Profit shifting and the attractiveness of Advance Pricing Agreements

Rathke, A.; Rezende, A.; Watrin, C.; Antonio, R.

Abstract

This study investigates tax-induced profit shifting and the effect of the availability of Advance Pricing Agreement (APA) rules on the shifting behaviour of firms. We provide a theoretical model which demonstrates that an APA eliminates the transfer pricing uncertainty related to the calculation of the arm’s length parameter, and it eliminates the incidence of a tax penalization rate. In this case, APA may be attractive for firms focusing on a profit shifting strategy, as it reduces the implicit costs related to the expected tax amendment to be imposed by tax authorities. On an empirical application of our model, we find that firms have an incremental volume of intrafirm transactions with related parties located in low-tax countries with available APA, which is consistent with our theoretical prediction.