Income shifting and tax avoidance using tax havens

Abstract

This study examines whether Korean firms with related parties located in tax haven countries lower their tax burdens in the short-and long-term through the transactions with the related parties, by shifting income from high tax countries to low tax countries. Analyzing hand-collected footnote data on the amounts of transactions with individual related parties, in short term analysis, we find that the transactions with the related firms located in the tax haven countries do not reduce sample firms’ short-term tax burden, measured by annual effective tax rates. In addition, the amount of transactions with related parties located in the tax haven countries for the high tax rate firms is not significantly associated with the tax burden. In contrast, long-term analyses over three-and five-year periods suggest that related party transactions with the related firms located in the tax haven countries alleviate tax burden. The reduction of the tax burden is achieved mainly through sales and revenue transactions. In sum, we conclude that the impact of Korean firms’ related party transactions with the related firms located in the tax haven countries on tax avoidance behavior differs across time horizons, firms mostly target long-term tax savings when they set up related firms in the tax haven countries. © 2020, Korean Accounting Association. All rights reserved.