Setting the scene
The international framework for the taxation of multinational enterprises (MNEs) is under severe pressure. This article discusses the sources of this pressure and initiatives at the global level to maintain an international consensus. It particularly focuses on how the digital economy creates significant challenges to existing international norms and how those norms might be expected to evolve.
Multinational enterprises are businesses that operate in several countries, sometimes globally. Not surprisingly, the rules governing the taxation of the profits that MNEs earn around the world are complex. Such rules are ultimately imposed by the countries in which the MNEs operate, but international standards have been developed over many years to create some consistency. Indeed, international coordination in this area of taxation is vital. Consistency reduces the costs of compliance by MNEs and provides for some certainty of treatment. Mismatches between country approaches can result in the same income (or sometimes the same legal entity) being taxed by more than one jurisdiction and create tax-avoidance opportunities in which some part of the income is not taxed anywhere.
Consistency has historically been achieved through a network of bilateral treaties between countries, largely adopting principles and guidance developed by the Organisation for Economic Co-operation and Development (OECD), but also by the United Nations (UN) and through regional protocols, such as those within the European Union (EU).
The international tax framework is under stress. Increasing globalization has created opportunities for MNEs to arrange their businesses to minimize their global tax bills, often by shifting profits to low-tax jurisdictions, sometimes through complex mechanisms with little commercial rationale. Governments are responding to protect their tax revenues and to address concerns over the perceived unfairness of MNE international tax planning. Also, there is increasing awareness of the difficulties faced by lower-capacity developing countries in implementing complex international tax principles, with the effect that many struggle to collect the right amount of tax from MNEs operating in their jurisdictions. In recent years, and perhaps most disruptively, the digital economy’s rise has changed the international commercial landscape and raised questions about whether and how the international taxation architecture can adapt.
These issues overlap. The digital economy brings with it increased concerns about international tax planning and the use of low-tax jurisdictions. Any measures to address these issues must also take into account the impact on developing countries’ tax revenues and the capacity of developing countries to implement them.
Although the international tax framework has always been dynamic, recent years have seen ambitious efforts to develop innovative, revised approaches to international taxation. To a large extent, the OECD has led these moves, which have given rise to enhanced standards backed by international peer-review mechanisms. The OECD is now attempting to build an international consensus on developing new and innovative international tax tools. The next section describes these actions.
i. Taxing the digital economy
The rise of the digital economy presents perhaps the most disruptive and difficult challenge currently faced by the international taxation framework. The digital economy allows MNE digital service providers to engage with and earn profits from citizens of a country on a very large scale but without the need for a physical presence. However, the existing international taxation framework’s design means that, without such a physical presence, many jurisdictions are left with little or no right to tax the profits that MNE digital platforms earn from income generated from their citizens.
Some countries have taken or instigated unilateral actions to introduce measures to tax the profits earned by MNEs from the delivery of digitally provided services to citizens and businesses within their jurisdictions. These typically take the form of “digital services taxes”, which impose a tax on the gross income generated in their territories. Moves in this direction have also been made by the United Nations, which is introducing a new article to its Model Tax Convention to provide for measures designed to tax income earned by purely digitally provided service providers. Initiatives have also been made by the European Union and regional tax organizations.
Such moves have not been supported by the OECD, which has instead spearheaded an initiative to develop a consensus approach that would recognize an enhanced allocation of MNE profits to the markets in which the consumers reside. This initiative reaches beyond the digital economy to embrace more traditional customer-facing businesses. The OECD’s impact assessment estimates that this move would mean that taxing rights on about $100 billion of profit could be reallocated to market jurisdictions and would lead to modest increases in global tax revenues. On average, low-, middle- and high-income economies would all benefit from revenue gains, while “investment hubs” would tend to lose tax revenues.
The future of the OECD’s initiative remains in doubt, though. Perhaps not surprisingly, the United States does not seem to support this initiative, as many of the largest digital service providers are ultimately owned in the US. Other tensions exist. The tax benefit to smaller developing countries may be very low, and the administrative costs of participation may be prohibitive to such countries. Developing countries may also be concerned about this initiative’s mandatory nature, which would restrict their rights to develop unilateral alternatives or supplementary approaches that better match their implementation capacities.
The World Bank is contributing to the debate and working with developing countries and regional organizations to help assess the likely impact of all these measures on tax revenues and to design the most appropriate policy positions and legal provisions as well as administrative approaches to, for example, the collection of digital-service taxes. There is limited practical experience of these types of measures and still much to learn at this stage.
ii. Tackling other international taxation challenges
Effective taxation of the digital economy requires tools to counter tax planning and avoidance involving, in particular, the shifting of profits to low-taxed jurisdictions. This requires effective tax measures and access to the information and data that tax administrations require to administer these rules.
