Searching for Profit-Shifting in China

This paper investigates profit-shifting behaviour among multinational corporations (MNCs) in China. We exploit the flat-rate structure of China’s corporate income tax, along with its system of targeted, preferential rates, to estimate the relationship between profits and tax rates. Our sample consist of approximately 60,000 observations of foreign-owned MNCs from the years 2005-2009. Using the traditional approach of regressing before-tax profits on tax rates, we find evidence consistent with profit-shifting. However, this approach is suspect because the nature of China’s tax preferences make it especially vulnerable to omitted variable bias. Accordingly, we employ finite mixture modelling to search for the existence of a group of profit-shifting MNCs. While our analysis identifies two types of firms, subsequent investigation failed to produce any evidence linking these to profit-shifting behavior. Robustness checks exploiting the panel nature of the dataset, along with further investigation of investment-tax elasticities, confirm our null finding of profit-shifting. One reason for the lack of profit-shifting among Chinese MNCs may be that corporate tax rates were relatively low during this period.