This paper examines tax-induced income shifting behavior among the affiliated firms in the
Korean business groups (chaebol). Korean corporate income tax law does not require consolidated
tax returns, and business groups with a large number of affiliated member firms have incentives to
shift income across member firms to reduce overall taxes of the group. Korean chaebols provide a
good experimental setting to explore within-jurisdictional income shifting because, under the
peculiar governance structure of chaebol firms, business decisions for each affiliated firm are
coordinated by the controlling owner-manager of the group, so a coordinated strategy among the
affiliated firms can be utilized to reduce overall tax burdens for the group as a whole.
For a large number of Korean companies that are subject to external audits, we perform
univariate and multivariate regression analyses on income shifting behavior of chaebol firms
compared with non-chaebol control firms. Our evidence supports tax-motivated income shifting
activities of chaebol firms. The extent of income shifting is found to depend on its effect on nontax
cost factors such as earnings, leverage, and cash flow rights of the controlling shareholders. We also
find that income shifting occurs mainly through operating rather than nonoperating income,
suggesting that transfer pricing could be a likely channel for income shifting. Further, the income
shifting becomes less intensive when the statutory corporate tax rate decreases, confirming that our
findings of income shifting are tax related rather than motivated by income management. In
addition, we find that the income shifting is weaker for the post-Asian financial crisis period than
the pre-crisis period. Our study provides some insights on the within-jurisdictional income shifting
activities where research is limited.
