant. In Column (2) we apply a propensity score matching

where the first stage models the likelihood of being publicly listed. The coefficient of the

interaction term of wAETRs and PUBLICg is also insignificantly different from zero. Overall, the

results of Table 8 indicate that there are no significant differences in the association between

33
subsidiary local tax avoidance and aggregate group tax avoidance between public and private

multinationals. However, when we split the sample based on Eastern versus Western EU MNC

origin (panel B), we do observe that Eastern EU MNCs employ less within-country tax avoidance

compared to MNCs from Western EU countries (-0.074; p<0.10). This result is consistent with

expectations that tax avoidance contributes more to total group tax avoidance in Western EU

compared to Eastern EU settings potentially because of developed anti-avoidance rules in

Western EU settings. The result, however, is not statistically significant in a sample where we

require the Eastern EU MNCs to be comparable to Western EU MNCs in a similar way as we

model public versus private MNCs.

Tax-strategic decisions, however, may not be uniformly applied across all subsidiaries. Based

upon a similar sample as ours of EU multinational group and subsidiary accounts, De Simone,

Klassen and Seidman [2017] for instance show a different ROA responsiveness to tax incentives

between profitable and unprofitable affiliates in high-tax jurisdictions, suggesting that loss

affiliates are treated separately in cross-border transfer pricing decisions. Another characteristic

that may be non-trivial in the possibility to avoid a high tax bill is the closeness to and familiarity

with the local tax system. MNCs that operate globally may be focusing first on domestic

subsidiaries to reduce the tax bill and only afterwards resort to local tax avoidance in foreign

affiliates. Also, avoiding taxes domestically may be preferable above shifting taxable income out

of the home country and repatriating it back at a cost (Blouin, Krull, and Robinson [2012]).

Empirically, we differentiate between domestic and foreign subsidiaries and expect to observe a

larger coefficient on local tax avoidance in domestic subsidiaries compared to foreign

subsidiaries.

34
 Also, subsidiary local tax avoidance is expected to pay off more than income shifting

practices in contexts where transfer prices can be contested more. One example where more

uncertainty arises is for global MNCs that are vertically integrated. BEPS Action Plan 10, for

instance, names the lack of a suitable comparable unit price (CUP) as one of the primary

concerns for tax authorities to contest applied transfer prices.19 This is true because transfers

within large vertically integrated corporations cannot be regarded as equivalent to transactions

between unrelated parties. Consequently, in cases of vertical-type value chain transfers, it may be

more efficient to focus on subsidiary local tax avoidance than to rely on tax-reducing transfer

pricing since the latter has a higher risk of being challenged by the (local) tax authorities.

Empirically, we differentiate between horizontal subsidiaries (i.e. subsidiaries active in the same

2-digit SIC as the corporate headquarters) and vertical subsidiaries (i.e., subsidiaries active in a

different SIC as the corporate headquarters) and expect to observe a larger coefficient on local tax

avoidance in vertically integrated subsidiaries compared to horizontal subsidiaries.

***INSERT TABLE 9 HERE***

In Table 9, we investigate differences within groups, i.e. we want to know for which

subsidiaries the correlation between AETRg on wAETRs is more pronounced. In Panel A, we

compare domestic subsidiaries with foreign subsidiaries. Thus, we compute the pretax weighted

abnormal effective tax rate separately for domestic subsidiaries (wAETRdomestic) and for foreign

subsidiaries (wAETRforeign). The sample size is reduced to about 30% of the original sample as we

now require each group to have at least one foreign and one domestic subsidiary in the final

19
The OECD Base Erosion and Profit Shifting (BEPS) Action Plan 10 relates to transactional profit split methods
and aims to “…establish arm’s length outcomes or test reported outcomes for controlled transactions by determining
the division of profits that independent enterprises would have expected to realise from engaging in a comparable
transaction or transactions.” For more information refer to: https://www.oecd.org/ctp/transfer-pricing/Revised-
guidance-on-profit-splits-2017.pdf

35
sample. Panel A shows that we find significantly positive coefficients for both domestic and

foreign subsidiaries, but the effect is more pronounced for domestic subsidiaries. To rule out the

concern that this may be a result driven by the economic importance of the domestic subsidiaries,

we match both types of subsidiaries based on pretax income. More in particular, Column (2)

includes observations where the foreign pretax income is within a 25% range of the domestic

pretax income. Now, the results suggest that only the coefficient for domestic subsidiaries is

statistically significant (0.106, p<0.001). Overall, these results make us conclude that the focus

on local tax avoidance is largest in domestic subsidiaries, suggesting that the familiarity with the

headquarters’ local tax administration gives rise to larger local tax avoidance opportunities.

