Do Multinational Enterprises Exploit a Window of Opportunity? An Empirical Analysis of Profit Shifting in the Absence of Restrictions

This paper investigates multinational enterprises’ (MNEs) response to a unique window of opportunity for temporarily unrestricted profit shifting. The window unexpectedly opened because of a ruling by the European Court of Justice in 2006 that suspended the application of controlled foreign corporation (CFC) rules within the European Economic Area. It closed with a subsequent piece of anti-shifting legislation on thin capitalization in 2007. We identify causal effects of the suspension of the CFC rules on profit shifting by exploiting random variation in the size of MNEs’ windows that results from variation in the business year starting dates across MNEs. Using detailed balance sheet information on internal debt shifting between foreign low tax subsidiaries and their parents, we find that MNEs’ response to the window of opportunity is remarkably moderate in terms of both the probability and the volume of internal lending. On the one hand, this results from substantial short-term rigidities: internal lending increases with window size. On the other hand, MNEs in general responded with a fair amount of reserve which is indicated by low total levels of internal lending throughout the window. Presumably, this is caused by legal uncertainty about the scope of internal debt shifting that would be accepted by tax offices.