The current state of international political and economic affairs is fragile. There are threats to sustainable growth and challenges to trade relationships from China, the UK, the United States and beyond. International tax policy is having a similarly uncertain moment with individual countries seeking to expand their taxing rights of multinationals in unilateral fashion — making double taxation scenarios more likely.
In recent decades, the international tax policy debate has become more focused on the treatment of profits from intangible assets and those made by large companies in the digital sector. Critics of the current system argue that because multinationals are able to locate their profits from intellectual property, software, and other valuable intangibles in low-tax jurisdictions, some combination of residence and market countries should have a right to tax profits from those assets.
Additionally, some digital firms find themselves in the spotlight because they are often able to reach their customers around the world without investing in a physical distribution or sales network that could expose them to direct tax liability in the countries where they make their sales. At the same time, these digital firms rely heavily on user data to improve their products and provide lucrative ad targeting services.
Last March was a pivotal moment in this debate. The UK, the European Commission and OECD all released policy papers within a 10-day period covering various approaches to taxing digital firms. The OECD report did not provide a specific policy outline but pointed out that the digital economy should not be “ring fenced” for tax policy.
These policy papers followed the adoption of tax reform in the United States that provided a novel approach to creating a minimum tax regime for US multinationals.
In the months that followed, specific proposals from various OECD countries began to surface.
Policymakers in Germany and France began to push for a global minimum tax while the UK advanced an argument for allocating taxing rights based on users. The US Treasury weighed in with an approach that would give countries more taxing rights based on investment in marketing intangibles (like trademarks and proprietary customer data) by multinational businesses. US officials have also given tacit support to a global minimum tax regime. Developing countries have recommended a system that apportions taxing rights based on a formula that would include sales, assets, and employment (and potentially users) paired with a definition of significant economic presence. Each of these proposals has now been included in a consultation document from the OECD.
Many countries believe that multinational companies should be paying more tax in their jurisdiction for various reasons. If each country were to act upon its own political instincts without regard for a multilateral agreement, then businesses could quickly be caught in a web of conflicting provisions and double taxation of income.
Yet, here we are with the UK, Spain, France, Italy and Austria each pursuing a digital turnover tax and countries like India, South Korea and Japan adopting provisions that fit their own views of how to include more profits from various multinationals (mostly digital companies) in their tax bases.
A multilateral agreement at the OECD could stem this tide, but negotiators should work to avoid serious distortions and severe economic consequences; the policies should follow some simple principles.
First, the allocation method and minimum tax should be assessed on a net basis and turnover taxes on multinationals should be eliminated to avoid double taxation. Taxes on turnover are distortive and raise the cost of services and products that consumers and businesses purchase while creating economic harm by taxing revenues despite profitability.
Second, foreign direct investment (FDI) should be exempt from the tax base to avoid creating new barriers to cross-border capital flows. Policymakers should heed the lessons from economic studies on FDI and taxation to avoid an approach that might reduce FDI globally.
Third, the system should be as simple as possible and not create distortions with thresholds and safe harbours. The new system will impact current multinationals directly, but it will also impact the incentives that growing companies face in aspiring to sell their products all over the world. A sufficiently complex policy with a safe harbour for small firms might make it more likely for a growing firm to get bought out rather than achieve success as a separate global firm.
The challenges to international tax policy are many, but the OECD has a chance to work toward a system that creates fewer distortions and negative economic effects than the current one. However, given the policies on the table, it will certainly take quite an effort to avoid further complexity of international tax rules that creates challenges to global trade and economic prosperity.
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