IMF POLICY PAPER

CORPORATE TAXATION IN THE GLOBAL ECONOMY

March 2019
IMF staff regularly produces papers proposing new IMF policies, exploring options for
reform, or reviewing existing IMF policies and operations. The following documents have
been released and are included in this package:

 A Press Release summarizing the views of the Executive Board as expressed during its
February 21, 2019 consideration of the staff report.

 The Report, prepared by IMF staff and completed on January 22, 2019 for the
Executive Board’s consideration on February 21, 2019.

The IMF’s transparency policy allows for the deletion of market-sensitive information and
premature disclosure of the authorities’ policy intentions in published staff reports and
other documents.

Electronic copies of IMF Policy Papers

are available to the public from
[Link]

International Monetary Fund

Washington, D.C.

© 2019 International Monetary Fund

Press Release No. 19/69 International Monetary Fund
FOR IMMEDIATE RELEASE Washington, D.C. 20431 USA
March 10, 2019

IMF Executive Board Reviews Corporate Taxation in the Global Economy

On February 21, 2019, the Executive Board of the International Monetary Fund (IMF)
discussed a paper setting out the current state of international corporate income tax
arrangements.

The policy paper Corporate Taxation in The Global Economy, explores options that have
been suggested for their future development, including several now being considered in
global fora and considering the contribution of the Fund to debates and processes now
underway.

The IMF is not a standard setting body in this area. Intensive discussions of possible changes
to the international tax system are now underway in the Inclusive Framework on Base
Erosion and Profit Shifting (BEPS)/the OECD, and the paper is intended to complement that
work, reflecting the distinct contribution that the IMF’s broad membership, mandate,
expertise and capacity building work position it to make.

The paper builds on an earlier IMF analysis (2014), which stressed the macro-criticality of
international corporate tax arrangements, the importance of cross-country spillovers in
analyzing corporate tax reform and the particular vulnerability of low income countries to
profit shifting activities. The paper discussed on February 21 continues these themes. It
provides an update on what has been achieved, an account of remaining challenges, and a
high-level overview of key economic aspects and implications of alternative schemes, some
of which are now under discussion. Finally, it stresses the importance of fully inclusive
cooperation in this area and reflects on the supportive role that the Fund can play in this
context.

The paper notes the considerable positive developments achieved since the previous paper
was discussed, including the G20/OECD BEPS project and the expansion of the OECD’s
body for reaching consensus around these issues to include over 125 countries in the new
Inclusive Framework. It notes too, however, that issues remain in continued opportunities for
profit shifting, and that concerns regarding tax competition and, more fundamentally, the
allocation of taxing rights across countries now underlie much of the discussion within the
Inclusive Framework.

The paper does not endorse any specific proposals for international tax reform. It recognizes
that views differ widely. Rather the paper identifies and discusses potential criteria by which
alternatives might be assessed—with special attention to the circumstances of developing
countries—and provides some empirical analysis to support discussions.

The paper stresses the need to maintain and build on the progress in international cooperation
on tax matters that has been achieved in recent years, and in some respects now appears
under stress. It considers the supportive role that the Fund can play in this context, including
by drawing on its capacity building work to inform the standard setting that others lead, and
stresses the importance of cooperation among the international organizations active in this
area, including through the Platform for Collaboration on Tax.

Executive Board Assessment1

Executive Directors welcomed the opportunity to take stock of recent developments in

international aspects of corporate taxation, and offered preliminary observations on
alternative proposals currently being debated. They acknowledged the importance of these
issues to all Fund members in their efforts to raise revenues in an efficient and equitable
manner, and the potential for significant cross-border spillovers.

Directors welcomed the significant progress made in addressing corporate tax avoidance and
enhancing multilateral cooperation, notably by the G-20/OECD project on Base Erosion and
Profit Shifting, and the Inclusive Framework that has broadened the scope of cooperation to
many non-OECD countries. At the same time, they noted that there remain shortcomings in
current international tax arrangements, and that many countries face pressures to introduce
unilateral action. Directors agreed that much remains to be done to find sustainable global
solutions, building on the progress achieved so far to ensure fairness, inclusiveness, and
broad consensus, although their views differed on the extent of needed reforms and the roles
of relevant bodies.