Similarly, we split subsidiaries into being in the same industry as the group based on a 2-digit

SIC code to proxy for vertical integration (Panel B). The coefficients of wAETRsame_industry and

wAETRdifferent_industry are both positive and statistically significant in Column (1), but are more

pronounced for subsidiaries that are in different industries compared to for horizontal subsidiaries

(0.064 versus 0.028; both p-values <0.01). If we match on pretax income in a similar way as we

did for foreign and domestic subsidiaries above, then we only observe a statistically significant

and positive coefficient for vertical subsidiaries: 0.194; p<0.01. This finding is consistent with

the conjecture that local tax avoidance is more related to total group tax avoidance in vertical

subsidiaries, i.e., in a setting where intra-group transfers of goods and services may be challenged

more by tax authorities.

***INSERT TABLE 9 HERE***

36
 7. Robustness Tests

A potential concern may be that our results are biased by the quality of the underlying dataset.

Although the results in Table 6 (column (4)) already indicate that the estimated associations grow

after we require to observe more subsidiary information, we here apply additional data

restrictions. A first additional requirement that we impose is restricting the sample to firms where

we observe at least 3 subsidiaries per group. A second requirement is related to the number of

peer firms to calculate the country-industry-year average. One potential concern is that this

measure is not-representative of a stable industry-average if we only observe a handful of

observations in the respective cluster. Therefore, we repeat our analyses and limit the sample to

observations where we observe at least seven observations in the respective cluster, both for the

computation of abnormal effective tax rates of groups and subsidiaries. Finally, we apply all data

restrictions of the previous columns in Column (3) and additionally require to observe minimum

50% of consolidated income. The sample size is here reduced to 6,247 group observations. The

coefficient of wAETRs, however, remains significantly positive for all additional data

requirements that we impose on our sample and is 0.0191; p<0.01 for the most restricted sample.

Overall, we conclude that data limitations – if anything – are likely to underestimate the relative

importance of subsidiary local tax avoidance to total tax avoidance.

***INSERT TABLE 10 HERE***

Next, we validate our empirical model specifications by iteratively changing the dependent

and independent variables. In model (1) we use observed effective tax rates instead of abnormal

effective rates. In particular, we define the dependent variable as the effective tax rates (ETRg).

Similarly, the independent variable is the pre-tax weighted subsidiary effective tax rate (wETRs),

instead of pre-tax weighted abnormal subsidiary effective tax rate. In model (2), we define

37
‘abnormal’ as the deviation relative to the statutory tax rate (ETR-STR) for both variables instead

of the deviation from the respective country-industry-year combination. Finally, in model (3), we

scale the weighted subsidiary abnormal ETR by total assets instead of pretax income

(wAETR_TAs). All modifications lead to consistent results and yield coefficients ranging from

0.126 (p<0.01) when we scaling by assets in Model 3 to 0.178 (p<0.01) when we run the model

with actual ETR observations.

***INSERT TABLE 11 HERE***

Finally, one may be concerned that our sample includes a high number of observations from

specific countries, e.g. Great-Britain. In untabulated results (available upon request), we re-run

the analyses of Table 6 and exclude Great-Britain. The results stay qualitatively the same. We

also repeat this procedure for all other 26 parent-countries (27 times in total). Overall, the results

are not driven by observations from a specific country.

8. Conclusion

The purpose of the current study is to investigate whether and if so to what extent MNCs

achieve lower consolidated effective tax rates (ETRs) via within versus across-country tax

avoidance. We first show that the parents of subsidiaries are an important determinant of

subsidiary tax avoidance. Next, after controlling for the standard ETR determinants identified in

prior tax research, we show that the consolidated tax avoidance of the average MNC in our

sample is related to the subsidiaries’ tax avoidance. This finding is consistent with the conjecture

that MNCs’ tax avoidance is partly explained by its domestic and foreign-affiliate country tax

avoidance and is not originating exclusively from cross-jurisdictional income shifting. This

finding indicates that the nearly exclusive attention on MNC cross-jurisdictional income shifting

strategies may be understating the totality tax planning actions of MNCs.

38
 To investigate whether within-country tax avoidance acts as a substitute rather than a

complement for cross-country tax avoidance (i.e., income shifting), we perform additional tests

based on MNC characteristics and the reliance on within-country tax avoidance. A time trend

analyses shows that firms rely more on the within-country tax avoidance in more recent years and

especially so after national governments have introduced countermeasures to try and minimize

base erosion and profit shifting. Furthermore, within-country tax avoidance is concentrated

among domestic subsidiaries and subsidiaries that are in a different industry than the corporate

group.

Our findings have important policy implications. In line with recent U.S. evidence by Dyreng,

et al. [2017] who show that over the last 25 years domestic-only firms experienced a similar

decrease in cash ETRs compared to multinationals, the current study suggests that the almost

exclusive focus on multinational income shifting when debating tax avoidance is underestimating

the full spectrum of MNC tax avoidance opportunities. Therefore, we suggest tax regulators and

corporate decision-makers to focus also on within-country tax avoidance and how this helps

MNCs in lowering their overall tax bill. Importantly, our findings suggest that in an era

characterized by austerity and government deficits and where the pressure for a fairer tax game is

growing, MNCs respond by updating their most preferable tax planning strategies. While our

results suggest cross-sectional differences in subsidiary local tax avoidance that is in line with

economic intuition, we invite future research investigating changes in national tax systems that

may impact MNC decisions to substitute income shifting by local tax avoidance and vice versa.

