Income Shifting in Italian Business Groups and some Governance Implications

This paper explores the relationship among group control, financial reporting strategies and governance implications in the pursuit of domestic tax planning. A very large number of papers deals with international tax planning in multidivisional enterprises, but very few are devoted to exploring significant incentives for national business groups to engage in tax planning strategies. In this paper we propose a one-period model relating to the tax incentives of income shifting in Italian business groups. We show that, given the total amount of expected earnings before taxes and the dividends received by the firms belonging to a business group, an optimal solution to the problem of minimizing the group tax burden exists. The optimal solution involves a gain in value for the group as a whole; nevertheless, since in business groups ownership is often differentiated among shareholders (often because of the separation between ownership and control), income shifting may determine wealth transfers, often in favor of the controlling shareholder. We therefore analyze the management and governance implications of such income shifting, for both shareholders and stakeholders (i.e. managers). This revised version was published online in July 2006 with corrections to the Cover Date.