As an important element of the current debate, Directors welcomed the discussion on tax
challenges associated with digitalization. They recognized that this is a difficult issue,
technically and politically, and that views on whether special treatment is needed, and if so in
what form, continue to differ widely. For the long term, a number of Directors considered
that it would not be desirable or feasible to design ring-fenced solutions. Directors looked
forward to the final report from the OECD to the G-20 in 2020, which could serve as a basis
for a cooperative approach going forward.

1
An explanation of any qualifiers used in the summing up can be found here:
[Link]
Directors noted other challenges that have yet to be fully addressed. They welcomed the
emphasis in the paper on profit shifting, which is a particular concern for developing
countries. They also pointed to the damage from continued harmful tax competition,
including the risk of a race to the bottom, while recognizing the importance of respecting
national sovereignty in tax matters. Some Directors were of the view that the benefits of fair
tax competition should also be acknowledged.

Directors noted that views on the relative merits of alternative reform proposals vary to a
great extent. They emphasized that much depends not only on the detail of specific proposals
and their implementation but also on the relative importance attached to the various
assessment criteria. Noting the tentative nature of the staff assessment, Directors stressed that
it should be interpreted and communicated with caution. While Directors considered it too
early to endorse any of the particular alternatives, they found the discussion a useful
analytical complement to existing debates. Specifically, many Directors saw the benefit of
minimum taxation in dealing with harmful tax avoidance and profit shifting practices.
Directors emphasized that, to better inform the ongoing debate, considerable further analysis
of the reform proposals is needed with respect to legal issues, practical consequences,
including distributional effects, and implications for various groups of countries with similar
or unique characteristics.

Directors underscored the need for an inclusive process for discussing international taxation,
especially as fundamental issues in the allocation of taxing rights come under discussion.
Many Directors felt that the current governance arrangements, with the OECD as a central
body and standard-setter and supported by the Inclusive Framework, are broadly appropriate.
At the same time, many Directors saw room for improvements, including to enhance the
representation of developing and low-income countries in the decision-making process.

Directors emphasized the important role of the Fund in the area of international corporate
taxation, focusing on its universal membership, macroeconomic perspective, and analytical
expertise. They stressed in particular the value of Fund advice and extensive capacity
building, helping member countries to implement best practices on tax policy and
administration. While recognizing that the Fund is not a standard-setting body in
international taxation, they noted that the Fund is well placed to undertake economic analyses
of the impact of possible changes, both within and across countries, as well as to ensure that
their implications for developing countries are adequately considered. In this context, most
Directors advocated a more active role for the Fund in providing analytical contribution,
influencing the debate, and fostering broader cooperation. A number of Directors stressed
that efforts to bridge data gaps would need to take account of confidentiality issues and
limited capacity in many developing countries.
Directors underscored the importance of continued close collaboration with the OECD and
other international organizations active in this area, to ensure that the Fund’s work remains
complementary to, and avoids duplication of, that of others. They noted that the Platform for
Collaboration on Tax provides a useful framework for bringing together the IMF, OECD,
UN, and World Bank, and could continue to play an active role in supporting international
tax coordination.
 CORPORATE TAXATION IN THE GLOBAL ECONOMY
January 22, 2019
EXECUTIVE SUMMARY
The international corporate tax system is under unprecedented stress. The
G-20/OECD project on Base Erosion and Profit Shifting (BEPS) has made significant
progress in international tax cooperation, addressing some major weak points in the
century-old architecture. But vulnerabilities remain. Limitations of the arm’s-length
principle—under which transactions between related parties are to be priced as if they
were between independent entities—and reliance on notions of physical presence of
the taxpayer to establish a legal basis to impose income tax have allowed apparently
profitable firms to pay little tax. Tax competition remains largely unaddressed. And
concerns with the allocation of taxing rights across countries continue. Recent unilateral
measures, moreover, jeopardize such cooperation as has been achieved.

This paper reviews alternative directions for progress. The call for taxation “where
value is created” has proved an inadequate basis for real progress. There now seems
quite widespread agreement that fundamental change to current norms is needed—but
no agreement, as yet, on its best form.

Key concerns are to better address both profit shifting and tax competition—and
ensure full recognition of the interests of emerging and developing countries. Low
income countries (LICs) are especially exposed to profit shifting and tax competition
(and have limited alternatives for raising revenue) and their limited capacity is now
stretched further by increased complexity. For them, securing the tax base on inward
investment is key.