39
 9. Appendix

A9.1 Documentation Requirements, Country overview

Country Documentation Information on the Documentation

Requirement Requirement
(Year)
Austria No No official requirement, although deemed
beneficial in practice
Belgium No No documentation obligation and penalty
effect, although deemed beneficial in case
of litigation defense
Czech Republic No OECD Guidelines are followed, no specific
documentation requirements
Denmark Yes (1998) Significantly tightened rules only since
2006
Estonia Yes (2007) Exemption for SMEs
Finland Yes (2007) Exemption for SMEs
France Yes (2010) L13B of the French Tax Procedure Code.
No tax return disclosures required.
Germany Yes (2003) Section 90 of the General Tax Code.
Greece Yes (2008) For fiscal years 2008 and later.
Hungary Yes (2010) Decree introduced in 2009 but effective
from 2010 only.
Iceland No
Ireland Yes (2011) Penalty effect is mitigated by
documentation existence.
Israel Yes (2006) Israel Tax ordinance Section 85A.
Luxembourg No
Norway Yes (2008) Above threshold taxpayers need to file on
related-party transactions.
Poland Yes (2001) Since 2007 also applied in PE profit
allocation.
Portugal Yes (2002) Corporate Income Tax Code Article 63.
Penalty up to 100,000 Euro.
Slovak Republic Yes (2009) Guideline needs to be followed on
intragroup transaction values
Slovenia Yes (2005) Domestic only groups only need to prepare
upon request. Multinational firms must
prepare cross-border intra-company
transactions.

40
 Spain Yes (2009) Royal Decree 1793/2008
Sweden Yes (2007) Chapter 19 Section 2b of Tax Return
Switzerland No Tax authorities may request information ex
post
The Netherlands Yes (2002) Art 8b of the Dutch Corporate Income Tax
Act
Turkey Yes (2007) Article 13 of the CIT Code
United Kingdom Yes (2008) HMRC Guidance sets detailed
documentation guidance.
This table reports information on the country-level document requirements of a selected group of subsidiary
countries in our study as compiled by Beer and Loeprick [2015]. Although the documentation requirements are for a
subset of the subsidiary countries that we observe in our sample, this overview captures close to 90 percent of all
subsidiary-country sample observations (i.e., 138,620 out of 158,749 observations).

41
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 11. Tables and Figures

Table 1. Location of Groups and Subsidiaries

AT BE DE DK ES FI FR GB IE LU NL PL PT SE Other Total
AE 0 0 0 0 0 0 0 4 0 0 0 0 0 0 0 4
AL 1 0 1 0 1 0 0 1 0 0 0 0 0 0 0 4
AT 1,471 72 1,495 93 62 77 10 264 21 14 130 0 3 110 26 3,848
AU 1 7 165 18 6 29 0 154 20 5 41 0 0 20 1 467
BA 2 1 62 7 11 8 2 8 0 0 8 3 0 10 92 214
BB 0 0 0 0 0 0 0 6 0 0 0 0 0 0 0 6
BE 76 5,796 1,699 213 150 118 429 787 347 130 2,573 5 8 384 3 12,718
BG 59 72 367 35 59 10 7 71 22 2 90 5 4 63 297 1,163
BR 2 5 24 2 41 3 0 10 2 2 7 0 18 4 0 120
CH 0 0 12 0 0 0 0 0 0 0 0 0 0 0 0 12
CI 0 0 0 0 0 0 0 2 0 0 0 0 0 0 0 2
CN 26 39 554 40 12 44 8 111 44 0 44 0 0 79 2 1,003
CO 13 59 213 8 179 10 4 176 45 11 33 0 5 28 0 784
CY 0 2 5 2 0 0 0 0 0 0 0 0 0 0 12 21
CZ 559 218 2,453 161 153 143 25 371 92 187 493 91 6 278 644 5,874
DE 595 472 9,721 483 236 250 119 1,086 202 83 1,099 58 17 401 73 14,895
DK 28 42 423 2,236 27 129 5 181 41 18 176 9 3 519 7 3,844
DZ 0 1 0 0 1 0 1 0 0 0 0 0 0 0 0 3
EE 5 8 42 30 8 253 2 11 1 1 17 3 5 85 70 541
ES 98 297 2,726 268 10,277 149 306 1,219 226 34 792 5 392 205 17 17,011
FI 27 59 491 248 15 2,919 22 228 79 17 69 0 0 983 9 5,166
FR 135 1,837 3,957 303 623 195 5,230 1,554 279 101 876 18 18 468 30 15,624
GB 155 460 3,303 472 489 313 180 10,807 968 71 1,120 22 9 604 76 19,049
GR 4 45 244 26 107 14 9 100 32 1 98 0 0 48 568 1,296
HR 132 36 391 49 13 24 2 55 11 4 32 8 5 30 276 1,068
HU 221 125 1,120 98 80 83 13 177 51 49 85 4 4 102 199 2,411
IE 0 37 305 71 91 36 1 605 265 17 119 0 17 60 3 1,627
IL 0 0 0 0 0 0 0 1 0 0 0 0 0 1 0 2
IN 9 8 120 13 9 15 4 71 9 6 23 0 0 24 3 314
IS 0 0 14 34 4 9 0 12 9 0 0 0 2 0 4 88
JP 4 0 51 2 0 11 0 27 11 3 7 0 0 11 0 127
KN 0 0 0 0 0 0 0 5 0 0 0 0 0 0 0 5
KR 14 48 500 62 14 44 7 144 46 9 37 0 0 83 0 1,008
KZ 0 0 4 0 0 0 0 0 0 1 12 0 0 0 3 20
LK 0 0 2 0 0 0 0 3 0 0 0 0 0 0 0 5
To be continued

