What Is Profit Shifting and How Does It Work?

Profit shifting is a collection of strategies multinational corporations use to move profits from higher-tax countries to those with lower or no taxes. The goal is to minimize a company’s total tax payment. By relocating profits on paper, these enterprises report lower earnings in high-tax jurisdictions and accumulate wealth in more favorable tax environments.

The scale of this activity is substantial, with estimates of hundreds of billions in lost tax revenue globally each year. This impacts governments that rely on corporate tax to fund public services and domestic businesses that cannot shift profits abroad. As a result, profit shifting has become a focus of international tax reform efforts.

Core Mechanisms of Profit Shifting

Transfer pricing involves setting the prices for goods or services exchanged between different parts of the same multinational company, known as subsidiaries. For example, a subsidiary in a high-tax country might manufacture a product and then sell it to a related subsidiary in a low-tax country at an artificially low price, ensuring little profit is recorded there. The subsidiary in the low-tax jurisdiction then sells the product to external customers at market price, concentrating the profit in that low-tax environment. While tax authorities require these prices to be at “arm’s length”—similar to what two unrelated companies would agree to—determining the correct price for unique goods can be complex and subject to manipulation.

Another mechanism involves the strategic placement of intangible assets, such as intellectual property (IP), patents, and trademarks. A multinational corporation can establish a subsidiary in a low-tax jurisdiction and legally transfer ownership of its valuable IP to that entity. Once the IP is held there, the subsidiary can charge royalties or licensing fees to other subsidiaries operating in high-tax countries for the right to use these assets. These royalty payments are tax-deductible expenses in the high-tax country, which reduces taxable profits, while the income is received in the low-tax jurisdiction where it is taxed at a very low rate.

Debt shifting through intra-company loans is another widely used technique. In this arrangement, a subsidiary in a low-tax jurisdiction lends money to a related subsidiary in a high-tax country. The borrowing subsidiary makes interest payments on this loan, which are treated as a tax-deductible business expense, lowering its taxable income. Conversely, the interest income is received by the lending subsidiary in the low-tax jurisdiction, where it is taxed minimally, reducing the corporation’s overall tax liability.

The Role of Low-Tax Jurisdictions

Beyond low tax rates, these jurisdictions, often called tax havens, provide a high degree of financial secrecy. They may have laws that prevent the disclosure of corporate ownership or financial information, making it difficult for tax authorities from other countries to track the flow of funds.

Another characteristic is a reluctance to exchange financial information with foreign tax authorities. While international pressure has led to some changes, many of these jurisdictions have historically resisted automatic information sharing agreements, making it harder for high-tax countries to challenge artificial profit arrangements.

These locations are not typically centers of major economic activity for the companies that use them. A subsidiary in a low-tax jurisdiction may have no factory, few employees, and conduct no actual sales or manufacturing. Its purpose is often purely administrative: to legally hold assets like intellectual property or to serve as a party in intra-company financial transactions.

International Regulatory Responses

The Organisation for Economic Co-operation and Development (OECD), with the G20, initiated the Base Erosion and Profit Shifting (BEPS) project to reform global tax rules. This effort produced a two-pillar solution, but international consensus fractured in early 2025 when the United States withdrew its support, creating uncertainty for global tax coordination.

Pillar One was designed to re-allocate a portion of the profits of the largest multinational enterprises to the countries where their customers are located. Its implementation has stalled without U.S. participation, which may lead countries to independently introduce or expand their own Digital Services Taxes (DSTs). A smaller component of this pillar, which simplifies transfer pricing for marketing and distribution activities, has been incorporated into OECD guidelines for voluntary adoption.

Pillar Two aims to establish a 15% global minimum corporate tax. While over 50 countries are moving forward with laws to implement this rule, the United States is a major exception. The U.S. will not adopt the rule and may take protective measures against countries that apply it to U.S.-based companies.

United States Specific Anti-Avoidance Measures

The United States has established its own framework to combat profit shifting, primarily through the Tax Cuts and Jobs Act. Following the U.S. withdrawal from the OECD-led international agreement, these measures now represent an alternative, and potentially conflicting, approach to global tax rules.

One of the provisions is the tax on Global Intangible Low-Taxed Income (GILTI). The GILTI rules are designed to subject income earned by U.S. companies’ foreign subsidiaries from intangible assets to a U.S. tax. This measure targets profits that have been shifted to low-tax countries and is considered by the U.S. to be its equivalent of a global minimum tax.

Another measure is the Base Erosion and Anti-Abuse Tax (BEAT). The BEAT functions as a minimum tax that applies to certain large corporations that make deductible payments, such as royalties or interest, to foreign affiliates. If these payments significantly reduce a company’s U.S. tax liability, the BEAT may apply, limiting the benefit of shifting profits out of the country.

The Foreign-Derived Intangible Income (FDII) deduction provides a tax incentive for income that U.S. corporations earn from exports linked to their domestic intellectual property. The FDII is intended to encourage companies to hold their intangible assets in the United States. The U.S. has signaled its intent to solidify these provisions as a permanent part of its tax code and may consider retaliatory actions against foreign taxes imposed on American firms under the Pillar Two framework.