Alternative international tax architectures differ not only in their economic

properties, but in how far they depart from current norms and the degree of
cooperation they require. No scheme is without difficulty, but there are clear
opportunities for improvement:1

 Minimum taxes on outbound investment can offer significant though incomplete

protection against profit shifting and tax competition and generate positive
spillovers for other jurisdictions (other than those with low tax regimes). Minimum
taxes on inbound investment can be especially appealing for LICs. These schemes
have the merit of being readily designed to complement current norms. But there is

1 It is assumed that primary taxing rights in relation to natural resources would remain with the location country.
INTERNATIONAL CORPORATE TAXATION

a tradeoff between ease of administration and risk of such bluntness as to

potentially jeopardize investment. Further, distortions remain (through for instance
the relocation of parent companies) and underlying weaknesses of the system are
patched rather than fixed. While minimum taxation has advantages over current
arrangements, it is not clear that it alone would prove a robust long-term solution.

 Further from current practice, but addressing current weaknesses more fully,
schemes of residual profit allocation (RPA)—broadly, allocating a normal return
to source countries, and sharing the residual on a formulaic basis. Such schemes
can substantially reduce profit shifting, as would other unitary approaches, while
retaining the familiarity of the arm’s length principle for straightforward cases. But
much depends on the way in which residual profits are allocated: tax competition is
more limited the greater the weight placed on allocation by the destination of sales
(or similar criterion), given the relative immobility of final consumers. The residual
profit allocation approach sets the scene for constructive discussion of the
allocation of taxing rights in relation to some part of international corporate profits,
though securing agreement on such apportionment will be difficult.

 Some allocation of taxing rights to destination countries features in many

proposals, including some residual profit allocation schemes: this is the most
effective way to address tax competition and profit shifting. Among such schemes—
and most remote from the current debate among policy makers—border adjusted
taxes—combining value-added tax (VAT)-like treatment of trade with a wage
subsidy—face potential World Trade Organization issues (because border
adjustability resulting in imports and exports being taxed differentially is not
currently permitted for (direct) corporate taxes) and may amplify refund problems
that arise under the VAT; and unilateral adoption could have significant adverse
spillover effects. They remain, nonetheless, the most complete solution to tax
competition and profit shifting. To the extent that erosion of the corporate tax leads
to increased reliance on the VAT moderated by a desire to keep labor taxes low, the
default outcome in the absence of more deliberate reform may be implicit but
imperfect taxation of this kind.

The economic impact and administrability of these schemes requires further

analysis—especially for emerging and developing countries. Even for advanced
economies, little is known, for instance, about the nature and extent of residual profits.
Data and research gaps for low income countries remain substantial.

Some improvements can be achieved unilaterally or regionally, but more

fundamental solutions require stronger institutions for global cooperation.
Addressing the distinct concerns of developing countries is critical, as is making full use
of the differing comparative advantages and mandates of relevant international
organizations.

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Approved By Prepared by Michael Keen, Victoria Perry, Ruud de Mooij, Alexander

Vitor Gaspar and Klemm, Christophe Waerzeggers, Cory Hillier, Kiyoshi Nakayama, Aqib
Rhoda Weeks-Brown Aslam, Sebastian Beer, Shafik Hebous, Kors Kool, Sébastien Leduc, Li
Liu, Zayda Manatta, Dinar Prihardini, and Alpa Shah. Research
assistance was provided by Victor Mylonas and Alice Park and
production assistance by Ana Popovich and Claudia Salgado.

CONTENTS

Acronyms and Glossary ____________________________________________________________________________ 5

INTRODUCTION __________________________________________________________________________________ 7 

TAKING STOCK ___________________________________________________________________________________ 8 

A. Recent Developments ___________________________________________________________________________ 8 
B. Key Problems with Current Arrangements ____________________________________________________ 10 

THE DIGITALIZATION DEBATE _________________________________________________________________ 14 

ALTERNATIVE ARCHITECTURES _______________________________________________________________ 18 

A. Evaluating Alternative International Tax Systems______________________________________________ 18 
B. Minimum Tax Schemes ________________________________________________________________________ 21 
C. Border-Adjusted Profit Taxes __________________________________________________________________ 25 
D. Formula Apportionment ______________________________________________________________________ 31 
E. Sharing Residual Profit ________________________________________________________________________ 35 
F. Assessment ____________________________________________________________________________________ 40 

