Efficient Taxation of Multi-National Enterprises in the European Union

1. Efficient Taxation of Multi-National Enterprisesin the European Union Stefano Micossi, Paola Parascandolo and Barbara Triberti Università di Siena, 24-25 January 2003

2. Outline • Some general principles for the taxation of enterprises • Features of an efficient decentralised (“federal”) system • Problems with the present system and proposed solutions

3. A nice quotation to start with • Economists have always been puzzled by the idea of a corporate income tax (CIT) which “does not quite fit into the conventional classification of taxes…they have been accustomed to thinking of a dichotomy between direct taxes on individuals and indirect taxes on merchandise…the corporate tax fits into neither of these categories” (Colm 1938)

4. Rationale for the CIT and criticism • The CIT as “back-stop” for personal income taxation - the mantra of “integration”; equal treatment of retained and distributed earnings • Revenues collected from enterprises for practical reasons (“that’s where the money is”), expedient to tap all sources of revenue • Treating labour and capital incomes alike violates efficiency (Ramsey), leading to reduced and distorted capital accumulation; eventually, much of CIT is shifted onto labour anyway • Equity requires “equal treatment of equals”, not equal treatment of all incomes; at all events, why double taxation of savings and exemption of certain incomes (public debt, pensions, etc)?

5. CIT in open economy • Efficiency case against CIT is strengthened by capital mobility (higher elasticity of supply..); indeed many countries have already shifted to DIT, with lower burdens on capital incomes • Comprehensive taxation requires world-wide taxation of residents, massively violated by different treatment of trans-border dividend and interest payments and widespread exemptions • Residence-based taxation is inconsistent with current practice of taxing business at source • And violates capital import neutrality (non-discrimination), since the tax burdens of similar businesses in the same national market may vary with the legal residence of the parent company

6. The benefit view of corporate taxation • Once abandoned the mantra of “integration” and accepted “source” taxation of business, corporate taxation may still be justified under benefit view • The role of public policies for business is to provide an environment in which it is convenient to work and invest: education and research, infrastructure, simple laws and a good judiciary… • Enterprises location decisions depend on many factors but taxation may be seen as a price for location advantages • Since capital elasticity not infinity, there is room for efficient differentiation of CIT rates and tax competition for the location of investment • This approach is undermined by profit-shifting

7. Effective and presumptive taxation • When effective income is taxed, work and effort are undesirably discouraged • Presumptive taxation of income, or business activity, encourages effort and discourages laziness: those with above-average productivity will pay proportionately less and those who are less productive will pay proportionately more • Systems of presumptive taxation can offer advantages of simplicity in the identification of the tax base • In 1993 Sadka and Tanzi proposed in this line to abandon corporate income as corporate tax base and tax total physical assets

8. Competitive federal systems • The mobility of persons and capital across jurisdictions improves the allocation of productive resources • It may also contribute to a better outcomes in the choice and quality of public goods (Tiebout) and discipline rent seeking politicians and officials (Buchanan); • Race to the bottom unlikely since capital elasticity to taxation not very large and location benefits are manifold; Tanzi and Shucknecht (2000) confirm • Over time lower tax burden likely to lead to higher growth and revenues; static defence of high rates and “own” revenues wrong and counterproductive

9. Tax base harmonisation • Profit shifting due to different definitions of tax base across jurisdictions is inefficient and wasteful: • capital structures and internal transactions distorted by tax optimisation; free riding on countries that offer best location advantages • Commission study: different bases not important in determining effective incidence of taxation except in few countries (I, E, G, L, S), hence in a way they are not needed • The Keen objection: if we eliminate profit shifting, may real capital will move…but I consider this an an advantage, not a drawback

10. Base definition • Why income: • Makes sense when purpose is comprehensive taxation, otherwise less compelling • Largely conventional magnitude; difficulties in the distinction between current and capital spending are magnified by increased importance of intangibles and human capital; disagreements across countries • What definition of income • The arrival of the IAS offers potentially common civil-law basis, but for the time being no agreement on maintaining civil-law basis for corporate taxation, nor on future extension of IAS to individual company statutory accounts

11. Features of efficient federal systems • Common corporate tax base • Neutrality: • (a) “vertical”: investments unaffected at the margin by taxation  normal income or other presumptive base • (b) “horizontal” (capital import) with rate differentiation in response to location benefits and source taxation • Subsidiarity: • freedom to set tax rates • administrative autonomy in assessment and collection (based on common base), including need to limit need for day to day administrative collaboration

12. Current system in current system • Each business unit taxed separately based on SA/ALP income allocation between separate units • ALP has severe conceptual (what prices) and monitoring problems; ample room for divergent interpretations and uncertainty • When tax authorities differ, double taxation or tax loopholes may result • Different combinations of residence and source principle for dividends and interest also liable to produce double taxation • Trans-border loss offsetting limited to branches, partial and uneven; profit deferral only for subsidiaries; conflicting tax claims from CFC

13. A digression on formula apportionment (FA) • FA allocates the tax base among business units based on objective presumptive indicators; it require agreement on tax base and definition of business unit • Conceptually inferior to SA/ALP since it assumes proportionality between profits and factors in the formula – in practice a simple way out of SA/ALP • It does not require consolidation for application once the tax base definition has been agreed upon • the choice of factors in the formula acts as a tax on those factors; hence neutrality and simplicity critical in choice of formula

14. Overcoming SA/ALP problems Two approaches may be considered: • The first one popular with old-timers in this dossier, is to stick to corporate income as tax base, in some agreed common definition, but move to EU-wide consolidation with formula apportionment (FA); rate convergence not required (tax competition): HST and OCBT • The second one entails decentralised separate taxation of business units in every member state (jurisdiction), based on presumptive indicators of activity (and location benefits), with pure source-based approach

15. Home State Taxation • Consolidation and taxable base are determined under the law of the legal residence state (residence taxation); only MNE and optional • No agreement needed on tax base definition, in practice, mutual recognition of tax bases; in practice only workable with similar definitions of tax base across countries • Companies would operate in the same national market under different tax laws, so capital import neutrality would be violated • 15 tax laws applied within one country; maximum interference in administrative autonomy and need for continuous cooperation in monitoring and enforcement

16. Common base taxation • Under OCBT agreement needed on common tax base; only MNE and optional • Only two systems within each country • Consolidation of corporate income (effective or normal)

17. Problems common to both systems • Taxable base: why income, why not total gross assets or liabilities, as in Sadka-Tanzi (1993) • Only MNEs and optional: distortions; reaction of domestic companies; need to experiment • Is it really so easy to consolidate: no agreement on group definition for civil and fiscal purposes; profit and loss allocation when less than 100% participation poses severe problems

18. The decentralised alternative • Separate taxation of business units country by country based on pure source principle - exemption of all cross border dividends, interests, capital gains/losses and royalties) • Presumptive tax base, as in formula apportionment e.g. VAT base, sales, employment (tax on labour?) • VAT base neutral with respect to productive factors and forms of financing (no deductions); administrative infrastructure already in place • No deductions, no loss offsetting; both features consistent with Sadka-Tanzi • Capital import neutrality; benefit view; direct use of formula without hurdles of consolidation