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Business enterprises view tax as an expense and may try to avoid it. Multinational enterprises are in a better position to avoid tax because different countries have different tax rates and tax rules that multinationals can exploit. The most widely known method of international tax avoidance involves shifting profits from high to low tax jurisdictions, causing erosion of the tax base of high tax jurisdictions.

The incidence of profit shifting by multinational enterprises in developed countries has been confirmed by many empirical studies over several decades. By contrast, similar studies that focus on developing countries have only emerged in the past few years.

In a recent article published in the eJournal of Tax Research, we investigate whether foreign-owned Indonesian companies (FOICs) that are subsidiaries of foreign multinationals shift profits out of Indonesia in response to variations in their parents’ tax rates. Specifically, we examine the question using a research method introduced by economists James Hines Jr and Eric Rice in their 1994 seminal paper with some modifications.

The modified Hines and Rice approach

The basic premise of the Hines and Rice approach is that pre-tax income consists of two components: (1) ‘true’ income, which is income produced using capital and labour inputs; and (2) ‘shifted’ income, namely income shifted across borders because of a tax incentive in the form of a tax rate difference between countries. Hines and Rice’s 1994 paper examines whether US multinationals operating in various host countries shift profits to low-tax jurisdictions.

We modify the original Hines and Rice approach in several ways. The first modification is related to the dependent variable (pre-tax income).

Our study uses pre-tax profit, both pre-tax accounting profit and taxable income in Indonesian tax returns, rather than pre-tax non-financial income, namely earnings before interest and taxes (EBIT), as the dependent variable. This is because we focus on finding indirect evidence of cross-border profit shifting in Indonesia through the effect of the parents’ tax rate variation on the profits reported by FOICs in their Indonesian tax returns.

The estimated effect is expected to capture potential cross-border profit shifting activities through all possible channels, including transfer pricing and high debt financing. Employing EBIT is likely to be only necessary when one tries to disentangle the transfer pricing and debt shifting channels. Therefore, as in prior studies, we use pre-tax profit as the dependent variable to detect the existence of cross-border profit shifting in Indonesia.

The second modification is related to the independent variable (which captures tax incentives). We use the parent’s tax rate (PTR) rather than the average tax rate in each host country as the independent variable because our study focuses on the incoming investments of Indonesia as opposed to Hines and Rice’s study which focuses on the outgoing investments of the United States.

Using the parent’s tax rate as the independent variable is expected to provide evidence of the effect of the parent’s tax rate on the accounting profit and taxable income reported by FOICs in their Indonesian tax returns. Our study predicts that the relationship is positive – that is, the higher (lower) the tax rate of the parent’s country, the higher (lower) the accounting profit and taxable income reported in Indonesia. We use the statutory tax rate instead of the effective tax rate as the parent’s tax rate. While there has been a debate regarding which of these is a better proxy for tax incentives to shift profits, we are of the opinion that the statutory tax rate may act as a better proxy for an incentive to shift profits because it is set by the government and is therefore exogenous to firms’ choice.

The third modification concerns the control variable for the level of productivity in the host country which is excluded from our study. This variable is excluded because the data we use are about MNE affiliates in only one host country, namely Indonesia, as opposed to multiple host countries as in the study by Hines and Rice.

We measure profit in two ways: (1) taxable income based on Indonesian tax law, and (2) accounting profit based on financial reporting rules to investigate whether FOICs shift profits out of Indonesia.

Our study uses a sample that includes all foreign-owned Indonesian companies with tax return data supplied by the Directorate General of Taxes under a data non-disclosure agreement. For privacy protection, firms are anonymised. The dataset only shows the country where the immediate parent of an FOIC is located. The study period covers the seven years from 2009 to 2015. The final sample consists of 3,390 (3,188) observations for the regression model using accounting profit (taxable income) as the dependent variable.


The regression results indicate that a one percentage point lower the tax rate of the parent’s country reduces the accounting profit and taxable income reported by FOICs in their Indonesian tax returns by 2.56% and 2.89%, respectively. The findings are similar to those of Hines and Rice (1994).

Our findings also seem to suggest that before the Organisation for Economic Co-operation and Development introduced the Base Erosion and Profit Shifting (BEPS) Project in 2013, FOICs demonstrated an increasing trend of shifting profits out of Indonesia. However, once Indonesia joined the BEPS Project, the magnitude of profit shifting was held back for two years, 2013 and 2014.

In 2015, the size of profit shifting resumed its upward trajectory. This phenomenon might be due to the lack of effective actions taken by the Indonesian government up to 2015 to fight profit shifting by foreign multinationals after joining the BEPS project.

Overall, the results of our study provide evidence to show that FOICs use profit shifting strategies to avoid Indonesian corporate income tax. This is consistent with the suggestion in prior studies that developing countries suffer from profit shifting by multinational enterprises.


Journal article

Purba, A. and A. Tran, 2023, “Detecting profit shifting in Indonesia using the Hines and Rice approach”, eJournal of Tax Research, 21(1), 27-54. Available at

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