European corporate taxation is not harmonized. European multinational corporations that do business via subsidiaries and branches in EU member states have to deal with many different tax laws. These include the corporate tax laws in their home country and those of their subsidiaries and branches, which leads to compliance costs and transfer pricing issues.
The European Commission has supported the plan of introducing a common consolidated corporate tax base (CCCTB) for a decade, and the first draft directive was issued in 2011. Under the CCCTB, a multinational corporate group is taxed on the basis of its consolidated group profit and it is determined according to a common set of rules (including accounting for intangibles, goodwill, provisions, cross-border loss offset, etc). Intra-group transactions are eliminated and intra-group profits are not taxed.
For taxation purposes, the consolidated group profit is then allocated to the member states in which the subsidiaries and branches are located, according to a formula. The formula includes the factors of sales, labour, and assets each accorded one third, similar to the original Massachusetts Formula (single sales factor). Allocated profit to each member state will be taxed at the local corporate tax rate. In this regard, tax rates are not harmonized across the EU.
The conceptual pros
A CCCTB as described above would have several major conceptual advantages:
- Instead of the legal entity (i.e. the individual firm), the economic entity (i.e. the group) is taxed. The legal form of business organization is no longer relevant for taxation, thus ceasing the needs for artificial separation of business along the lines of legal form, which reduces arbitration and bias.
- This is reflected on the one hand in the fact that intra-group transfer pricing at arm´s length is no longer relevant, as all intra-group transactions are eliminated as part of the consolidation process.
- On the other hand, losses of one part of business can be set off against profits of another part of business, across group members, and across countries. The result of the group as a whole is the one which is relevant for taxation.
Consequently, the tax burden (from loss offset) as well as compliance costs (from dealing with one tax system only and from saving all efforts connected to transfer pricing) would be reduced.
The practical (or political) cons
Unfortunately, a CCCTB system would face numerous impediments:
- From a political perspective, it seems virtually impossible that 28 (or 27, excluding the UK) member states would agree on one allocation formula. The process requires unanimity among the member states, and any formula would have winners and losers. For instance, small states, where sales are small and the sales factor has little weight in the formula, would fear their corporate tax revenues are reduced. Or states with low wage levels might lose because of the labour factor. Also, member states would lose the right to use some of the most important fiscal policy tools, such as tax credits and investment reliefs, as any unilateral change of the tax base is prohibited. Tax rate would become the only fiscal policy instrument available to member states.
- Even if a formula can be agreed on, multinationals will react. Instead of shifting profit, multinationals will shift factors (in particular assets and labour) to low-tax member The effect of such factor shifting on the real economy is still under-researched, even though some insightful analysis is available (eg. Bettendorf, van der Horst, de Mooij, Devereux, Loretz, 2009). If more weight is put on sales, corporate tax would become more like a sales tax, which implies a shift to a consumption tax system.
- The directive with its few articles shall replace numerous rules, regulations, decrees, and case law in each country, which have evolved and been refined over the past decades. In other words, the new rules would leave much room for interpretation. Such room will either be filled by existing domestic law, which frustrates harmonization, or it will be filled by creative interpretation of the law by multinationals, which may increase tax avoidance (eg. Eberhartinger & Petutschnig 2017).
- While group profit shifting via transfer pricing would no longer be possible, other profit shifting activity from CCCTB-countries to non-CCCTB-countries (i.e. the rest of the world) is unaffected, notwithstanding anti-BEPS measures.
So what’s next?
The European Commission has reacted to some of the concerns. After pausing the process, and in the wake of the Anti-BEPS initiative by the OECD and G20, the original idea of a CCCTB is now split in parts.
A common corporate tax base (CCTB) is suggested as a first step and the aims of consolidation and formula apportionment are set aside in this first step. The CCTB draft directive in 2016 provides for generous R+D benefits, for an allowance for equity (see further Petutschnig & Rünger, 2017), for exit taxation, and for an interest barrier. Further rules relate to other issues such as deductibility, valuation, and timing. The directive shall incorporate Anti-BEPS measures, some of which are already included in the EU Anti Tax Avoidance Directive (ATAD).
In effect, this will transform the 2011 CCCTB draft directive (with its noble intentions) into an anti-BEPS measure. While the 2016 directive reduces considerably leeway for cross-border base erosion and profit shifting, the remaining rules for the determination of taxable profit still leave considerable room for interpretation and discretion. Thus, new leeway for tax avoidance is created.
In a second step, a new CCCTB directive (note the third ‘C’ for ‘Consolidation’) has also been redrafted in 2016 and it shall introduce consolidation and formula apportionment, similar in concept to the 2011 draft directive. Currently, a new formula is under discussion, which would add a fourth factor “data”, in addition to sales, labour, and assets. The new factor combines “data collected” and “data exploited”, and shall capture the digital economy. However, the concerns raised above still apply, maybe even more so.
It is unclear yet whether the new CCTB directive and the new CCCTB directive will be adopted. The first leads to member states giving up their fiscal sovereignty with regard to defining multinationals´ income, and raises new issues of tax avoidance. The second, even more so, leads to unforeseeable shifts in member states´ tax revenue and even less foreseeable macroeconomic effects as a result from factor shifting by multinationals.
The concept of a CCCTB, including full consolidation and cross-border loss offset, is intriguing. It should be supported because it eliminates many of the biases that come with the existing system in which we pretend that group entities are independent of each other. Unfortunately, the practical obstacles for implementation are not yet resolved, and the economic consequences are almost impossible to judge. If these concerns are overcome, a theoretically beautiful concept (at least in my eyes) of group taxation could come into place.
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