Is formulary apportionment the path to multinational tax reform?

Joann Martens Weiner, Ph.D.

The George Washington University

Presented to the Independent Commission for the Reform of International Corporate Taxation,

New York City, March 18, 2015

Impacts of current international corporate tax framework

21st century globalized economy with large, highly-integrated multinational enterprises

19th century tax system based on principles of separate entity accounting with arm’s length pricing

High compliance costs with transfer pricing for both businesses and tax administrations

System encourages base erosion and profit shifting – some examples: Google saved $60 billion in taxes with a “Double Irish with a Dutch sandwich,” (NY Times), Apple had more than $100 billion offshore and avoided $9b in U.S. taxes in 2012 (Senate PSI), Starbucks made “losses” in 14 of 15 years doing business in the U.K. (Kleinbard)

Why a modern tax system is needed: Data from 4 countries

  Germany Japan UK US

Share of tax receipts by source, 2011

Personal income taxes 24.8 18.4 28.2 37.1

Corporate income taxes 4.7 11.8 8.6 9.4

Social security and payroll 38.5 41.4 18.7 22.8

Goods and services 29.1 18.4 32.3 18.3

         

Corporate tax rate, (combined, 2014, %) 30.2 37.0 21.0 39.1

Corporate tax receipts (% of GDP) 1.7 3.4 3.1 2.3

         

Capital positions as a share of GDP, 2012        

Inbound FDI (%) 26.1 3.8 60.1 16.3

Outbound FDI (%) 36.5 19.0 69.8 27.4

         

Source: Altshuler, Shay and Toder (2015)        

Five specific recommendations for a formulary apportionment system

Replace system of separate-entity accounting and arm’s length pricing with common consolidated tax base with formulary apportionment

Exempt active foreign-source income from host country taxation (i.e., limit to water’s edge)

Enforce common anti-abuse (“CFC”) rules File tax returns in a single tax jurisdiction and work with

a single tax authority Reach international consensus on formula For complete analysis, see the European Commission’s

2011 proposal for corporate tax reform

The European Union’s approach (proposed March 16, 2011)

Common Consolidated Corporate Tax Base (CCCTB) One-stop shopping for tax administration Common anti-abuse rules Exempt foreign-source income Limit taxation to the EU’s water’s edge One tax base One formula Consolidate profits and losses across borders within EU Member states set their own tax rates Optional for businesses

The formulary apportionment solution

Instead of measuring profits in each country by using transfer prices for internal transactions, distribute the consolidated tax base for the entire corporation according to where the corporation does business

The location of the corporation’s business is determined by the location of its business activity

Business activity can be measured by location of capital (property), labor (payroll and employees) and sales

The apportionment formula

Three factors Property – tangible property, buildings, machines, inventories Labor – employees and employee compensation (incl. benefits) Sales – based on destination

Each factor weighted equally Labor factor includes payroll and the number of employees Designed to reflect both supply and demand as well as

different levels of labor productivity across the EU member states

Corporate tax base is allocated according to the weighted-average share of each factor

Impact of CCCTB and apportionment in the EU CCCTB would save businesses 700 million euros in reduced

compliance costs and 1.3 billion euros through consolidation every year

More than half of US and EU corporate groups now doing business in the EU would benefit from the CCCTB (tax burden falls)

A typical US company would see its tax burden fall by 6% and a typical EU company would save 5% in taxes

Introducing CCCTB would increase the effective average tax rate only slightly, from 24.4% to 25.1%

Tax planning still possible for US companies due to lack of harmonization of withholding taxes on dividends, interest and royalties

Other developments to consider

The OECD’s Base Erosion and Profit Shifting (BEPS) project Taxation in the digital economy Some interest groups in the U.S. advocate moving to

formulary apportionment, e.g., salesfactor.org proposes a single-factor sales-based formula

Sol Picciotto of the Tax Justice Network has proposed using unitary taxation with a three-factor apportionment formula

The District Economics Group and the Project for Corporate Tax Fairness recently held a briefing on corporate income taxation under formulary apportionment

Where to find additional analysis?