5.1 Introduction

The existence of multinational groups can be explained by the internalization theory: multinational companies can gain efficiency as a result of economic integration.1 By internalizing transactions within the firm, profits are generated. The application of the separate entity approach for tax purposes leads to distortions: group companies are treated as if they are separate entities, while group companies and separate entities are not equal. The separate entity approach leads to double taxation and provides tax avoidance opportunities. In situations where the outcome is too much or not enough taxation as a result of the separate entity approach, a group approach is often applied.

On a domestic level a clear example of a group approach is the application of a group taxation regime. Such a regime counters the distortive consequences of the separate entity approach to a certain extent. Depending on the exact rules of the group regime, the group as such can become the taxable person. The regime is generally applied on a domestic level: solely the profits within the borders of a certain country are included. This can include profits of legal entities as well as profits of permanent establishments.

While group taxation regimes normally only apply to domestic profits, group taxation 2.0 variants – as referred to in this chapter – apply or can apply in a cross-border context. These systems reflect the enterprise approach to a larger extent. Additionally, they apply a different profit allocation method. Instead of the separate entity, the group and its consolidated profit is the starting point. To subsequently allocate the profits, a formulary apportionment method is applied. For the consolidation two main variants are applied: a water’s edge approach and a worldwide approach.

Under a water’s edge approach, the domestic profits and losses are consolidated before they are apportioned to the states with an economic connection to the income. The individual jurisdiction does not look beyond its respective boundary to calculate income.2 The ‘water’s edge’ concept comes from the United States: under this approach overseas affiliates are not part of the consolidation.3

Under a worldwide approach all the income and losses of a multinational enterprise are consolidated prior to their apportionment among the worldwide taxing jurisdictions with an economic connection to the income. For the worldwide approach the borders of a country are thus not relevant. Therefore, this approach is more comprehensive.

Canada applies formulary apportionment at the subnational level. This is a variant of water’s edge formulary apportionment. At EU level, too, there is a call for Member States to apply a group approach to make their income tax systems more in line with the economic reality of multinational companies. The most far-reaching draft Directive in this respect is the CCCTB.4 Please note that the EC will replace the CCCTB with BEFIT in 2023. As indicated in par. 1.5, the CCCTB proposal will still be discussed in this research due to the alleged similarities between het two proposals. The CCCTB treats entities belonging to a group of companies within the EU as a single taxpayer. The CCCTB is also a variant of water’s edge formulary apportionment, for which the borders of the EU are relevant instead of the domestic borders. Therefore, it applies to a bloc group. A bloc group is a corporate group that consists of various members that are resident in a number of participating countries.5A worldwide formulary apportionment system computes the worldwide consolidated profits of a multinational group without reference to the legal form of the business. This goes a step further than a group taxation regime, a water’s edge regime and the CCCTB.

As discussed, on a tax treaty level a separate entity approach is currently applied. Each legal entity that is liable to tax is a treaty resident. The question arises whether the group approach that is taken in existing national legislation – both for group taxation regimes as well as for the group taxation 2.0 variants – could be desirable at the international tax treaty level. Therefore, this chapter revolves around the question: to what extent is a group approach currently applied in domestic tax law and would such an approach be recommendable from the perspective of the objectives of the OECD MTC? Basically, the question thus is whether such a group approach would contribute to preventing juridical and/or economic double taxation and/or tax avoidance, or more generally: would it stimulate cross-border investments by contributing to the neutrality of the system (i.e., are taxes levied in a way in which economic processes are distorted as little as possible)?

It could be argued that this approach is ‘the other way around’ as tax treaties solely allocate taxing rights, and thus restrict countries in their possibilities to tax income. Taxing rights granted under a tax treaty can only be enforced if a country has the possibility at a national level to tax the income or assets. Any potential changes to international tax treaties would thus also need to be reflected in national law. Even though it will probably not be possible in practice to reach an agreement to change the OECD MTC to use a completely new approach, and to correspondingly amend all national laws, this thought experiment can still provide insights on the application of tax treaties to groups of companies.

The starting point for this chapter is that it is clear what to tax, i.e., what the taxable basis consists of. This is taken as a starting point as on a tax treaty level the main question is how to allocate taxing rights. Determining the taxable basis as such is not in scope of tax treaties.

This chapter first of all explains existing group taxation regimes: who is the taxable person in those regimes and what are the tax consequences of the chosen approach (par. 5.2). Subsequently, it elaborates on group taxation 2.0 variants: water’s edge formulary apportionment, the CCCTB and worldwide formulary apportionment (par. 5.3). The systems are discussed starting with the system that least reflects the enterprise approach and continuing with systems that apply the enterprise doctrine to a larger extent. Both the question ‘who to tax’ as well as the question ‘where to tax’ is addressed. In this chapter attention is paid to the concurrence of the discussed regimes with tax treaties. Furthermore, the extent to which the systems could fit within the OECD MTC is discussed. The chapter ends with a conclusion (par. 5.4).