Destination-based cash flow taxation
European Tax Policy Forum Policy Paper (2017)
Abstract
Governments worldwide use targeted tax policies to trade off the gains from increased FDI against the cost of excessive profit shifting by multinational firms. We show that optimal tax systems generally incorporate both thin capitalization rules, which tax discriminate between purely national and multinational firms, and controlled-foreign-company (CFC) rules, which discriminate between home-based and foreign-based multinationals. Introducing CFC rules is optimal if investment elasticities of home-based and foreign-based multinationals differ due to transaction costs for FDI. We also analyze the effects of reduced transaction costs for FDI and reduced costs for debt shifting on the optimal policy mix. Our results correspond to the observed development of anti-avoidance rules in OECD countries.
Working paper
WP 15/21 Wei Cui, Critical Review of Proposals for Destination-Based Cash-Flow Corporate Taxation as an International Tax Reform Option
WP 14/07 Michael P. Devereux & Rita de la Feria, Designing and implementing a destination-based corporate tax
Research Highlight 2019
Are destination-based taxes incompatible with WTO law?
Over the past 15 years, the United States has twice considered introducing a destination-based cash flow tax (DBCFT) as a way of reforming its corporation tax (in 2005 and in 2016/17). The DBCFT has two main advantages over the existing system (and others currently being considered by the OECD): it is economically efficient – leaving business investment, location and financial decisions unaffected by taxation – and it is much more robust to profit shifting.
Despite these advantages, the DBCFT has not (yet) been passed into law. Many issues were raised and discussed in the US tax policy debate in 2016/17; one of these was the question of whether a DBCFT would violate the law of the World Trade Organisation (WTO). Legal scholars have generally argued that there would be such a violation. This research project sets out to analyse the position, and comes to a different – and, to a certain extent, opposite – conclusion.
The research analyses historical records from the OECD and the Council of the General Agreement on Tariffs and Trade (GATT). This shows that the finding that the DBCFT would be contrary to WTO law is based on misconceptions as to how WTO law interacts with taxation. Indeed, this historical approach helps to show that some of the legal arguments made in past scholarship are also based on a misrepresentation of views expressed in the 1960s and 1970s. The project uses case-law materials to provide an extensive analysis of GATT and WTO law disputes on destination-based taxes.
The main conclusion of the paper is that there is a relatively low risk of the DBCFT being found to be in violation of WTO law. This could have a significant impact on future tax reforms in the United States and elsewhere. By using the DBCFT as a case-study to reflect on the trade implications of taxes imposed in the country of destination, this research also highlights that other new types of destination-based taxes should not be disregarded because of their alleged incompatibility with WTO law
Alice Pirlot ‘An Analysis of the Alleged WTO Law Incompatibility of DestinationBased Taxes’, to be published in the Florida Tax Review.
The DBCFT has been proposed and analysed in detail by the Oxford International Tax Group, chaired by Michael Devereux: see Alan Auerbach, Michael Devereux, Michael Keen and John Vella ‘Destination-based cash flow taxation’, Oxford University Centre for Business Taxation Working Paper 17/01. This will form part of an Oxford University Press book by the group, to be published in 2020.
Research Highlight 2017
Destination-based cash flow taxation
This paper sets out a possible approach to the international taxation of corporate profit: a destination-based cash flow tax (DBCFT). The idea of the DBCFT was first set out in a paper by Stephen Bond and Michael Devereux in 2001, and is one of a number of options that have been considered over the last three years by CBT’s group of economists and lawyers, chaired by Michael Devereux. The other current members of the group are Alan Auerbach, Michael Keen, Paul Oosterhuis, Wolfgang Schön and John Vella. In June 2016, the Ways and Means Committee of the US House of Representatives published a Blueprint document “A Better Way for Tax Reform”, which proposes a version of a DBCFT. Given the recent US debate on this proposal, we summarise the paper in some detail here.
The DBCFT has two basic components.
• The “cash flow” element gives immediate relief to all expenditure, including capital expenditure, and taxes revenues as they accrue.
• The “destination-based” element introduces border adjustments of the same form as VAT: exports are untaxed, while imports are taxed.
This is equivalent in its economic impact to introducing a broadbased, uniform rate VAT and making a corresponding reduction in taxes on wages and salaries.
The paper evaluates the DBCFT against five criteria: economic efficiency, robustness to avoidance and evasion, ease of administration, fairness and stability. It does so both for the case of universal adoption by all countries and the more plausible case of unilateral adoption.
• A central motivation for the DBCFT is to improve economic efficiency by taxing business income in a relatively immobile location – the location of final purchasers of goods and services (the “destination”). The DBCFT should not distort either the scale or the location of business investment and eliminates the tax bias towards debt finance.
• Taxing business income in the place of destination has the advantage that the DBCFT is robust against avoidance through inter-company transactions. Common means of profit shifting – including the use of inter-company debt, locating intangible property in low-tax jurisdictions and mispricing inter-company under a DBCFT.
However the distinction between universal and unilateral adoption is important. With adoption by only some countries, those not adopting are likely to find their profit shifting problems to be intensified as companies may seek to shift profit to countries adopting a DBCFT. These issues are explored in more detail in a separate paper by the same co-authors: “International tax planning under the destination-based cash flow tax”, CBT Working Paper 17/17.
• The DBCFT provides long term stability since countries would broadly have an incentive to adopt it – either to gain a competitive advantage over countries with a conventional origin-based tax, or to avoid a competitive disadvantage relative to countries that had already implemented a DBCFT. It would also be resistant to tax competition in tax rates.
The effective incidence of the tax would be on domestic residents financing consumption other than from wages, including from profit subject to the DBCFT. The DBCFT would be more progressive than a single rate VAT, and probably more so than existing corporate taxes. Fairness between countries is harder to assess, but – combined with taxes on natural resources – preliminary evidence suggests that few countries would be likely to see a reduction in their tax base as a result of border adjustment in itself.
The paper also looks closely at the application of DBCFT treatment to the financial sector, and raises and discusses a number of significant implementation issues - both administrative and legal.
Alan Auerbach, Michael Devereux, Michael Keen and John Vella, CBT Working Paper 17/01
Research Highlight 2011
Where should profit be taxed?
The international corporation tax system has developed in a way which has resulted in the primary place of taxation being where capital, or economic activity, is located. Although this is the international norm, its theoretical rationale is weak. As a proxy for personal income tax, corporation tax should be levied where the shareholder resides. But existing taxes do not follow this pattern, with the result that economic activity and profits are diverted between countries for tax reasons. This research project makes a theoretical contribution to analysing the most efficient location for taxing profit. It considers taxation at residence, source and destination (like VAT). It shows that a destination-based corporation tax can be neutral with respect to investment and location decisions. It also shows that an individual country could benefit from switching to a destination-based tax even if no other countries did so.
Michael Devereux
