Samenvatting
Summary lectures- Taxation of Multinationals (FEM11162)
This document contains a summary of the lectures during the course, i.e., summary of chapters 1 to 7.
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Taxation of Multinationals – summaryChapter 1: Introduction and Stylized Facts
§1.1: Introduction
Income/profit shifting: shifting income/profits within a multinational from a high-tax affiliate to a
low-tax affiliate → in order to reduce the global tax payments.
Different ways of (income) profit shifting with different implications for both multinational and
countries:
1. Transfer pricing
2. Debt shifting
Income shifting may be tax planning (legal) or tax evasion (illegal).
§1.2: Stylized Facts and Starting Point
Multinational companies (MNCs): core feature is that they have at least one affiliate in one other
country.
Important to look at FDI (growth rate): increase in FDI (growth rate) implies that you either set up a
new multinational in another country or that you are expanding your multinational.
o When growth rate of FDI increases, the growth rate of multinational increases as well.
o During 1985-1999: the worldwide growth rate of FDI was 18% while growth rates of GDP and
exports were respectively 2.5% and 5.6% → so multinationals gained importance.
o Intra-firm trade counts for 30-40 percent of all worldwide trade.
o From statistics: FDI outflows six times higher in 2015 (1.474) compared to 1990 (242).
→ GDI outflow stock almost twelve times higher in 2015 (25.045) compared to 1990 (2.091).
→ GDP in 2015 (73.152) three times higher compared to GDP in 1990 (22.327)
Top 10 of largest multinationals (ranked by revenue) consists of firms active in oil, auto and tech
sector while number one is Wal-Mart stores. When you compare the revenues of these large
multinationals to GDP of countries, you conclude that multinationals are really big and do have a lot
of sales and the multinationals are really powerful.
→ revenues of number 2, 3 or 4 (oil firms) are comparable to the GDP of Ireland, the revenues of
Wal-Mart stores is exceeding GDP of Argentina.
Luxembourg, the Netherlands, Belgium, Ireland etc. are outliers of FDI flows/GDP when compared to
the average FDI flows/GDP in the European Union or OECD member states → countries are
characterized as tax havens.
Offshore profits of US multinationals in select jurisdictions (% of US GDP) have been stable between
1995-2015 when looking at the six largest economies: Germany, France, Italy, India, China and Japan.
However this ratio has increased rapidly in seven low-tax jurisdictions in the same period:
Luxembourg, Ireland, Netherlands, Switzerland etc.
→ when aggregating the curves; profitability of the firms has increased enormously in seven low-tax
jurisdictions (by almost 4 times).
,Since 2012 (financial crises) tax avoidance is gaining in public and political attention. Attention is also
likely to increase after Covid-19 since governments have to pay their increased debt with tax
revenues.
o Global MNCs do pay almost no taxes: Apple 1.9 percent and Google, 2.5 percent on non-US
profits while average corporate income tax (CIT) is between 20 and 25 percent.
o Starbucks UK did not pay taxes in 14 out of 15 years before 2012.
o Due to tax competition, there is a global tax revenue loss of USD 650 billion each year and
one-third of this loss is occurring in developing countries.
o 40 percent of MNCs global profits are shifted to tax havens (=USD 600 billion in 2015)
→ using CIT of 25 percent: USD 150 billion not paid by shifting US profits to tax havens.
However, when using national statistics (macro data) there are measurements errors when we count
shifted income twice and this leads to an overestimation. When controlling for overestimating,
consensus estimate is that 10 percent of corporate tax revenue is lost due to profit shifting (= 0.3
percent of GDP loss).
Mechanisms of tax avoidance:
o Two main strategies: 1. (abusive) transfer pricing and 2. international debt shifting.
o Additional features:
▪ Loopholes: double non-taxation when residence in one country and all
decisions being made by the board of management in another country →
with few countries you manage to not pay any taxes.
▪ Treaty shopping: optimize geographical income flows to get best tax
treatments → for example: due to tax treaties of the Netherlands (double
Irish-Dutch sandwich).
Abusive transfer pricing: two affiliates of one MNC are trading (patents/trademarks etc.) and can set
smart pricing i.e. over-/under invoicing so that the profits arise in the low-tax jurisdiction.
o Affiliates must justify to the tax authorities that prices are at arm’s length → costly (lawyers
and consultants).
o When disputed by tax authorities (illegal): concealment costs and fines when there is tax
evasion.
o Might be necessary to restructure production in order to facilitate transfer pricing; leads to
efficiency costs on one hand in order to reach tax saving on the other hand.
