International corporate taxation
While international corporate taxation in the global and digital world is in need of an overhaul, none of the reforms proposed so far provide an entirely satisfactory solution to the problem. In recent years, VATT has evaluated the tax revenue losses Finland incurs from the profit shifting of multinational corporations and assessed the impacts of the European Union's Common Consolidated Corporate Tax Base (CCCTB) on corporate tax revenues in Finland.
International corporate taxation in need of an overhaul
In a globalised and digitalised world, international corporate taxation is in need of an overhaul. The current system is particularly ill-suited for the taxation of multinational companies because it treats each member company of a multinational group making global decisions as a separate taxable entity. It also aims to ensure that the right to tax is exercised where value is generated even though determining the location of value generation is becoming increasingly difficult.
The current system encourages multinational companies to shift profits to low-tax countries; this, in turn, encourages countries to engage in tax competition which erodes global corporate tax revenues. We estimate that profit shifting results in corporate tax losses amounting to hundreds of billions of euros at the global level.1 In Finland, the annual losses of tax revenue are likely to be hundreds of millions of euros. Profit shifting also distorts the division of tax bases between countries and the competition between multinational groups and enterprises operating at national level.
Would a common tax system solve the problem?
Both individual countries and multinational parties have been seeking ways to prevent tax avoidance. The 15-point action plan of the OECD’s Base Erosion and Profit Shifting (BEPS) project consists of recommendations which, if implemented, would improve the resilience of national tax regimes to tax avoidance.2 The EU’s Anti-Tax Avoidance Directive (ATAD), on the other hand, contains tax system changes which each Member State should incorporate in their national legislation.3 The limitation of the deductibility of borrowing costs contained both in the OECD action plan and in the Directive has also been applied in Finland since the beginning of 2014.4 What the two proposals have in common is that they preserve the structure of the current corporate taxation system, especially the taxation of companies as separate entities.
The Common Consolidated Corporate Tax Base (CCCTB)5 set out in a directive proposed by the European Commission in 2016, on the other hand, would change the fundamentals of the tax system and also allow the taxation of profits reported outside the country’s borders. CCCTB would combine the profits of the member companies domiciled in the EU into a common group-level tax base. The right to tax the consolidated tax base would be shared between EU Member States using an apportionment formula in which consideration is given to the location of the group’s production factors and the markets for its products.
The OECD is also proposing a reform that would alter the basic structures of the tax system.6,7 The profits of an international corporation would be divided into two parts. The part corresponding to ‘normal profits’ would be taxed in accordance with the existing rules, while a share of the portion exceeding it would be allocated between the countries in which the companies’ customers live, using a fixed formula. There would also be instruments to ensure that companies pay a certain minimum level of taxes on their profits.
EU’s CCCTB proposal would reduce Finland's corporate tax revenues
The main aim of the CCCTB proposal put forward by the European Commission is to create a system allowing more effective prevention of tax avoidance. It is a continuation of a proposal presented in 2011, to which a number of new elements (such as two-stage implementation) have now been added. In the first stage of the reform, the tax base legislation of individual countries would be harmonised. In the second stage, the tax bases of group companies would be combined and allocated between countries using an apportionment formula in which the location of sales, employees and capital in the Member States are considered. Joining the system would be mandatory for large corporations. As part of CCCTB, the European Commission is also proposing an allowance for equity capital (AGI allowance), a generous R&D deduction and new anti tax avoidance measures, such as limitation on interest deductions, CFC legislation, and a general anti tax avoidance rule (GAAR rule). Tax rates would remain at the discretion of the Member States.
Determining the tax base at group level would mean automatic and full consolidation of profits and losses across individual companies of a corporate group which, as a rule, would shrink the tax base. At the same time, reallocation from low-tax countries to high-tax countries would increase global tax revenue.8,9
We have assessed the impacts of the reform on Finland’s corporate tax revenues.10 The calculations are static, which means that the changes in the behaviour of companies and countries resulting from the reform have not been considered. The calculations indicate that Finland's tax revenues would probably shrink under the new system. The automatic intra-group loss consolidation, and the AGI and R&D deductions are the main reasons for the decrease. While reducing tax revenue, the deductions also make the new system attractive to companies that are of such size that they could stay outside it. They also encourage investments and capital accumulation. It is estimated that the reform package would reduce the Finnish tax revenue by 16% whereas the tax revenue would increase as much as 10% without the AGI and R&D deductions. In fact, contrary to what is stated in some previous estimates, it seems that the formula used for apportioning the tax bases among countries would not in itself be particularly problematic for Finland and the reasons for lower tax revenues have to be sought elsewhere in the system.11
The large number of corporate tax reform proposals have produced little clarity
In the light of our static tax revenue calculations, the CCCTB proposal presented by the European Commission in 2016 is not particularly attractive to Finland. The system would also encourage corporations to strategically select locations offering the financial variables contained in the apportionment formula. This might have problematic effects on the regional distribution of production and tax revenue in Europe. The tax incentives and the automatic loss consolidation would, however, encourage companies to make investments and expand their operations.
The system might well increase tax competition between countries. Under the new system, countries would no longer compete over mobile profits but the focus would rather be on employment and investments. Targeted tax reliefs would no longer be possible under the new system as the same tax base rules would apply to all companies. This could further underline the role of the corporate tax rate in the tax competition. Moreover, the system would be limited to the Member States of the European Union. The current system (and its shortcomings) would continue to apply to transactions between members of corporate groups operating in Europe and in other parts of the world.
It also seems that none of the other proposed reforms would offer an entirely satisfactory solution to the problems of international corporate taxation. While it is likely that the OECD’s BEPS project and the EU’s ATAD will be successful in reducing profit shifting, they will also add to the complexity of the tax regime, increasing the costs incurred by the public administration and companies.12 According to initial estimates, the OECD’s pending proposals also appear to have their problems.13 What appears particularly problematic is a system created as the sum of several overlapping reforms, which can hardly meet the general requirements set for a good tax system.14
3) European Commission (EC 2016a) Proposal for a council directive laying down rules against tax avoidance practices that directly affect the functioning of the internal market, COM(2016) 26 final, 2016/0011(CNS), Brussels, 28.1.2016.
13) Ks. esim. Devereux, M., Bares F., Clifford S., Freeman J., Guceri I., McCarthy M., Simmler M. and Vella J. (2020) The OECD Global Anti-Base Erosion Proposal, Oxford University Center for Business Taxation, Said Business School.
14) Mirrlees, J., Adam, S., Besley, T., Blundell, R., Bond, S., Chote, R., Gammie, M., Johnson, P., Myles, G. and Poterba J. M. (2011): Tax by Design: The Mirrlees Review. Oxford University Press.