49
Table 1 continued
LT 9 30 163 95 0 169 5 43 6 0 27 29 0 108 171 855
LU 7 229 263 2 13 4 13 173 11 144 55 0 0 5 2 921
LV 11 11 142 129 5 187 0 55 8 0 37 22 0 220 237 1,064
MA 0 10 83 3 72 1 31 8 0 0 5 0 0 2 0 215
MD 0 0 3 0 0 0 0 0 0 0 0 0 0 0 1 4
ME 2 0 3 0 1 0 0 0 0 0 4 1 0 0 17 28
MK 6 1 3 2 0 0 0 2 0 0 0 0 0 0 19 33
MT 6 0 112 1 5 0 0 53 12 3 6 5 1 12 96 312
MU 0 0 1 0 0 0 0 0 0 0 0 0 0 0 0 1
NL 58 226 1,039 121 188 30 19 776 128 41 2,383 0 23 145 17 5,194
NO 32 83 623 662 10 579 4 352 82 32 265 7 0 1,655 25 4,411
NZ 0 1 159 37 3 4 0 98 23 0 25 0 0 14 0 364
PA 0 0 0 0 3 0 0 0 0 0 0 0 0 0 0 3
PE 0 8 22 2 36 0 2 28 0 0 20 0 3 0 4 125
PH 0 9 147 25 6 11 1 49 17 7 18 0 0 13 1 304
PK 0 0 22 0 0 0 0 5 0 0 0 0 0 0 0 27
PL 205 326 2,419 407 246 270 145 576 187 30 633 1,571 67 515 142 7,739
PT 25 126 556 87 1,312 62 118 223 46 14 204 8 1,469 67 9 4,326
PY 0 0 0 0 0 0 0 0 0 5 0 0 0 0 0 5
RO 236 198 996 108 156 45 107 304 87 15 385 69 27 73 263 3,069
RS 82 27 229 23 53 5 6 24 3 0 67 15 0 38 143 715
RU 60 107 649 84 43 191 22 310 10 13 227 64 5 71 195 2,051
RW 0 0 0 0 0 0 0 0 0 0 2 0 0 0 0 2
SE 93 145 1,263 773 51 1,049 25 529 117 17 419 35 8 7,228 31 11,783
SG 3 0 186 38 0 13 3 116 28 0 84 0 0 24 7 502
SI 103 23 373 38 4 32 5 43 6 0 12 9 1 32 201 882
SK 288 86 961 131 117 75 60 122 84 17 195 48 5 83 212 2,484
TH 0 0 2 1 0 0 0 0 0 0 1 0 0 0 0 4
TR 7 17 111 10 21 3 7 27 3 0 32 0 0 16 1 255
TT 0 0 0 0 0 0 0 8 0 0 0 0 0 0 0 8
TW 0 0 1 0 0 0 0 0 0 0 0 0 0 0 0 1
TZ 0 0 2 0 0 0 0 0 0 0 0 0 0 0 0 2
UA 34 16 251 10 27 26 0 33 30 3 130 72 5 22 41 700
UY 0 3 4 0 2 2 0 2 0 2 1 0 0 0 0 16
Sum 4,904 11,428 41,252 7,763 15,042 7,644 6,959 22,210 3,711 1,109 13,218 2,186 2,130 14,943 4,250 158,749
This table provides the locations of the subsidiaries (rows) and the origin of the respective parents (columns).

