The alignment between reported profits and real activity in times of the BEPS Action Plan

Abstract Several empirical studies suggest that companies allocate profits regardless of the underlying real activity to avoid taxes. The Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) Action Plan, with its first formal document published in 2014, requires the taxation of profits where economic value is created. In this study, we investigate whether firms have improved the alignment between reported profits and real activity. We examine a large unconsolidated sample of European Union (EU) subsidiaries and find that earnings and economic activities are better aligned in the years after the BEPS Action Plan. Following the publication of the OECD’s recommendations, the average misalignment of 12.58% to 14.47% of a corporate group’s reported profits decreased by more than 5%. This alignment is achieved by both the relocation of profits and real activity. Other measures by the EU probably contributed to this improvement. Our study informs politicians and researchers about firms’ reactions to the measures against BEPS.