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Safe haven or earnings stripping rules: a prisoner’s dilemma?

Zarko Kalamov ()

International Tax and Public Finance, 2020, vol. 27, issue 1, No 3, 38-76

Abstract: Abstract Multinational firms use internal debt financing to shift profits from high-tax to low-tax countries. Therefore, governments restrict the deductibility of interest expenses by applying thin-capitalization rules (TCRs). TCRs fall into two main categories: safe haven rules (SHR) and earnings stripping rules (ESR). We analyze the optimal TCR choice in a two-country tax competition model. We show that unilateral replacement of SHR by ESR imposes a negative profit shifting externality on the other country. This effect can explain the recently observed switch from SHR to ESR in many countries. However, ESR may be a dominant strategy even when SHR is socially optimal, i.e., the observed policies of ESR implementation may indicate a prisoner’s dilemma.

Keywords: Thin-capitalization rule; Safe haven rule; Earnings stripping rule; Profit shifting (search for similar items in EconPapers)
JEL-codes: F23 H25 H7 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1007/s10797-019-09545-w

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Handle: RePEc:kap:itaxpf:v:27:y:2020:i:1:d:10.1007_s10797-019-09545-w