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The Effects of Economic Substance Act on Offshore Investment Structures and Tax Avoidance

relocating subsidiaries from tax havens. We expect that these companies are less likely to
establish tax haven subsidiaries and more likely to liquidate or relocate these subsidiaries
after the enactment of the Economic Substance Act.
Furthermore, this study applies regression analysis to assess the effects of the

Economic Substance Act on changes in the maximum number of ownership layers within
offshore investment structures and the proportion of revenue allocated to tax haven
subsidiaries. We expect that these companies would reduce the number of ownership

layers in their offshore investment structures and allocate a smaller proportion of revenue
to their tax haven subsidiaries after the implementation of the Economic Substance Act.
Last, to address potential endogeneity issues, the study employs two-stage least
squares regression to examine whether these companies increase their share of tax costs
after the enactment of the Economic Substance Act. The two-stage least squares regression

model simultaneously estimates endogenous variables (e.g., the establishment of tax haven
subsidiaries) and the effects of the Economic Substance Act on ETR and CASHETR
of these companies. We expect these companies would exhibit increased ETRs and

CASHETRs after the implementation of the Economic Substance Act.

3. Findings

The empirical results of the study show that the enactment of the Economic Substance

Act significantly curtails the establishment of new subsidiaries in tax havens. Further,
these companies increasingly liquidate or relocate existing subsidiaries to jurisdictions
outside tax havens. The results suggest that the additional costs and compliance burdens
introduced by the Economic Substance Act reduce the attractiveness of tax havens as

destinations for profit-shifting and tax avoidance. Firms are deterred from using tax
haven subsidiaries as vehicles for minimizing tax liabilities because of stricter economic
substance requirements.
Furthermore, the maximum number of layers in corporate offshore investment

ownership structures significantly declined after the implementation of the Economic
Substance Act, reflecting a simplification of pyramid ownership structures. These
companies respond to the Economic Substance Act by streamlining their equity investment
arrangements and reducing structural complexity to mitigate tax risks and compliance

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