Corporate Tax

Worldwide corporate taxation: what to tax?

For the past month or two there has been news about broad support in 130 countries for a global minimum corporate tax rate of 15%.

The general claim is that a minimum tax rate will be a strong discouragement for companies trying to use accounting methods to move their profits to low-tax countries. But the problem of international corporate taxation is much more difficult than agreeing on a minimum tax rate.

Ruud de Mooij, Alexander Klemm, and Victoria Perry have edited a collection of essays setting out the topics in Corporate Income Taxes Under Pressure: Why Reform is Needed and How it Could be Designed (IWF, 2021).

Imagine a hypothetical multinational corporation. It is a US based company with management and headquarters in the US. However, the company has subsidiaries in a dozen other countries that support its global production chain, and sells its products with extensive advertising / marketing in several dozen other countries. All in all, the company is making a profit. But was the profit made by the US administration of the country? From the production facilities in other countries? A combination of the two? What about the countries where the actual sales take place?

It’s easy to make this example a little more complex. What if the multinational also had a business consulting arm based in non-US country # 1, an insurance line based in non-US country # 2, and a research and development facility based in non-US country No. 3 owns. Again, these different branches take place within the individual company, but all of their services for the company are provided digitally – without physical products that are shipped across national borders. The company must make decisions about what is appropriate to pay each of these parts of the company – and decide what part of its total profits (if any) should be allocated to each branch of the company.

Finally, remember that every country along the production chain has two goals: it wants to encourage economic activity within its own borders, and it wants to have some of the corporate tax revenue for itself. Some countries will place more emphasis on attracting economic activity; others will place a greater emphasis on revenue-gathering. Some countries may argue that if they attract economic activity with low corporate taxes, they can instead generate tax revenue with VAT or wage taxes during production. Each country will have its own corporate tax rules, perhaps following the same general pattern, but also with its own favoritism and policies. For example, countries can impose a certain corporate tax rate and then have different provisions in the tax code, or other agreements about what types of public services are provided to the company, thereby lowering the effective corporate tax rates. In addition, it is a general rule of international corporate taxation that a company should not be taxed more than once on the same profit.

When considering the appropriate tax rules for multinational corporations, generalized statements of support for a minimum rate of 15% (even if that support is tested in the furnace of practical politics) do not attack the problems at hand. The question is not so much the tax rate (15% or another level), but which governments are allowed to tax which parts of the production chain.

In Chapter 3 of the book, Narine Nersesyan sets out these issues in The Current International Tax
Architecture: A Brief Introduction. ”She writes (quotations and footnotes omitted):

In the case of cross-border business activities, the question arises as to where the profits resulting from this activity are to be taxed. Basically, there are at least three options for assigning a taxation right:

• Source: the countries in which the production takes place
• Residence: the countries in which a company is considered to be resident
• Destination: the countries in which the sale takes place

The commonly used tax architecture for determining the place where profits are taxed is now almost 100 years old – designed for a world in which most of the trade in physical goods took place, where trade made a less significant contribution to global GDP and the global value chains were not particularly complex. … The current international tax framework is based on the so-called “compromise of the 1920s”. In principle, as part of the “compromise”, the primary right to tax active company income is transferred where the activity is carried out – in the “source country” – while the right to tax passive income such as dividends, license fees and interest is transferred to the “country of residence” – in which the legal entity or person who receives and ultimately owns the profit is domiciled. However, the system has evolved in a way that departs significantly from this historic “compromise” and international tax regimes currently rest on a fragile and controversial balance of taxation rights between countries of residence and source countries. …

While the national laws of each individual country dictate the rules, the international tax system – very importantly – is overlaid by a network of more than 3,000 bilateral double taxation treaties. These typically add (among other functions) a level of definitions and income distribution rules that attempt to reconcile and therefore change the rules imposed by individual signatories. … The key role of the international tax architecture is to regulate the division of taxation rights between the potential tax claim areas in order to avoid both excessive taxation of an individual activity and non-taxation of a business activity.

The problem of dividing a multinational company’s profits among the various activities it carries out in a number of countries is really difficult as each country is reaching for a piece of the pie. But now there are companies incorporated in one country with management and control activities in another country and assets and jobs and still other countries.

Various chapters of the volume examine possible tax policies for multinational corporations, including withholding taxes (although it will be difficult to identify the “source” of profits); residence-based taxation (although it will be difficult to find out the real residence (or domiciles?) of a multinational company); target-based taxation (which would distribute the global profits of a multinational corporation based on where the sales are ultimately made – and you can imagine how a country with large exporters selling elsewhere would get that idea); or a formulaic approach (which tries to solve all of these problems with a formula that includes all of these elements).

I am not just offering the advice of despair here. I am sure there are steps that can prevent companies from booking a large portion of their profits in jurisdictions where almost nothing of their actual activity takes place. But rethinking the roots of multinational corporate taxation in a way that is acceptable to politicians in most countries is a real Herculean task.

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