Patent Concentration, Limited Comparable Information, and Tax-Motivated Income Shifting

Abstract

We study the effect of patent concentration on tax-motivated income shifting. Using affiliate-level data for European multinational corporations (MNCs) and employing the relative share of patents held by an MNC in a country-industry-year as a measure, we show that the concentration of patent ownership facilitates tax-motivated income shifting. This effect is economically significant: a one standard deviation increase in patent concentration implies 59.6 percent more income shifting at the margin. When testing for the mechanism, we find that our results are driven by patent concentration limiting the information set of the local tax authority and increasing an MNC’s transfer-pricing discretion. Overall, our study identifies patent concentration as an important driver of tax-motivated income shifting and suggests that the size of the local tax authority’s information set is critical in curtailing potentially aggressive tax strategies. Hence, in order to be effective, tax-policy measures must broaden this information set.

Keywords: income shifting; intellectual property; knowledge diffusion; transfer pricing

JEL Classification: H25, H26, L11; O34