Negotiating Taxes

• In Event: Pen Pals with the IRS

Abstract

This paper examines negotiated agreements known as Advance Pricing Agreements (APAs) between multinational enterprises (MNEs) and tax authorities. APAs establish the appropriate transfer pricing methodology for intra-group transactions, thereby determining the level of profits that must be reported domestically and defining the corresponding tax base subject to corporate taxation. Crucially, successful APA negotiations provide certainty to MNEs, since tax authorities commit to not auditing the agreed transfer pricing practices throughout the duration of the agreement.

Leveraging novel micro-data from the French tax authority, which includes comprehensive records of APA negotiations from 2002 onwards, this study first characterizes APA engagement and profiles participating firms. Our analysis reveals that while APAs are becoming increasingly prevalent, participation remains concentrated among very large enterprises. Specifically, only 0.02% of firms filing tax returns in France engage in APAs, yet these firms represent more than 8% of total sales.

In a second step, we identify APA-engaged firms through their negotiated agreements and track their tax returns over time. Using a staggered difference-in-differences design, we find that unilateral APAs—those involving a single MNE and one tax authority—lead to significant increases in profits reported domestically compared to bilateral APAs involving multiple tax jurisdictions. Furthermore, our findings indicate tangible real effects on firms' outcomes: reduced audit uncertainty from APAs correlates with substantial increases in APA-engaged firms' total sales.

Finally, by linking tax returns to audit histories, we estimate a Nash bargaining model to quantify each negotiating party's bargaining power. This analysis explores how bargaining strength varies with firm size, industry sector, and the firm's presence in tax havens.

Given the growing relevance of APAs and the economic significance of participating firms, this research contributes valuable insights into international corporate taxation. Our results highlight that while APAs effectively enhance tax base retention, the outcomes are influenced by disparities in firms' bargaining power.

Authors

• Eva Davoine, UC Berkeley

• Sebastien Laffitte