The Reform of International Taxation - An Uphill Battle

The taxation of multinational companies is not a topic suited for soapbox platitudes. It is simply too complex. Yet politicians continue to make it a subject of public debate. The governments of France, Germany, and the UK have declared that public coffers are threatened by the tax avoidance practices of multinational companies. EU Council President van Rompuy has placed this issue on the agenda of the next EU summit in May. And the president of France, François Hollande, has even declared that he wants to "eradicate" tax havens.

Generally it is a good thing that policymakers are dealing with the problem of tax avoidance. Yet there is a danger that this newfound attention for the issue will devolve into nothing more than an effort to pass the blame for the horrendous state of public finances, with multinational companies simply serving as a whipping boy. We can hardly blame companies for taking advantage of opportunities to lower their tax burden, provided they are not violating the law. Clearly, there are gray areas in which the dividing line between legal tax avoidance and illegal tax fraud is blurry. And while there are clear cases of tax evasion, these mostly concern individuals, and not multinational corporations.

In any event, tax fraud and tax avoidance are only one side of the coin. On the other side is the danger of double taxation. Invariably, multinational companies are faced with several countries seeking to tax their profits. One example is the upper limit on the deductibility of interest payments in Germany. Multinational companies that finance their activities with credit obtained from foreign subsidiaries are required to include interest payments taxable profits in Germany. However, these interest payments are also taxed as revenues abroad. In addition, some governments that denounce international tax avoidance create rules in their taxation systems that promote such avoidance. In the UK, for example, the so-called Patent Box came into effect on 1 April 2013. According to this rule, revenues from patents receive favorable treatment, with a lower tax rate on earnings of 10 per cent. This creates an incentive to shift taxable profits to the UK.

The reform of the international tax system does not merely require tax rules to become stricter. Double taxation as well as non-taxation need to be minimized. And this can only be achieved with action at the EU and global level. The international community needs to come to an agreement on if and how the right to tax corporate profits should be reallocated.

Source country taxation  is an important topic in reform discussions. This form of taxation has the advantage of making the relocation of profits to low-tax countries much more difficult. However, double-taxation agreements and European law place severe restrictions on source taxes . Changing the existing rules would be difficult, but not impossible. Participating countries would have to accept two things that they don't like: First, while they would acquire some taxation rights, they would have to forgo others. If cross-border interest payments and license fees are taxed at source, then they cannot be taxed a second time elsewhere. Germany, for example, would have to forgo taxing interest payments and license fees obtained by domestic firms from abroad. At a minimum, taxes paid abroad would have to be credited against taxes in Germany. Second, countries that collect source  taxes lose attractiveness for international investment. For this reason, many countries do not collect such taxes.

Accusations and inflammatory language are little help when it comes to reforming the international tax system. Reform requires tough negotiations, and making progress will always be an uphill battle. It remains to be seen whether international policymakers will demonstrate the patience and willingness to compromise that is essential for progress on this issue.