50
 Table 2. Summary Statistics - Subsidiaries
Variable n Mean Sd Min P25 P50 P75 Max
ETRs 158,749 0.247 0.139 0.001 0.171 0.251 0.306 0.802
AETRs 158,749 0.000 0.124 -0.527 -0.053 0.000 0.043 0.702
ROAs 158,749 0.147 0.147 0.002 0.046 0.102 0.195 0.795
PPEs 158,749 0.189 0.247 0.000 0.011 0.072 0.284 0.965
INTANGs 158,749 0.020 0.064 0.000 0.000 0.000 0.006 0.433
LEVs 158,749 0.557 0.270 0.002 0.353 0.576 0.773 1.091
SIZEs 158,749 9.259 2.043 4.573 7.902 9.157 10.508 14.832
LAGLOSSs 158,749 0.079 0.269 0.000 0.000 0.000 0.000 1.000
This table presents the summary statistics for the subsidiaries. ETR is the GAAP effective tax rate. AETR is the
abnormal effective tax rate defined as ETR minus the country-industry-year average. ROA is pretax income
divided by total assets. LEV, PPE, and INTANG are total debt, PPE, and intangible assets deflated by total
assets. SIZE is the natural logarithm of total assets. LAGLOSS equals one if the firm had negative pretax income
in the previous year. All non-dichotomous variables are winsorized at the 1% and 99% level.

51
 Table 3. Regression Results - Subsidiaries
Dep. Var.: AETRs (1) NO FE (2) Parent-Country (3) Parent-Sub. Pairs (2) GROUP FE
ROAs -0.119*** -0.120*** -0.122*** -0.132***
(53.74) (54.11) (54.20) (54.67)
PPEs 0.004*** 0.004*** 0.005*** 0.003**
(3.09) (3.16) (3.52) (2.13)*
INTANGs 0.035*** 0.036*** 0.039*** 0.04***
(7.21) (7.53) (7.92) (7.62)
LEVs 0.023*** 0.023*** 0.024*** 0.027***
(19.63) (19.33) (19.78) (20.58)
SIZEs -0.007*** -0.007*** -0.007*** -0.008***
(41.63) (41.49) (40.23) (41.40)
LAGLOSSs -0.025*** -0.025*** -0.025*** -0.024***
(22.00) (22.02) (22.01) (20.57)
Subs. Country-FE Yes Yes Yes Yes
Parent-Subsidiary
FE No Parent-Country Group
Country
N 158,749 158,749 158,749 158,749
R2 – adj. 0.032 0.033 0.040 0.095
R2 0.033 0.034 0.045 0.138
cov(AETRs,FE)/var(AETRs) 0.002 0.012 0.109
R2 explained by FE in % 0.058 0.267 0.789
This table provides OLS regression results. The dependent variable is AETR which is the subsidiaries’ abnormal
effective tax rate defined as ETR minus the country-industry-year average ROA is pretax income divided by total
assets. LEV, PPE, and INTANG are total debt, PPE, and intangible assets deflated by total assets. SIZE is the
natural logarithm of total assets. LAGLOSS equals one if the firm had negative pretax income in the previous year.
The models include fixed-effects for subsidiary countries. Model 1 includes no group fixed effects, Model 2
includes 26 parent-country fixed effects, Model 3 includes 787 parent-country/subsidiary-country pairs fixed
effects, and Model 4 includes 7759 MNC group fixed effects. All non-dichotomous variables are winsorized at the
1% and 99% level. /* marks significance at the 1% level, according to two-sided tests.

52
 Table 4. Summary Statistics - Groups
Variable n Mean Sd Min P25 P50 P75 Max
ETRg 34,111 0.284 0.142 0.013 0.208 0.270 0.333 0.839
AETRg 34,111 0.000 0.126 -0.550 -0.063 -0.004 0.043 0.650
wAETRs 34,111 -0.009 0.099 -0.423 -0.054 -0.004 0.031 0.677
#SUBSg 34,111 4.654 9.774 1.000 1.000 2.000 4.000 248.000
#SUBSforeign 34,111 2.786 7.563 0.000 1.000 1.000 2.000 207.000
∆TAXINDEXg 34,111 0.035 0.128 -0.479 0.000 0.000 0.087 0.516
ROAg 34,111 0.097 0.083 0.005 0.041 0.074 0.125 0.467
PPEg 34,111 0.244 0.194 0.001 0.080 0.209 0.359 0.836
INTANGg 34,111 0.091 0.144 0.000 0.004 0.025 0.109 0.672
LEVg 34,111 0.577 0.195 0.121 0.443 0.590 0.717 1.000
SIZEg 34,111 11.766 1.968 7.922 10.368 11.511 12.969 17.265
LAGLOSSg 34,111 0.065 0.246 0.000 0.000 0.000 0.000 1.000
PUBLICg 34,111 0.245 0.430 0.000 0.000 0.000 0.000 1.000
This table presents the summary statistics. ETR is the GAAP effective tax rate. AETR is the abnormal effective
tax rate defined as ETR minus the country-industry-year average. wAETR is the by pretax income weighted
average of abnormal effective tax rates (AETR) of the groups’ subsidiaries. #SUBS is the number of
subsidiaries. #SUBSforeign is the number of foreign subsidiaries. ∆TAXINDEX is the difference between the
parents’ tax attractiveness index as proposed by Keller and Schanz (2013) and the average tax attractiveness
indices of the respective subsidiaries. ROA is pretax income divided by total assets. LEV, PPE, and INTANG
are total debt, PPE, and intangible assets deflated by total assets. SIZE is the natural logarithm of total assets.
LAGLOSS equals one if the firm had negative pretax income in the previous year. PUBLIC is an indicator
variable coded one if the respective group is publicly listed, and zero otherwise. All non-dichotomous variables
are winsorized at the 1% and 99% level.

