The impact of offshore profit shifting on the measurement of GDP

The Case of the UK

Programme:

Topic:

Trade

Summary

We explored the role of profit shifting by multinational enterprises (MNEs) for the UK between 2007 and 2017. To do this, we used firm-level financial accounts data from ORBIS – covering firms around the world and containing information on the ownership links between them. We constructed a counterfactual profits measure by apportioning total profits of the MNE group to its subsidiaries and associates and compared them with profits actually reported in each country. The UK was a net winner from profit shifting in 2017 (had more profit actually recorded in the UK than implied by the counterfactual), but a net loser in 2007.

Overview

Measuring the contribution of multinational enterprises (MNEs), those enterprises who are producing goods or delivering services in more than one country, to national GDP is inherently problematic. MNEs operating in today’s globalised economy are characterised by two distinct features: first, they have intangible assets which can be located anywhere; and second, they have access through subsidiaries to multiple tax locations. These features give MNEs the capacity to assign their assets in ways that profit the company but break the link between production and location, fundamental to meaningful measurement of national income and production. The situation risks mismeasurement of MNEs’ contributions to GDP in their resident country.

We use firm-level financial accounts data to identify firms that are part of MNE groups, and thus potentially recording more or less profit in the UK than their activities imply. We construct a counterfactual profits measure, by apportioning total profits of the MNE group to all its subsidiaries and associates, using turnover as the apportionment variable.

We find that in 2017 the UK was a net winner from profit shifting, but in 2007 it had been a net loser from profit shifting. The result was not much changed by incorporating associate ownership relationships as well as subsidiaries.

Methods

We used firm-level data from ORBIS – a dataset covering firms worldwide, compiled by Bureau van Dijk (BvD). ORBIS gives us financial data, including balance sheet variables, covering all industrial firms from around 200 countries, and an ownership links dataset which provides information on the links between a firm and its owner(s)/shareholder(s) in each year. In our first paper we consider only firms with global ultimate owner (subsidiaries), which must have a minimum 50% ownership share; in our follow-up paper, we considered also associate relationships which include ownership links with 10-50% ownership shares.

After a long and cumbersome cleaning, matching and merging process of both datasets, we obtained a dataset covering all subsidiaries belonging to MNEs with any presence in the UK for the 2007-2017 period. From this, we calculated a counterfactual profits measure for each subsidiary, by apportioning total profits of the MNE group to each subsidiary according to its share of turnover. We then compared this counterfactual measure with reported profits to identify the ‘winners’ and ‘losers’ from profit shifting.

Findings

We found that, in 2017, the UK was a net winner from profit shifting, with £41bn more profit being actually recorded in the UK than would have been the case based on our counterfactual measure. That’s 1.9% of GDP extra profit recorded in the UK in 2017. The result is the same whether including just subsidiaries (50%+ ownership shares), or also including associates (10-505 ownership shares).

Conversely, in 2007, the UK was a net loser from profit shifting, with £24bn less profit actually reported in the UK than our counterfactual measure suggest should have been. The scales tip in the UK’s favour from 2009 onwards, after the financial crisis. Associate ownership relationships were far more important in 2007 than in 2017, but don’t change the fact that the UK was a net loser from profit shifting at that time.

The industries providing the biggest wins from profit shifting or the UK in 2017 were oil, gas and mining related industries, pharmaceuticals, and telecoms. The industries with the biggest new losing positions for the UK in 2017 were financial services, and manufacturing of basic metals and machinery and equipment.

Impact

Our research provides helpful insights from the ONS in constructing their national accounts, with can be difficult in an increasingly globalised world. We think tax authorities, such as HMRC in the UK, will also be interested in this work, since it sheds light on the degree of profit shifting and thus potential lost tax revenue.