GOVERNANCE OF THE INTERNATIONAL TAX SYSTEM AND THE ROLE OF THE

INTERNATIONAL FINANCIAL INSTITUTIONS _________________________________________________ 42 

ISSUES FOR DISCUSSION _______________________________________________________________________ 46

References__________________________________________________________________________________________76

BOX
1. Varieties of Digital Services Tax__________________________________________________________________17

FIGURES
1. Estimated Revenue Losses from Profit Shifting in 2013 _______________________________________ 10 
2. Trends in Statutory CIT Rates __________________________________________________________________ 12 
3. The Rise and Demise of the Largest Ten Companies __________________________________________ 14 

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4. Corporate Income Tax Revenue by WEO Income Group 1990-2017 __________________________ 20 
5. DBCFT and CIT Revenues ______________________________________________________________________ 28 
6. Factors Shaping the Revenue Impact of the DBCFT ___________________________________________ 29 
7. Tax Base Effect of Formula Apportionment ____________________________________________________ 34 
8. Excess of Current CIT Bases over Routine Return ______________________________________________ 38 

TABLES
1. Estimated Revenue Losses from Profit Shifting for the G-7____________________________________ 11 
2. Summary Assessment, Assuming Global Adoption ____________________________________________ 41 

APPENDICIES
I. Consultation____________________________________________________________________________________ 47 
II. The International Tax Framework—Core Elements and Concepts _____________________________ 49 
III. Multilateral Measures—BEPS and ATAD ______________________________________________________ 50 
IV. International Provisions of the TCJA __________________________________________________________ 53 
V. Profit Shifting: Evidence and Opportunities ___________________________________________________ 54 
VI. Tax Competition ______________________________________________________________________________ 57 
VII. Some Developments Concerning Developing Countries _____________________________________ 59 
VIII. Digital Service Taxes: Enacted and Proposed ________________________________________________ 61 
IX. Revenue Implications of Formula Apportionment ____________________________________________ 63 
X. The Scale and Allocation of Routine and Residual Profits _____________________________________ 69 

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Acronyms and Glossary

ACE Allowance for Corporate Equity
AEOI Automatic Exchange of Information
ALP Arm’s Length Principle/Pricing
ATAD Anti-Tax Avoidance Directive of the EU
BEAT Base Erosion Anti Abuse Tax (under the TCJA)
B2B Business to Business
B2C Business to Consumer
BEPS Base Erosion and Profit Shifting
CbC Country by Country reporting
CEN Capital Export Neutrality
CEMAC Communauté Economique et Monétaire de l’Afrique Centrale
CFC Controlled Foreign Corporation
CIN Capital Import Neutrality
CIT Corporate/Company Income Tax
CON Capital Ownership Neutrality
CSO Civil Society Organization
DBCFT Destination-Based Cash Flow Taxation
DBACE Destination-Based Allowance for Corporate Equity
Destination country Country in which the purchaser is located (same as market country)
DPT Diverted Profits Tax
DST Digital Services Tax
DTA Double Tax Agreement
EOI Exchange of Information
FA Formula Apportionment
FATF Financial Action Task Force
FDI Foreign Direct Investment
FDII Foreign Derived Intangible Income (under the TCJA)
GAAR General Anti-Avoidance Rule
GF Global Forum on Transparency and Exchange of Information for Tax
Purposes
GILTI Global Intangible Low Taxed Income (under the TCJA)
LIC Low Income Country
LOB Limitation of Benefit
LSR Location Specific Rent (rent uniquely associated with a specific location)
Market country Country in which the purchaser is located (same as destination country)
MLI Multilateral Convention to Implement Tax Treaty Related Measures to
Prevent BEPS (The ‘Multilateral Instrument’)
MNE Multinational Enterprise
Normal return Minimum return required on an investment
OIT Offshore Indirect Transfer

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PE Permanent Establishment
PCT Platform for Collaboration on Tax
PPT Principal Purpose Test
Profit shifting Shifting of where profits are booked for tax purposes, and encompasses
base erosion
Rents Earnings in excess of the normal required return
Residence country For a corporation (most frequently the location of managerial functions;
occasionally the place of incorporation)
Residual profit Profits in excess of routine
Routine return Broadly equivalent to normal return, commonly as identified by transfer
pricing methods
RPA Residual Profit Allocation
Source country Jurisdiction in which production of goods or services occurs
TA Technical assistance
TCJA Tax Cuts and Jobs Act: The informal title of the 2017 U.S. tax reform
Territorial system Business profits are taxed only in the source country
User participation Contribution by the user of the product to the business model
WAEMU West African Economic and Monetary Union
Worldwide system Business profits taxed in the residence country, wherever in the world
they arise—generally with credit for taxes paid in source countries

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INTRODUCTION
1. This paper takes stock of the current state of international corporate tax arrangements
and considers options for their future development. It builds on the analysis in IMF (2014) to
focus on developments—practical and intellectual—since then.2 That paper, which will be referred to
for background at several points, stressed the macrocriticality of the issues at stake, described
international tax arrangements and their considerable vulnerabilities, and sketched alternatives.