For many years, countries have introduced unilateral measures to counter profit shifting into low-tax jurisdictions. These include controlled foreign corporation (CFC) rules that enable them to tax ultimate parent companies located in their jurisdictions on some of the profits earned by subsidiaries in low-taxed jurisdictions. In 2017, the United States enacted the Global Intangible Low-Taxed Income (GILTI), which provides for a minimum level of tax on an MNE group’s foreign income. The OECD is working on a consensus approach to this type of rule that draws on elements of existing CFCs and the US’s GILTI rules. These rules would subject MNE profits to a minimum level of taxation so that any income taxed at a lower rate would be subject to a top-up, normally in the shareholder company’s jurisdiction.
It remains to be seen whether international consensus can be achieved on this type of approach. In the meantime, the World Bank is working to influence the debate to ensure that any outcome benefits both developing and developed countries. One issue of concern to the World Bank is that the basic rules as currently proposed would redistribute the right of taxation over undertaxed income to the jurisdiction of the ultimate parent company. This fails to recognize that profit may have been diverted into low-taxed regimes from other entities in other jurisdictions, including developing countries. (Low Tax Jurisdictions and Preferential Regimes: Policy Gaps in Developing Economies)1
Recent years have seen successful initiatives aimed at providing tax jurisdictions with information to allow them to tax MNEs operating in their countries effectively and to counter profit shifting to entities benefitting from low taxation. A key development, driven by the OECD, has been the making of revised guidance on transfer-pricing documentation that MNEs should prepare, both centrally and locally, and provide when requested to do so to the countries in which they operate. This is supplemented by country-by-country reporting, also promoted by the OECD, which requires the largest MNEs to report key information and data on their international operations to the tax jurisdictions in which they operate.
More focused on the taxation of individuals, the Global Forum on Transparency and Exchange of Information for Tax Purposes has developed a framework for monitoring and peer-reviewing the adoption of internationally developed standards for exchanging information between tax administrations, including automatic exchange. The World Bank has worked closely with the Global Forum and the OECD to support more than 50 countries in adopting the rules and processes required to implement international tax and transparency standards, including through capacity building for their effective implementation. This work has contributed, for example, to the recovery of tax revenues through transfer-pricing audit adjustments of $19 million in Uganda (2020) in only one case and $116 million in Vietnam (2017).
Where do we go from here?
There is no doubt that the international taxation framework requires reassessment to cope with the pressures described in this article, and the willingness shown by the OECD and others to revisit existing principles and consider innovative approaches is promising. These developments are necessary and welcome.
That said, the taxation of the digital economy is still in flux, and obstacles to agreement at the OECD level are many. We might expect to see a continuing increase in countries introducing unilateral digital-service taxes, driven by concerns over whether and when an international consensus is achievable and about the likely yield of the current proposals. Some countries may also be wary about surrendering the right to take unilateral measures, which the OECD framework would require. Perhaps concerns about consistency and double taxation may be best addressed through international bilateral treaties, and the United Nations’ model-treaty article provides a promising route to this.
While the transparency agenda has made enormous progress and has had a clear impact on international tax avoidance, the extent to which the current discussions on countering profit shifting will see similar success remains to be seen.
The OECD proposals introduce elements of simplified and formulaic approaches to the taxation of MNEs, which lower-capacity tax administrations may welcome. However, considerably more work is needed to support developing countries’ efforts to effectively implement existing international tax concepts, such as transfer pricing, as well as newly developed measures. This must be a priority for the future and is an area of capacity development in which the World Bank is deeply involved.
Finally, in the medium and long term, more far-reaching and innovative approaches may be needed and should be considered. For example, global formulary apportionment, which seeks to divide the right to tax MNE global profit on a formulaic basis between countries, might address many of the challenges discussed above, although this is not on any currently visible horizon. This, and other approaches, are discussed in a 2019 World Bank Group (WBG) publication (International Tax Reform, Digitalization and Developing Economies).2
In addition, a forthcoming World Bank publication will contribute to the debate by analyzing the current international tax proposals under consideration and the proposed unilateral approaches to the taxation of the digital economy. The book will propose a new and possibly complementary solution: a “digital data tax” (DDT), with the potential to be administered globally. The proposed DDT would comprise two components: a toll tax to access the market and a service charge for contracted internet bandwidth (administered globally) or for significant digital presence (administered nationally).3
Total global e-commerce sales
1World Bank Group: Low Tax Jurisdictions and Preferential Regimes: Policy Gaps in Developing Economies, March 2019, Jonathan Leigh Pemberton and Jan Loeprick
2 World Bank Group: International Tax Reform, Digitalization and Developing Economies, October 2019, Colin Clavey, Jonathan Leigh Pemberton, Jan Loeprick and Marijn Verhoeven
3World Bank Group: Tax Theory Applied to Taxing the Digital Economy: Analysis of the Tax Disruptive Aspects of Digital Business Models and Proposal for a Digital Data Tax and a Global Internet Tax Agency, forthcoming in the spring of 2021, Christian Oliver Lucas-Mas and Raul-Felix Junquera-Varela.