EconPol Policy Brief: A Simpler Way of Taxing Businesses in the Digital Age

The OECD should consider simpler rules for allocating profits and taxing rights to countries where international companies have their markets. This is a proposal put forth in a study by EconPol, the European Network for Economic and Fiscal Policy Research. The OECD has suggested that taxing rights of multinational companies should be allocated using a revenue-based formula. “I argue against the application of a rule that requires an international agreement on rules for assessing a common corporate tax base, which is a politically ambitious undertaking,” says Wolfram Richter, author of the study. A more practical method relies on unilateral profit splitting and can be implemented without determining a company’s common corporate tax base.

Countries could be granted the right to impose a withholding tax on outbound payments, such as payments for digital services. If there are allocable costs, as for example with pharmaceuticals and vaccines, these should be tax-deductible with the condition that the country receiving the payments adopt the new tax regime. “The distinctive feature of this method is that splitting is applied not to global profits, but only to the profit earned on remote sales to a foreign market,” Richter explains.

Under current international tax rules, multinational enterprises pay corporate income tax where production occurs. The OECD/G20 proposal aims to adjust international tax rules to the new digital economy. Its goal is to require large multinationals to pay some of their income taxes where revenue is generated; i.e., in countries where the consumers or users are located. To this end, profit allocation and nexus rules are being revisited. An agreement by the almost 140 participating countries is expected by midyear, but progress is slow. “The simpler method of profit splitting as suggested should be seriously considered by the OECD. Not only is it economically more convincing, but it might also facilitate reaching an agreement on a new international tax regime,” Richter concludes.