There is an increasing concern in the international policy debate that firms in the globalized,
digital economy avoid income and consumption taxes. We examine to what extent the income
tax-motivated profit shifting differs if firms are active in the digital economy and if firms report
sales in order to minimize consumption taxes. We exploit a unique setting in Europe over the
period 2007-2015 with international corporate income and consumption tax rate differences.
Within this setting, firms in the digital service sector are able to manage the consumption tax
burden whereas firms offering physical services are not. We find limited evidence that multinational
firms with affiliates providing digital services are particularly aggressive income taxmotivated
profit shifters and document strong evidence that these affiliates’ reported sales are
associated with incentives to avoid value-added taxes. We further find that income tax-motivated
profit shifting behavior is attenuated for firms engaging more actively in consumption tax
planning. Our study offers a new explanation why some firms avoid more income taxes than
others in the sense that minimizing the consumption tax burden can be a dominating tax consideration
that imposes a constraint on income-tax motivated transfer pricing.
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