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Treaty Application for Companies in a Group (FM nr. 178) 2022/6.2.2.3
6.2.2.3 Defining the tax base (‘what to tax’)
L.C. van Hulten, datum 06-07-2022
- Datum
06-07-2022
- Auteur
L.C. van Hulten
- JCDI
JCDI:ADS659449:1
- Vakgebied(en)
Omzetbelasting / Plaats van levering en dienst
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The system in the United States works without a harmonized basis (M.J. McIntyre, ‘The Use of Combined Reporting by Nation States’, Tax Notes International 2004, vol. 35, no. 10, par. 5., see also S. Picciotto, ‘Towards Unitary Taxation of Transnational Corporations’, Tax Justice Network 2012, par. 2.3).
How, for example, should the profits of a foreign group company realized in another currency be dealt with? It seems logical to include exchange rate results in the determination of the consolidated profit, as this would result in actual changes in equity.
It has also been suggested to implement an activity-by-activity approach towards unitary taxation instead of a combined income approach (M.C. Durst, ‘Analysis of a Formulary System, Part IV: Choosing a Tax Base’, Tax Management Transfer Pricing Report 2013, vol. 22, no. 12, p. 902). Such a system would apply to the global income derived from a segment of the business activities. A big disadvantage of such a system is that it requires segmentation of a taxpayer’s income into subcomponents. This would be a very subjective process, which already has proven to lead to tax avoidance (M.C. Durst, ‘Analysis of a Formulary System, Part IV: Choosing a Tax Base’, Tax Management Transfer Pricing Report 2013, vol. 22, no. 12, p. 905) and therefore does not seem feasible.
R.S. Avi-Yonah & K.A. Clausing, ‘Chapter 11: Reforming Corporate Taxation in a Global Economy: A Proposal to Adopt Formulary Apportionment’, p. 337-338, in J. Furman & J. Bordoff (eds.), Path to Prosperity: Hamilton Project Ideas on Income Security, Education, and Taxes, Washington, DC: Brookings Institution Press 2008. This would have as an additional advantage that the book income and tax income would become more closely aligned. True book to tax conformity would offer a huge administrative advantage. However, it seems unlikely that countries would agree upon such a system (M.C. Durst, ‘Analysis of a Formulary System, Part V: Apportionment Using a Combined Tax Base’, Tax Management Transfer Pricing Report 2013, vol. 22, no. 15, p. 974).
B.F. Miller, ‘Worldwide Unitary Combination: The California Practice’, p. 150 in C.E. McLure, Jr. (ed.), The State Corporation Income Tax: Issues in Worldwide Unitary Combination, Stanford, CA: Hoover Institution Press 1984.
OECD, Addressing the Tax Challenges of the Digital Economy, Action 1 - 2015 Final Report, Paris: OECD Publishing 2015. Following the work of the OECD in the BEPS project, the EU examined whether the digital economy requires adjustments to the permanent establishment concept. On March 21, 2018, the EU published two draft directives containing rules on how to deal with the taxation of digital services in the future. These proposals, inter alia, include the introduction of a notional permanent establishment in legislation and in tax treaties if digital services are offered or supplies are made in a country (Proposal for a Council Directive laying down rules relating to the corporate taxation of a significant digital presence, COM(2018)147).
The proposed solutions were: (1) modifications in the permanent establishment definition; (2) revised transfer pricing guidance; and (3) a recommendation on designing effective CFC rules (OECD, Addressing the Tax Challenges of the Digital Economy, Action 1 - 2015 Final Report, Paris: OECD Publishing 2015, p. 12).
OECD, Tax Challenges Arising from Digitalisation - Report on Pillar One Blueprint: Inclusive Framework on BEPS, Paris: OECD Publishing 2020, p. 103-104.
OECD, Tax Challenges Arising from Digitalisation - Report on Pillar One Blueprint: Inclusive Framework on BEPS, Paris: OECD Publishing 2020, p. 105.
F. Clarke, G. Dean, & K. Oliver, Corporate Collapse: Accounting, Regulatory and Ethical Failure, Cambridge: Cambridge University Press 2003.
P. Sikka & R. Murphy, ‘Unitary Taxation: Tax Base and the Role of Accounting’, ICTD Working Paper 2015, no. 34, par. 5. Differences include for example differences in deprecation and other capital allowances (for accounting purposes according to the rate at which the value declines over time, while for tax purposes a faster rate is generally applied to stimulate investments) and differences in income inclusions (income from long-term contracts is generally included earlier for tax purposes to prevent taxpayers from deferring the income) (M.C. Durst, ‘Analysis of a Formulary System, Part V: Apportionment Using a Combined Tax Base’, Tax Management Transfer Pricing Report 2013, vol. 22, no. 15, p. 973).
The financial statements should provide insight into the financial situation for purposes of control and decision-making. It may require interpretation as well as recording factual information. Taxation is in principle aimed at raising revenue.
S. Picciotto, ‘Taxing Multinational Enterprises as Unitary Firms’, ICTD Working Paper 2016, no. 53, par. 6.2.
OECD, Tax Challenges Arising from Digitalisation - Report on Pillar One Blueprint: Inclusive Framework on BEPS, Paris: OECD Publishing 2020, p. 107.
In a unitary taxation system tax will continue to be levied on corporate profits. However, which corporate profits are to be taxed, and how those profits should be calculated, is the question. This seems to be the main problem of switching from the current arm’s length principle to a unitary taxation system, as a consolidated tax base would be required. Harmonization of the tax base does not seem essential for the application of unitary taxation.1 Though, application of unitary taxation clearly benefits a lot from a common set of rules to define the tax base.2
In the literature it has been suggested to use financial reporting – for which international standards exist – as the starting point for calculating the global profits3 of a multinational enterprise.4 This is a logical starting point as the worldwide consolidated financial accounts attempt to reconcile differences in income definitions between countries.5 However, there are variations between different consolidated accounting standards. As indicated, the OECD is working on a global solution for the taxation of profits in the digitalised economy. This started as part of the OECD BEPS project.6 The final report on Action 1 included various solutions.7 Still, as the digital economy raised broader tax challenges for policy makers, the OECD continued to work on these issues. In 2020 the Pillar One Blueprint was published. In the Pillar One proposal it is suggested to accept all consolidated financial accounts produced under national General Accepted Accounting Principles, as lang as the relevant accounting standard ‘produces equivalent or comparable outcomes’ to the consolidated financial accounts prepared under IFRS.8 It is suggested to not apply any book-to-book harmonization adjustments, as this would make the system significantly more complex.9
A problem with respect to adhering to the consolidated financial accounts is that tax laws would depend on the decisions of a private-sector body (the IASB). Additionally, companies have flexibility in recognizing income, assets, liabilities, expenses, profits and losses for accounting purposes.10 Due to the conceptual differences between the accounting and taxation meaning of those concepts, the question is whether accounting data can be used for the assessment of corporate tax liabilities.11 The conceptual differences result from the different goals that are pursued from an accounting versus a tax perspective.12 A conversion of the consolidated accounts to tax accounting standards might be a solution.13 The Pillar One proposal includes certain book-to-tax adjustments (the deduction of certain items of income while certain expenses are added back). To facilitate administration and compliance, the adjustments are kept to a minimum.14
All in all, determining the exact definition of the tax base for a unitary taxation system requires balancing accuracy and administrative simplicity. This would require further research. In line with the OECD MTC objectives, the system should be designed to minimize possibilities of double counting of income. Additionally, tax avoidance possibilities should be minimized.