2. There has been significant progress on coordinated measures, most notably the
G-20/OECD Base Erosion and Profit Shifting (BEPS) project.3 This project sought to limit the
most egregious types of international corporate tax avoidance by achieving multinational
agreement on technical fixes and new/improved standards in such areas as transfer pricing and
treaty abuse. It did not, however, seek to change the fundamentals of the century-old international
tax architecture.

3. But there have also been unilateral developments going beyond the BEPS outcomes—
reshaping the debate and in some cases jeopardizing the coordinated approach of BEPS. The most
central are: (1) The 2017 U.S. tax reform (the ‘Tax Cuts and Jobs Act’, TCJA), which, in addition to
implementing BEPS, introduced major structural novelties in its international provisions; and, (2) The
adoption/announcement by several countries of short-term measures in the one area in which the
BEPS process has yet to find common ground: dealing with corporate tax aspects of digitalization.

4. With the international tax system in a state of flux, ideas for far-reaching reform are
receiving serious attention,4 reflecting wide recognition that the roots of current problems—not
only continued vulnerability to avoidance but unaddressed pressures from tax competition—are
deep. The destination-based cash flow tax and residual profit allocation schemes discussed in IMF
(2014) had rarely featured in policy discussions; since then, the former has been widely discussed in
the U.S.,5 and variants of the latter proposed by the U.S., U.K., and European Commission.

5. Against this background of risks to order in international taxation, this paper

considers options for fundamental reform. It begins by reviewing recent developments and the
key problems that remain, and then discusses one of the most prominent: the international tax
implications of digitalization. It then identifies and assesses more fundamental options for reform
before considering the capacity of current governance arrangements to achieve substantial

2 It draws too on a public consultation, key points from which are summarized in Appendix I.
3 The outcome documents are at [Link]
4 Schön (2017, pp.1) speaks of an “overwhelming consensus that the international tax regime needs to be
reshaped’’—but notes too that “this is not a self-evident truth.”
5Following the proposal in A Better Way: [Link]
[Link].

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improvement.6 Finally, issues for discussion are raised with guidance sought from Directors on the
impact of the paper on IMF advice going forward, including on the role of the Fund and the
Platform for Collaboration on Tax (PCT).

TAKING STOCK
6. This section reviews developments in international taxation since IMF (2014) and
outlines remaining problems. For background, Appendix II provides a primer on current
international tax arrangements.

A. Recent Developments

7. There has been substantial progress in aspects of multilateral tax coordination:7

 The G-20/OECD BEPS project, launched in 2013, aimed to close gaps in international tax rules
that allowed corporate tax bases to be eroded or artificially shifted to low/no tax jurisdictions.
The guiding principle was to “ensure that profits are taxed where economic activities take place
and value is created.”8 To this end, the project addressed 15 problematic areas, with the final
‘BEPS package’ of 2015—endorsed by G-20 leaders—including four ‘minimum standards’ and
amendments to core OECD guidance (on transfer pricing, for instance) and delineation of
preferred practices (such as on interest deductibility).9

 To facilitate and support BEPS implementation, the OECD has developed an innovative
multilateral instrument (MLI) that enables simultaneous changes to multiple Double Tax
Agreements (DTAs), and established an ‘Inclusive Framework’ (IF) whose (now 127) members
commit to the BEPS package and its consistent implementation, including the minimum
standards. Many countries have been very active in ensuring BEPS-consistency of their rules.10

 The European Union’s Anti-Tax Avoidance Directive (ATAD) makes some of the BEPS
outcomes, beyond the minimum standards, mandatory for member states (on interest
deductibility, for instance) and also includes other measures (for example in requiring a common
General Anti-Avoidance Rule (GAAR)).

