On 10 March 2019 the IMF reported that the Executive Board have been discussing a policy paper on Corporate Taxation in The Global Economy , looking at the way forward in the international tax system.
Problems arise from the allocation of risk among members of a group; the valuation of intangible assets; and the avoidance or limitation of physical presence in a country. These problems will increase as digitalisation gives rise to more complex, intangible-heavy business models.
Recent international tax measures have not dealt with the problem of tax competition. The IMF paper suggests that revenue losses from tax competition through reductions in tax rates are higher than revenue losses from tax avoidance.
There are also problems with the allocation of taxing rights and the extent to which the source country can protect its tax base.
Digital economy
Some countries have proposed a unilateral digital services tax, arguing that user participation is inherent to the value of the product, creating value by attracting other users or by creating information that is useful to advertisers.
A different approach could be to regard taxation of digital enterprises in terms of location specific rents charged in relation to the information provided to the enterprise by its users in a specific location. This would require a concept of “virtual permanent establishment”, and rules on allocating the income to be taxed.
Minimum taxes
The IMF prefers to address profit shifting and tax competition taking into account the interests of developing countries. Minimum taxes combat profit shifting by ensuring that profits are subject to a minimal level of taxation.
Minimum taxes on outbound investment
Minimum taxes on outbound investment could be seen as reducing the pressure on source countries to engage in tax competition. They protect higher tax countries against low tax rates abroad and they also reduce the benefit to source countries from offering low tax rates.
Minimum taxes on inbound investment
An example of a minimum tax on inbound investment is the US base erosion anti-abuse tax (BEAT). This sets a minimum tax at a lower rate than the corporate income tax but applied to a tax base that excludes deductible expenses for items such as interest, royalties and management fees paid to foreign related parties.
Minimum taxes can however be arbitrary to the extent that they may capture genuine business transactions.
Minimum taxes for low income countries
Low income countries need a strategy involving measures to protect their tax base, combined with minimum taxes. They can cap the deductibility of certain payments to related parties; or apply a broader rule to disallow tax deductions for base erosion payments that are not subject to an effective tax rate in the country of the recipient.
Final withholding taxes could be imposed at relatively high rates. Withholding taxes could be imposed on transactions to which they have not traditionally applied, such as technical service fees.
Border-adjusted profit taxes
These are a form of destination-based taxation in which exports are excluded from the tax base but imports are excluded. This mirrors the operation of VAT but a border-adjusted profit tax would allow a deduction for wages.
Destination-based cash flow taxÂ
The destination-based cash flow tax (DBCFT) would apply border adjustment and would apply cash flow treatment, so investment is immediately expensed and interest is not deducted. Financial flows would be disregarded, so there would be no deduction for interest and no incentive for profit shifting by pushing debt into particular jurisdictions.
Destination-Based Allowance for Corporate Equity/Capital (DBACE)
This would retain a provision for interest deducibility but would also allow a tax deduction for a notional return on equity. This could also be a border-adjusted tax.
Formulary apportionment
Formulary apportionment becomes more attractive as economic integration increases. Although formulary apportionment reduces the scope for profit shifting it could increase tax competition among states if the factors used in the apportionment formula are mobile. Tax competition to attract production factors could increase.
Developing countries are likely to benefit from apportionment if factors such as employment are used in allocating profits to jurisdictions.
Residual profit allocation
This could be a way forward in dealing with complex integrated business operations by a more formulary approach. Recent proposals suggest apportioning residual profit on a formulaic basis, after allocating the routine on the basis of costs incurred by the parties. Countries could tax the routine profit and the residual profit at different rates. The scope for profit shifting would be limited to the routine profits and prevented by the application of the arm’s length principle. Tax competition to attract residual profit would be reduced to the extent that apportionment is based on destination-based sales or user participation.
