The Destination–Based Cash Flow Tax and the Double Tax Treaties
Introduction
The destination-based cash flow tax (DBCFT), described further below, is intended to replace a tax on corporate income or profits. This paper discusses how a DBCFT, if adopted by one or more states, would fit with existing double tax treaties.1 Given that the form of double tax treaties is based on the assumption that both contracting states operate a traditional income tax system2 and given that a DBCFT is economically equivalent to a VAT combined with a reduction in payroll taxes, it is not surprising that, as the discussion below shows, treaties are poorly equipped to accommodate a DBCFT.
The treatment of a DBCFT under a double tax treaty depends crucially on whether a DBCFT is within the scope of the “taxes covered” provisions which are typically included in tax treaties, and in relation to which the various provisions of the treaty are intended to operate. The discussion therefore proceeds by reference to three questions:
1. Is a DBCFT within the scope of the taxes normally covered by double tax treaties?
2. What are the implications under the treaty of a DBCFT, both in the case where (i) a DBCFT is not in scope of the treaty’s “taxes covered” and also (ii) in the alternative situation where a DBCFT is in scope?
3. What are the key policy considerations, including (i) for states with a DBCFT and (ii) for states operating a traditional corporate income tax?
The discussion is pursued primarily by reference to the situation where one state introduces a DBCFT and a treaty counterpart state operates a traditional corporate income tax.
Working paper
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 Destination-Based 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 2018
How would a destination-based tax fit with existing double tax treaties?
The destination-based cash flow tax (DBCFT) has been proposed as a major reform of the international tax system by Michael Devereux and co-authors. The idea was seriously considered in the USA in 2005 and was again the subject of intense debate in the USA in 2017. Although it was ultimately rejected on both occasions, the political and economic forces that led to its consideration remain, and one can reasonably expect that it will be considered again in the future. This indicates the need for further analysis of the proposal. This paper discusses how a DBCFT, if adopted by one or more states, would fit with existing double tax treaties.
The provisions of most double tax treaties are based on the OECD Model Tax Convention on Income and on Capital, reflecting the assumption that both contracting states operate a traditional income tax system. Given that a DBCFT is economically equivalent to a VAT combined with a reduction in payroll taxes, it is not surprising that, as the discussion in the paper shows, treaties are poorly equipped to accommodate a DBCFT.
The treatment of a DBCFT under a double tax treaty depends crucially on whether a DBCFT falls within the scope of the “taxes covered” provisions which are typically included in tax treaties, and in relation to which the various provisions of the treaty are intended to operate. The analysis on this point is not straightforward and the paper therefore considers the relevant implications in the situation both where the DBCFT is covered, and where it is not.
The discussion identifies a number of existing difficulties with the OECD Model Treaty which have a wider relevance than simply to the status of the DBCFT for treaty purposes. For example, there is a discussion of the vague and imprecise standards for assessing the nature of a tax on “income” for treaty purposes. The paper also considers the key policy considerations. This includes the likely treaty policy of states enacting a DBCFT, as well as the implications for states with no DBCFT.
Richard Collier and Michael Devereux, “The Destination-Based Cash Flow Tax and Double Tax Treaties”, Oxford University Centre for Business Tax Working Paper 17/06, July 2017.
An abbreviated version of the paper, “The Border-Adjusted Tax and Tax Treaties”, was published in Tax Notes International, December 28, 2017, 1181.
Research Highlight 2017
The destination-based cash flow tax and double tax treaties
This paper discusses how a DBCFT, if adopted by one or more states, would fit with existing double tax treaties. Given that the form of double tax treaties is based on the assumption that both contracting states operate a traditional income tax system and given that a DBCFT is economically equivalent to a VAT combined with a reduction in payroll taxes, it is not surprising that treaties are poorly equipped to accommodate a DBCFT.
The treatment of a DBCFT under a double tax treaty depends crucially on whether a DBCFT is within the scope of the taxes.
Richard Collier and Michael Devereux, CBT Working Paper 17/06