53
 Table 5. Correlations - Groups
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)
(1) ETRg 0.82* 0.14* 0.02* 0.00 0.00 -0.17* -0.02* 0.12* 0.11* -0.01 0.00 -0.08*
(2) AETRg 0.89* 0.12* 0.02* 0.00 -0.01 -0.17* 0.00 0.10* 0.08* 0.00 0.01 -0.02*
(3) wAETRs 0.11* 0.11* -0.12* -0.07* 0.02* 0.03* -0.01 -0.08* -0.02* -0.10* -0.01 -0.11*
(4) #SUBSg -0.01 -0.02* -0.07* 0.60* 0.00 -0.08* 0.07* 0.29* 0.04* 0.53* -0.05* 0.34*
(5) #SUBSg,foreign -0.01 -0.01 -0.05* 0.91* 0.28* 0.03* 0.03* 0.20* -0.02* 0.38* -0.03* 0.27*
(6) ∆TAXINDEXg -0.01 0.00 0.02* 0.00 0.06* 0.02* 0.02* -0.03* -0.01 0.04* 0.02* -0.03*
(7) ROAg -0.20* -0.18* 0.02* -0.06* -0.03* -0.01 -0.14* -0.09* -0.32* -0.21* -0.17* -0.05*
(8) PPEg -0.02* 0.00 0.00 0.03* 0.01 0.03* -0.18* -0.13* -0.05* 0.16* 0.00 -0.01
(9) INTANGg 0.08* 0.08* -0.05* 0.17* 0.15* -0.05* -0.09* -0.24* 0.09* 0.33* 0.02* 0.38*
(10) LEVg 0.12* 0.10* -0.01 0.07* 0.04* 0.00 -0.27* -0.02* 0.05* 0.06* 0.09* -0.06*
(11) SIZEg -0.02* -0.02* -0.08* 0.46* 0.42* 0.02* -0.22* 0.16* 0.25* 0.08* -0.04* 0.42*
(12) LAGLOSSg 0.03* 0.04* -0.02* -0.03* -0.02* 0.02* -0.12* 0.01 0.03* 0.10* -0.04* 0.01
(13) PUBLICg -0.08* -0.04* -0.08* 0.28* 0.25* -0.04* -0.06* 0.00 0.36* -0.05* 0.44* 0.01
This table presents Pearson correlations in the lower triangle and Spearman correlations in the upper triangle. ETR is the GAAP effective tax rate. AETR is the
abnormal effective tax rate defined as ETR minus the country-industry-year average. wAETR is the by pretax income weighted average of abnormal effective tax
rates (AETR) of the groups’ subsidiaries. #SUBS is the number of subsidiaries. #SUBSforeign is the number of foreign subsidiaries. ∆TAXINDEX is the difference
between the parents’ tax attractiveness index as proposed by Keller and Schanz (2013) and the average tax attractiveness indices of the respective subsidiaries.
ROA is pretax income divided by total assets. LEV, PPE, and INTANG are total debt, PPE, and intangible assets deflated by total assets. SIZE is the natural
logarithm of total assets. LAGLOSS equals one if the firm had negative pretax income in the previous year. PUBLIC is an indicator variable coded one if the
respective group is publicly listed, and zero otherwise. All non-dichotomous variables are winsorized at the 1% and 99% level. /* marks significance at the 1%
level, according to two-sided tests

