How should foreign profits be taxed?

This research reviews the recent debate on the taxation of foreign source income of multinational firms. For a long time the optimality of the tax credit system, referred to as the ‘old view’, was widely accepted, and served as an important benchmark in the policy debate. Recently, however, a ‘new view’ has emerged, which argues that rules for taxing foreign profits might be in need of reform. However, the direction of reform is controversial. Some authors view exemption as the best option on the grounds that domestic and outbound investment are not substitutes. Others argue for exemption on the grounds that, if corporation tax is a tax on domestic economic activity, justified as firms benefit from public services, then corporate income earned abroad should not be taxed domestically. A third, more pragmatic view, places less emphasis on the impact of taxation on the international capital allocation and focuses on the implications of taxes on foreign profits for administration and compliance costs.

Clemens Fuest