Residual profit splitting: a theory-based approach to tax multinationals

What is it about?

Internet giants such as Google, Apple etc. are known for paying hardly any tax on their huge profits. The current system of international corporate taxation makes this possible by shifting profits to low-tax countries. This is met with incomprehension by the public. The critical question, however, is how the current system should be reformed in order to remedy the deplorable state of affairs. The OECD is pushing its 2-pillar solution. Pillar 2 provides for minimum taxation without being able to ensure inter-jurisdictional tax equity. This is expected from Pillar 1 and the establishment of a new taxing right that does not require a permanent establishment nexus. While the implementation of Pillar 2 is quite advanced, skepticism is spreading about Pillar 1 for two reasons. Firstly, Pillar 1 works to the detriment of the USA, and it is hard to imagine that the USA will ultimately accept this. Secondly, there are conceptual reservations about the design of Pillar 1, which aims to subject large multinational companies to unitary taxation. This requires the abandonment of the well-established method of separate entity accounting (SEA) and the introduction of a formulary apportionment (FA) of the global profit tax base. The abolition of SEA meets with great reservations among tax experts. The introduction of unitary taxation requires a level of multilateral cooperation that the world has not seen before in comparably ambitious format. In view of geopolitical fragmentation trends, the proposal comes across as out of date. The attached article promotes the model of residual profit splitting (RPS), which offers several advantages. Thus, RPS • targets inter-jurisdictional tax equity • retains SEA and relies on withholding taxation • eliminates the incentive for profit shifting by addressing the flaws in the current system of corporate profit taxation at the root. The flaws are rooted in payment-based taxation which is an open invitation to transfer-pricing abuse, particularly (but not only) in the case of intangible assets. RPS is best interpreted as a theory-based generalization of the withholding tax solution of Article 12B, UN Model Tax Convention, to cases where an MNE maintains a physical presence in the source country or intra-group supplies of goods and services entail allocable costs.

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