→ all costs should be out weighted by saving due to over-/under invoicing intra-firm trade.
International debt shifting: cost of equity (dividends) are not tax deductible while costs of debt
(interest payments) are tax deductible. This leads to an incentive to use debt instead of equity. MNCs
can choose between external debt funding (loans from capital market) and internal debt funding
(lending among related affiliates). You can use more external debt in high-tax jurisdictions but you
need savings from using debt should balance the costs arising from external debt. When organizing
smartly, you save a lot of money by allocating lots of external debt to the high-tax jurisdiction.
By labeling equity as internal debt funding, one affiliate in a high-tax country receives equity (as debt
on balance sheet) and can deduct the interest expenses and the other affiliate receives interest
income but tax rate is low in the other country. You also need to balance for the cost of using
internal debt.
,Political concern and action taken:
G20 introduces OECD BEPS Project in 2012 → in 2013: the project was claiming that revenue losses
from BEPS are substantial and creating inefficiencies (especially for developing countries).
Led to the OECD BEPS Action Plan 2015 to regulate profit shifting:
o Implementation of arm’s length principle.
o Improve information flow by requiring companies to report how much profit they make in
different countries (CbC reporting)
o Tighten thin capitalization rules to restrict deductibility of debt.
o CFC rules: restrict exemption principle for passive incomes.
Some argued that the tax system is outdated:
o Formula apportionment (CCCTB): use allocation factors to apportion global profits on
countries → to reallocate global profits to different countries in order to determine the
taxes.
▪ It could kill profit shifting but will lead to firms and shops moving because
there will be competition for real debt.
o OECD introduces market-based allocation for residual profits → unclear how it will look like.
o Destination-based cash-flow taxation: replace the corporate income tax by a sales tax for
firms.
When profit shifting is relying on the right setting and mechanisms, it will actually improve welfare
and the profit shifting will then not be bad.
For welfare analysis and design of regulation, it is necessary to have a good understanding of
mechanisms and carful modeling of institutions.
, Chapter 2: The international Tax System: a basic overview
§2.1: The Corporate Tax
The corporate tax is the ‘income tax’ of corporations/entities → corporations are legal persons;
independent entity with full legal personality (obligated to pay taxes).
Corporate tax base:
o Determined by accrual accounting: earnings minus expenses → allocated to the (tax) years in
which the earnings or expenses are used.
o Difference between book profits and economic profits occur from opportunity costs (costs of
equity).
o All revenues are liable to tax and almost all expenses are tax deductible including interest
expenses on debt and depreciation allowances.
o Cost of equity and fines are not deductible
→ leads to preference for debt over equity.
Double taxation and integration with personal income tax: distributed dividends are taxable income
at shareholders → can be an additional corporation tax at mother company or a personal income tax
at ultimate shareholder. Double taxation (economically) means that the same profit is taxed several
times at different payers.
o On corporate level: the inter-corporate dividends are usually exempted from corporate tax
and profits are only taxed once at source.
o On personal level: personal income tax liability on after-corporate-tax profits → most
countries offer some integration of corporate tax into personal income tax:
▪ Reduced personal tax rate on dividends, or
▪ Full (or partial) imputation: tax credit for corporate tax.
→ Both corporate and personal taxes matter for analyzing tax consequences.
o Only focus on corporate tax burden:
▪ When many shareholders are facing different personal (marginal) tax rates
or being subject to different income tax systems
▪ The dominating shareholders are often institutional investors and they do
not pay personal income tax (pension funds for example).
▪ Managers are evaluated on their performance after corporate tax → no
incentive to incorporate personal taxes.
So there is a focus on MNCs and corporate tax payments only!
§2.2: International Tax Principles
Unlimited tax liability: Natural persons being residents within country and legal persons with legal
seat or effective management in country; taxes liable on worldwide income → worldwide income
principle.
A Belgian citizen who is working in Germany and spending more than half a year in the Netherlands is
a tax resident in the Netherlands. It doesn’t matter where you earn your income but where you spend
your time; in the Netherlands you are tax liable on your worldwide income.
Limited tax liability: Non-residents performing economic activities in source country are taxes liable
on income derived in source country. For MNCs: when they setup branches in another country that
are not legal independent entities. Exports are usually not covered by territorial principle due to lack
of connection to territory → territorial income principle.
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