Analysis of International Corporate Taxation

We have made a submission, available here, to the consultation by Fiscal Affairs Department of the International Monetary Fund for their analysis of international corporate taxation.

December 2018

Summary

Following the excellent Spillovers report of 2014 further evidence has shown the revenue losses due to inadequate coordination of international tax rules, impacting more heavily on poorer countries. These also result from unilateral measures by states to protect their tax bases, the proliferation of which demonstrates that the G20/OECD project on base erosion and profit shifting (BEPS) has inadequately patched up the existing system. In addition to the macro-economic analysis of the welfare effects, we suggest that the IMF consider the micro-economic aspects of aggressive tax avoidance, notably abuse of dominant position and rent-seeking resulting from corporate concentration, and the encouragement to profit-shifting from the shift to hybrid territorial tax systems and from equity-based remuneration of senior corporate managers.

The BEPS project has so far failed to ensure that the profits of multinational enterprises (MNEs) are allocated to and taxed in source countries where their economic activities occur, and value is created. Although there have been extensive revisions of the rules on transfer pricing, this has made them even more complex and difficult to apply, because they still rest on the fictional underlying principle that members of a corporate group are independent entities dealing with each other at arm’s length, despite being under common ownership and centralised control. This approach entails detailed individual analysis of each taxpayer requiring specialist knowledge of its economic sector and business model, creating information asymmetries and an enormous administrative burden for tax administrations, especially in poor countries. Its subjective nature also creates conflict and uncertainty, instead of the predictability needed for decision-making by business.

What is required is a shift towards treating MNEs in accordance with the economic reality that a large part of these profits result from the economies of scale and scope and the synergies due to operating as unitary firms under centralised strategic direction. Three main approaches to unitary taxation have been proposed: residence-based worldwide taxation, a destination-based cash-flow tax, and formulary apportionment. We concur with the report of the Independent Commission on the Reform of International Corporate Taxation (ICRICT) that formulary apportionment is the best of these solutions.

We recognise that moving towards formulary apportionment will take time and needs preparation. A pragmatic approach towards such a system could be developed by building on the profit split method. This can be done by formulating standardised concrete allocation keys and weightings for common business models and industry sectors, refining and elaborating on the generic factors which generate profits: people, capital assets and sales. We urge the IMF, in conjunction with other relevant global and regional bodies, to devote serious resources to examination of this way forward.

BEPS Monitoring GroupComment