U.S.-based multinational companies with higher numbers of overseas employees might be reaping more lucrative tax benefits, thanks to complex tax-planning activities, compared to companies with predominantly U.S.-based employees, new research suggests.

In a study published April 9 in The Accounting Review, researchers explored the effect of foreign employment on both income-shifting and the tax uncertainty of foreign transactions. U.S.-based multinational companies with a substantial number of employees located in foreign jurisdictions with low tax rates were found to be more likely than other companies to "artificially" locate corporate earnings in those low-tax jurisdictions.

Nathan Goldman, an assistant professor of accounting at North Carolina State University and a co-author of the study, said the increasing globalization of U.S. companies makes this an important issue to investigate because enhanced opportunities for tax-planning activities are almost certain to arise.

"Companies like Caterpillar have been scrutinized in congressional hearings for having global revenues that do not match their economic footprint," Goldman told The Academic Times. "Congress continues to evaluate ways to structure tax policies to help limit base erosion and profit shifting among U.S. corporations. Thus, we were interested in how tangible investments, such as the firm's employment of personnel outside of the U.S., affect tax-planning activities."

With data covering 815 large multinational companies based in the U.S. from 2000 to 2016, the study used empirical models that enabled researchers to identify whether these firms were recording unusually high profit margins in low-tax jurisdictions relative to those reported in the U.S. The average firm included in the study's sample had 18,763 employees during the average year, 8,499 of whom were employed outside the U.S.

According to Goldman, the Internal Revenue Service follows an economic substance doctrine designed to prevent companies from minimizing or avoiding their appropriate tax burdens. "Income-shifting often faces concerns with this doctrine because it is a way for companies to lower their tax liabilities without economic substance," Goldman said. "By having employees overseas, companies can now better support these aggressive tax-planning activities with economic substance."

Years when firms reported a high degree of foreign employment were associated with greater outbound tax-motivated income-shifting, and companies with a higher percentage of foreign employees were more likely to have unusually high profit margins overseas. Researchers estimated that companies in the subsample with a high number of foreign employees shifted approximately $70 billion more income out of the U.S. compared with companies that reported lower foreign employment over the sample period.

Companies with more overseas employees also reported fewer unrecognized tax-benefit reserves on their financial statements, reflecting a decrease in tax uncertainty. In firms with a greater number of foreign employees, unrecognized tax benefits made up approximately 0.23% of total assets compared with 3.3% of total assets for companies with less foreign employment.

"Our findings underscore the importance of matching employees to economic activities," Goldman said. "On the company side, doing so helps provide flexibility and substance to more complex tax-planning activities. On the policymaker side, doing so helps limit aggressive tax-planning activities with lower substance." 

However, he added, the findings also highlight that companies may be using foreign employees to mask highly aggressive tax-planning activities. 

"Should this be the case," Goldman said, "governments may wish to consider [incentives] to more closely align foreign investment in physical operations with the location of their income."

The study, "Foreign employment, income shifting, and tax uncertainty," published April 9 in The Accounting Review, was authored by Katharine D. Drake and Frank Murphy, University of Arizona; and Nathan C. Goldman, NC State University.