2.2.4 The rationale behind a worldwide unitary taxation approach

The basic principle of a unitary taxation system is that the consolidated profits of a multinational group are computed without reference to the legal structure of the business. Since the firm is a single economic entity, it should be treated for tax purposes as a single economic entity. Unitary taxation treats an international enterprise that operates via various permanents establishments or via various group companies as one single entity. Unitary taxation basically means that the worldwide income of a multinational enterprise is combined in a single unit for tax purposes. No attention is paid to the legal form of an entity. In this manner the economic reality that an entity usually is part of a bigger enterprise with a shared profit motive is recognized. Through unitary taxation the problem of the assumed economic independence of the various entities within the multinational enterprise can be avoided. Unitary taxation reflects the economic reality that a multilateral company is a single business with a shared profit motive.1

If worldwide unitary taxation were to be implemented, the ultimate parent company would have to be the taxable entity. The group companies would be seen as transparent from the perspective of the state of the parent company. In essence, the domestic and foreign subsidiaries of the parent company would be permanent establishments of the ultimate parent company.2 A global group approach would hence mean that the legal design of a company no longer affects the total tax burden. This is logical, as splitting an enterprise into various legally independent entities does not influence the possibility to pay taxes.3 Corporate profits made by group entities around the world would be consolidated in accordance with the unitary business concept. Consolidation is entirely logical for integrated cross-border economic activities. Transactions between the entities will often lack economic significance. Additionally, intra-group transactions can be subject to manipulation with an aim to avoid taxes.4 The ability to prevent inappropriate income shifting is one of the main benefits from unitary taxation.5 Eliminating transactions between group entities eliminates arbitrage possibilities. It is aligned with economic reality,6 which means a fairer outcome that is less disruptive to the market. If there is an equal economic situation, there is an equal treatment for tax purposes.7 Applying a group approach in national and international tax law is thus a first step in designing a tax system that stimulates cross-border investments: a system that does not lead to double taxation, nor creates opportunities for tax avoidance.

If all global corporate profits are consolidated, the choice of legal form is no longer relevant. Unitary taxation would lead to a similar treatment of activities conducted via a subsidiary company and a permanent establishment. This is positive, as substance, not form, should determine the tax consequences. Consolidation as such does not solve the puzzle. If the global consolidation also meant a harmonized system with respect to tax rate and tax base, there would be no fiscal competition between countries. It would subsequently depend on the other elements of the system to what extent it would contribute to a tax neutral system in which the influence on business decisions is minimized.8 If in this harmonized system, e.g., debt would still be favoured over equity from a tax perspective (i.e., interest deductible versus dividends non-deductible), this would mean business decisions would be influenced.

A unitary business approach does not stop at the borders of a country.9 If the group were to be regarded as a single subjective taxpayer, provisions would have to be introduced for adequate double taxation relief for foreign entities. In order to properly design rules for the avoidance of double taxation, the profits of a group should be allocated to the domestic part, as well as to the various foreign parts, of a group. As such, unitary taxation does not contribute to answering the question: how to allocate profits? After consolidation within the group, the profits should be allocated to the various affiliated companies around the world. This allocation can take place using a predetermined formula (formulary apportionment),10 global profit split11 or another method.12 It could theoretically even take place via the currently applicable arm’s length principle. However, if the allocation method would be the arm’s length principle, unitary taxation would not contribute to avoiding double taxation and to eliminating opportunities for tax avoidance.

A unitary taxation system would mean that profits and losses of the group members would be consolidated. Effectively this means that cross-border loss compensation would be possible. Therefore, the economic double taxation that could follow from the limited possibilities to utilize losses cross-border would no longer be an issue.13

As from a group perspective there would be no intra-group flows of dividends, there should be no withholding tax on these flows. A full abolition of dividend withholding taxes in an intra-group context would eliminate juridical double taxation14 and also a variant of economic double taxation.15 Additionally, under a group concept, the double taxation, which in principle exists when a company makes a profit distribution to its shareholder, would no longer be an issue.16 Rules to eliminate economic double taxation would therefore no longer be necessary in these situations. Furthermore, the tax avoidance possibilities that are available in the current international tax framework in this regard would no longer exist.

If there were no intra-group payments of interest and royalties, this would mean that there should also be no withholding taxes on the passive income flows. This would mean that juridical double taxation for interest and royalties would no longer be an issue. If companies within a group falling within the scope of the group concept were to be treated as a single taxpayer, i.e., if the profits and losses of such taxpayers were to be consolidated, provisions aimed at combatting base erosion and profit shifting via interest deductions would no longer be necessary. At present, the existence of the arbitrary distinction between equity and debt – particularly in a group context – offers opportunities for achieving an optimal financing structure for tax purposes. Such a financing structure does not need to have anything to do with economic reality. After all, interest payments between group companies do not affect the total profit of a group. The currently applicable anti-abuse provisions at a national level – such as thin capitalisation rules – would become superfluous under a group concept. This would also mean that there would no longer be a variant of economic double taxation due to the non-deductibility of interest costs.17

Due to a group approach, transactions between group companies would no longer be visible for tax purposes. For example, the transfer of an asset within a group would not directly lead to the realization of the hidden reserves. From the point of view of the group as an economic unit, this makes perfect sense. After all, within that unit it does not matter whether an asset appears on the balance sheet of the parent company or on the balance sheet of one of the subsidiaries. Reorganization facilities would thus become superfluous under unitary taxation. Also, exit taxation would no longer be an issue.

In a tax system based on unitary taxation, the corporate veil is no longer relevant for tax purposes. The tax avoidance opportunities that exist due to the recognition of separate legal entities would no longer be available. Intellectual property would no longer be a tool for tax avoidance.18 If a subsidiary would be established in a low taxed jurisdiction, this does not influence the combined profit of the unitary business as such. This would mean that CFC rules would no longer be necessary. Additionally, as there would be no qualification conflicts, hybrid mismatches can no longer occur.

From the above it follows that a unitary approach seems to have a lot of advantages. However, in the literature it has been stated that treating a multinational group as a single taxable entity is inconsistent with legal and economic reality, as well as with the ability to pay principle.19 Before discussing this statement, I will first elaborate briefly on the ability to pay principle in relation to corporations. Applying the ability to pay principle to corporations is based on the idea that legal entities have the wealth to be able to pay taxes. This follows from the fiction that a legal entity is put on a par with natural persons, which gives the legal entity the possibility to possess assets and liabilities. Though, there is discussion in literature on whether the ability to pay principle can be applied to corporate entities. In fact, successfully applying the principle would require looking through the corporate form to determine which individual ultimate bears the tax.20 In the end, solely natural persons have an ability to pay taxes.21

However, if we assume that a corporate entity has an ability to pay, the question remains whether treating a multinational group as a single taxable entity is inconsistent with legal and economic reality, as well as with the ability to pay principle. Within a multinational group an entity can go bankrupt, which not necessarily influences the other group companies.22 A loss-incurring entity within a multinational firm has a different ability to pay than a profit-making entity. Therefore, it could be stated that treating a multinational group as one taxpayer for corporate income tax purposes is not in line with legal23 and economic reality.24 There seems to be no doubt that treating a multinational group as a single taxable entity is inconsistent with legal reality. In fact, in light of economic reality the legal reality is put aside. Economic reality and the ability to pay can be said to correspond to the worldwide resources of the group: it helps to determine what should be taxed, not how to allocate the tax base around the relevant jurisdictions.25 If the outcome of the allocation is that a loss-making entity needs to pay taxes, this is indeed not in line with the economic reality of that specific entity. However, for the group as a whole, economic reality would be reflected.