Withholding tax rates thus seem to be a determinant of reported profitability levels and the leverage of Ukrainian entities. However, the regression results indicate that the location of affiliated companies explains some residual variance, implying that the documented variation in firm profitability is not driven by withholding taxation alone. Specifically, after controlling for firm size, industry, macro‐shocks and withholding tax rates, we find that firms with an affiliate in either Cyprus or the British Virgin Islands are surprisingly unprofitable. The difference to comparable firms lies at 0.45 and 1.35, respectively, and is significant at the 10% and 1% level.<sup>39</sup> Similarly, the high profitability of MNEs with an affiliate in the Netherlands is not fully captured by withholding taxation or firm size.<sup>40</sup>

# **5. Conclusion**

To investigate the effect of reduced withholding tax rates on revenue collection in Ukraine, we combine administrative information on income flows and publically available firm level information. Our analysis of income flows suggests that there are important revenue losses linked to reduced withholding tax rates on dividend, interest and royalty payments. Combining information on historical variation in Ukrainian treaty provisions with administrative data we also find, however, that income flows to a specific country tend to decrease following an increase in the relevant withholding tax rate with the country. This effect reduces the simple mechanical revenue gain one can expect from renegotiating a withholding rate at a higher level. Furthermore, we investigate indirect costs of reduced withholding rates and find that the reported profits of Ukrainian multinationals are sensitive to withholding taxation, indirectly adding to total revenue losses. This effect is partly driven by differences in the use of debt financing. Group structures seem to impact the reported profitability of Ukrainian MNE affiliates.

Our findings point towards the importance of developing a comprehensive treaty policy approach to guide any future negotiations and/or revisions. This is particularly relevant with respect to the small number of major investment hubs (Cyprus, Netherlands, Switzerland, Luxembourg) accounting for a large share of income flows from Ukraine. A treaty can be beneficial where its benefits outweigh revenue losses. Consequently, further analysis of benefits should be done for the Ukrainian DTTs to see whether they measure up against the cost estimates in this paper. Notably, however, where investment activity is merely redirected via another country to take advantage of treaty benefits, but would have taken place irrespective of the treaty, revenue losses are not offset by any potential gains. The findings of this study suggest that further targeted enforcement may be needed to address such round‐tripping arrangements. Moreover, the analysis of reported MNE earnings suggests that the ownership structure and operations with affiliates in certain jurisdictions should receive increased attention in risk assessment and transfer pricing audit activities.

> 39 Effective final tax rates may explain some of the residual variance. However, we cannot reliably capture applicable tax rates given that jurisdiction may simply be used as a conduit.

> 40 For simplicity, the coefficient estimates on the locational dummies, reported in this paragraph, are not depicted in Table 2.

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