54
 Table 6. Regression Results - Groups
Dep. Var.: AETRg (1) (2) (3) (4) 50%
wAETRs 0.138*** 0.139*** 0.139*** 0.282***
(0.016) (0.016) (0.016) (0.037)
SIZEg -0.004*** -0.001***
(0.001) (0.000)
ROAg -0.280*** -0.003
(0.032) (0.013)
PPEg 0.002 -0.353***
(0.007) (0.029)
INTANGg 0.079*** -0.011
(0.022) (0.008)
LEVg 0.030*** 0.091***
(0.005) (0.025)
LAGLOSSg 0.005 0.037***
(0.005) (0.008)
#SUBSg -0.000** -0.002
(0.000) (0.001)
∆TAXINDEXg -0.008** 0.018***
(0.003) (0.006)
PUBLICg -0.017*** -0.021***
(0.003) (0.005)
Constant 0.001*** -0.004*** 0.052*** 0.027*
(0.000) (0.001) (0.010) (0.015)
Subs. Country-FE No Yes Yes Yes
N 34,111 34,111 34,111 14,920
R-squared 0.012 0.018 0.066 0.099
This table provides OLS regression results. The dependent variable is AETR which is the groups’ abnormal
effective tax rate defined as ETR minus the country-industry-year average. Model 4 limits the sample to groups
where the sum of the observed subsidiaries pretax-profits exceeds 50% of the group’s pretax-profits. wAETR is the
by pretax income weighted average of abnormal effective tax rates (AETR) of the groups’ subsidiaries. #SUBS is
the number of subsidiaries. ∆TAXINDEX is the difference between the parents’ tax attractiveness index as
proposed by Keller and Schanz (2013) and the average tax attractiveness indices of the respective subsidiaries.
ROA is pretax income divided by total assets. LEV, PPE, and INTANG are total debt, PPE, and intangible assets
deflated by total assets. SIZE is the natural logarithm of total assets. LAGLOSS equals one if the firm had negative
pretax income in the previous year. PUBLIC is an indicator variable coded one if the respective group is publicly
listed, and zero otherwise. The models include fixed-effects for subsidiary countries when indicated. Standard
errors are clustered at investor (group) country level and are provided within the brackets below the coefficients.
***/**/* marks significance at the 1/5/10% level, respectively, according to two-sided tests.

55
 Table 7. Time Trend - Groups
Panel A: Graphical Evidence

The figure on the left-hand side shows the yearly coefficient when regressing AETRg on wAETRs. The dependent
variable is AETRg which is the groups’ abnormal effective tax rate defined as ETR minus the country-industry-
year average. wAETRs is the by pretax income weighted average of abnormal effective tax rates (AETR) of the
groups’ subsidiaries. The figure on the right-hand side shows the respective time trend based on a regression of
wAETRs on a time trend.

Panel B: Regression Results

Dep. Var.: AETRg (1)
wAETRs 0.082***
(0.022)
wAETRs *TREND 0.010***
(0.003)
Controls Yes
Subs. Country-FE Yes
N 34,111
R-squared 0.067
This table in Panel B provides OLS regression results. The dependent variable is AETR which is the groups’
abnormal effective tax rate defined as ETR minus the country-industry-year average. TREND is a time trend
computed as the current year minus 2005. Control variables are included in line with Table 6. The models include
fixed-effects for subsidiary countries. Standard errors are clustered at investor (group) country level and are
provided within the brackets below the coefficients. ***/**/* marks significance at the 1/5/10% level,
respectively, according to two-sided tests.

56
 Table 7. – Continued
Panel C: Documentation Requirements and Local Tax Avoidance - Graphical Evidence

The figure plots the within-firm variation in association between weighted subsidiary abnormal ETR and parent
abnormal ETR over time. Practically, the dependent variable is AETRg,demeand_by_firm which is the groups’ abnormal
effective tax rate defined as ETR minus the own firm average. wAETRs,demaeand_by_firm is the by pretax income
weighted average of abnormal effective tax rates (demeaned by firm) of the groups’ subsidiaries. TREAT equals
one starting with the year the disclosure requirement were introduced. The annual association for group of treated
firms (solid line) is compared in any of the years t-3 to t+3 to that of random control firms. t=0 corresponds to
year of the documentation requirement introduction.

Panel D: Documentation Requirements and Local Tax Avoidance: Regression Results

Dep. Var.: AETRg,demaned by firm (1)
wAETRs, demaned by firm 0.161***
(0.015)
wAETRs, demeand by firm * TREAT 0.063***
(0.025)
Controls Yes
Subs. Country-FE Yes
N 34,111
R-squared 0.032
This table in Panel B provides OLS regression results. The dependent variable is AETRg,demeand_by_firm which is the
groups’ abnormal effective tax rate defined as ETR minus the own firm average. TREAT equals one starting with
the year the disclosure requirement were introduced. Control variables are included in line with Table 6. The
models include fixed-effects for subsidiary countries. Standard errors are clustered at investor (group) country
level and are provided within the brackets below the coefficients. ***/**/* marks significance at the 1/5/10%
level, respectively, according to two-sided tests.

57
 Table 8. Cross-Sectional Variation
Panel A: Public vs. Private Firms
Dep. Var.: AETRg (1) (2) PSM
wAETRs 0.143*** 0.129***
(0.020) (0.027)
PUBLICg -0.017*** -0.018***
(0.004) (0.004)
wAETRs *PUBLICg -0.017 0.011
(0.023) (0.020)
Controls Yes Yes
Subs. Country-FE Yes Yes
N 34,111 9,260
R-squared 0.066 0.075

Panel B: Eastern versus Western EU MNC Origin

Dep. Var.: AETRg (1) (2) PSM
wAETRs 0.141*** 0.154***
(0.017) (0.039)
EASTg 0.016*** 0.005
(0.038) (0.005)
wAETRs *EASTg -0.074* -0.086
(0.038) (0.051)
Controls Yes Yes
Subs. Country-FE Yes Yes
N 34,111 2,565
R-squared 0.067 0.058
This table provides OLS regression results. The dependent variable is AETR which is the groups’ abnormal
effective tax rate defined as ETR minus the country-industry-year average. PUBLIC is an indicator variable coded
one if the respective group is publicly listed, and zero otherwise. EAST is an indicator variable coded one if the
respective group is from an eastern European country. Model 2 shows observations based on a propensity score
matched sample where the first stage models the likelihood to be a public firm. Control variables are included in
line with Table 6. The models include fixed-effects for subsidiary countries. Standard errors are clustered at
investor (group) country level and are provided within the brackets below the coefficients. ***/**/* marks
significance at the 1/5/10% level, respectively, according to two-sided tests.

