Profit shifting to tax havens: Withholding tax impact on passive flows from Poland

Abstract

This paper aims to identify determinants and channels of tax avoidance through passive flows to tax havens using harmful tax competition, considering the effect of changes in withholding tax regulations. For the empirical analysis, we exploit the data of 110 ​907 nonresidents from 134 countries that gain passive flows paid by Polish taxpayers. We utilise data from IFT-2R returns on withholding tax (WHT) for 2012–2019. We use a two-stage Arellano-Bond estimator of the Generalised Method of Moments (GMM) with instrumental variables for dynamic panel data and the difference-in-differences method. We show that the amendment to the withholding tax legislation, preceded by a no-avoidance clause in 2017, reduced passive flows overall and separately from the manufacturing and service sectors, primarily profit-shifting through interest, royalties and intangible services payments. Moreover, our results confirm that the tax system tightening against aggressive tax competition has reduced passive income transfers from service companies, not manufacturing companies. Instead, the latter make higher transfers to tax havens included in both Polish and the E.U. list of countries applying harmful tax competition.