58
 Table 9. Within-Group Variation
Panel A: Foreign vs Domestic Subsidiaries
Dep. Var.: AETRg (1) (2) Match
wAETRdomestic 0.086*** 0.106**
(0.023) (0.050)
wAETRforeign 0.042*** 0.059
(0.010) (0.044)
Controls Yes Yes
Subs. Country-FE Yes Yes
N 12,509 9,260
R-squared 0.066 0.075

Panel B: Same Industry vs Different Industry

Dep. Var.: AETRg (1) (2) Match
wAETRsame_industry 0.028** 0.047
(0.013) (0.075)
wAETRdifferent_industry 0.064*** 0.194***
(0.015) (0.047)
Controls Yes Yes
Subs. Country-FE Yes Yes
N 8,954 853
R-squared 0.073 0.188
This table provides OLS regression results. The dependent variable is AETR which is the groups’ abnormal
effective tax rate defined as ETR minus the country-industry-year average. wAETRdomestic is the groups’ abnormal
effective tax rate of domestic subsidiaries. wAETRforeign is the groups’ abnormal effective tax rate of foreign
subsidiaries. wAETRsame_industry is the groups’ abnormal effective tax rate of subsidiaries that operate in the same
industry as the parent based on two digits sic codes. wAETRdifferent_industry is the groups’ abnormal effective tax rate
of subsidiaries that operate in a different industry as the parent. The second model of both Panels limit the sample
to groups that have their pretax-income approximately equally distributed in domestic and foreign subsidiaries
(same industry and different industry). Control variables are included in line with Table 6. The models include
fixed-effects for subsidiary countries. Standard errors are clustered at investor (group) country level and are
provided within the brackets below the coefficients. ***/**/* marks significance at the 1/5/10% level,
respectively, according to two-sided tests.

59
 Table 10. Robustness Tests
Dep. Var.: AETRg (1) min 3 subs. (2) min 7 cluster (3): (1) & (2) & 50%
wAETRs 0.155*** 0.140*** 0.191***
(0.028) (0.019) (0.047)
Controls Yes Yes Yes
Subs. Country-FE Yes Yes Yes
N 14,489 26,998 6,247
R-squared 0.100 0.100 0.100
This table provides OLS regression results. The dependent variable is AETR which is the groups’ abnormal
effective tax rate defined as ETR minus the country-industry-year average. Model 1 limits the sample to groups
where we observe at least 3 subsidiaries. Model 2 limits the sample to groups where we observe at least 7
observations for the respective country-industry-year cluster. Model 3 uses the restrictions of both previous
models and additionally the restriction that pretax-profits exceeds 50% of the group’s pretax-profits.
Control variables are included in line with Table 6. The models include fixed-effects for subsidiary countries
when indicated. Standard errors are clustered at investor (group) country level and are provided within the
brackets below the coefficients. ***/**/* marks significance at the 1/5/10% level, respectively, according to two-
sided tests.

60
 Table 11. Regression Results
Dep. Var.: (1) ETRg (2) ETR-STRg (3) AETRg
wETRs 0.178***
(0.022)
w(ETR-STR)s 0.167***
(0.023)
wAETR_TAs 0.126***
0.053***
Controls Yes Yes Yes
Subs. Country-FE Yes Yes Yes
N 34,111 34,111 34,111
R-squared 0.102 0.089 0.065
This table provides OLS regression results. The dependent variables are (1) the effective tax rates (ETR), (2) the
difference between the effective tax rate and the statutory tax rate (ETR-STR), and (3) AETR which is the groups’
abnormal effective tax rate defined as ETR minus the country-industry-year average. wETR is the by pretax-
income weighted effective tax rates of the groups’ subsidiaries. w(ETR-STR) is the by pretax-income weighted
average of the differences between the effective tax rates and the statutory tax rates of the groups’ subsidiaries.
wAETR_TA is the by total assets weighted average of abnormal effective tax rates of the groups’ subsidiaries.
Control variables are included in line with Table 6. The models include fixed-effects for subsidiary countries.
Standard errors are clustered at investor (group) country level and are provided within the brackets below the
coefficients. ***/**/* marks significance at the 1/5/10% level, respectively, according to two-sided tests.

61