 The cross-border exchange of tax-related information has continued to make remarkable

progress, notably within the framework of the Global Forum on Transparency and Exchange of

6It is assumed that it is desired to retain a substantial role for business-level taxation; and that personal-level taxes
can be used to achieve preferred outcomes in the final taxation of capital incomes. These are not trivial assumptions.
7 Details are in Appendix III.
8 OECD (2015f), pp. 4.
9 The Platform for Collaboration on Tax is preparing ‘toolkits’ to support developing countries address various issues
in international taxation, BEPS-related and other.
10 A useful tracking of measures adopted is at [Link]

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Information for Tax Purposes (GF, or Global Forum). The importance of the movement towards
Automatic Exchange of Information (AEOI) is confirmed by emerging evidence that this can be
especially effective,11 including in combating tax evasion. Both the G-20/OECD and the EU (for
non-EU members) publish lists of jurisdictions deemed non-cooperative, and the G-20 and the
EU have raised the possibility of countries adopting ‘defensive measures’ on this basis.

 In 2012 the Financial Action Task Force (FATF) standards were upgraded to include tax
crimes as predicate offenses to money laundering. They specify that countries must make the
beneficial ownership information of legal entities and arrangements available to national
competent authorities, including tax authorities; and recommend that countries ensure they can
rapidly exchange information related to money laundering and predicate offences.

8. There have also, however, been important unilateral initiatives going beyond BEPS,
and in some cases challenging established norms. These include:

 The adoption of ‘diverted profits taxes’ (DPTs) in the U.K. (2016) and Australia (2016), seen by
some as early departures from the consensual approach of the BEPS project.

 The Tax Cuts and Jobs Act, bringing not only a large cut in the federal U.S. corporate income tax
(CIT) rate (from 35 to 21 percent) but fundamental and novel changes in its international
provisions (Appendix IV)—one of which some have suggested may violate WTO rules and is
under review for consistency with the BEPS minimum standard on harmful tax practices.

 The adoption and proposal of ‘digital service taxes’ (DSTs) on revenues associated with selected
digital activities. These might be seen as attempts to circumvent the norm that only firms with
physical presence are liable to corporate income tax, and it has been suggested that the EU
proposal may violate WTO non-discrimination rules.12

9. The rapid trend towards the uncoordinated adoption of anti-avoidance measures risks
creating distortions. At one end of the spectrum General and (to a lesser extent) Specific Anti-
Avoidance Rules (G/SAARs) inevitably create uncertainties around notions of the artificiality of
business arrangements. At the other, while unilateral measures have generally been crafted to be
compatible with existing domestic laws and double tax agreement obligations, they may in some
cases result in double taxation, where the residence country may not provide full credit for their
payment. Double taxation is not inherently damaging—the total tax paid is ultimately what matters
most—but it can imply differential treatments across different taxpayers or arrangements, and
distort business decisions.

11Beer, Coelho, and Leduc (2019) find that AEOI reduces country-specific deposits in low-tax jurisdictions by
30- 40 percent—broadly in line with estimates in Johannesen (2014), Menkhoff and Miethe (2017) and Casi, Spengel
and Stage (2018). Pointing to the importance of full participation, several of these studies note, as do Johannesen
and Zucman (2014), signs of offshore deposits being relocated to other jurisdictions.
12 Hufbauer and Lu (2018).

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10. These trends may also amplify complexity and uncertainty—and potentially create
significant tensions. The BEPS project is not generally regarded as simplifying a system that was
already largely incomprehensible to all but the most expert. BEPS implementation, moreover, was
seen as creating additional uncertainty for both taxpayers and tax administrations.13 These concerns
are greatly amplified by the measures outside the BEPS outcomes that several countries have
adopted or proposed. Dispute is now elevated to the political level, as some measures are seen as
being unfairly targeted and violating established norms. Talk of ‘tax wars’ is premature—but
international tax relations have rarely been so sour.

B. Key Problems with Current Arrangements

Opportunities for Profit Shifting Remain14

11. Revenue losses from profit shifting have been substantial for many advanced
economies—and even more so for developing countries (Figure 1 and Table 1). Quantification
remains difficult—even the signs of the country-specific effects in Table 1 differ15—but work since
IMF (2014) confirms the significance of the issue.

Figure 1. Estimated Revenue Losses from Profit Shifting in 2013

500 2

450 1.8

400 1.6

350 1.4

300 1.2

250 1

200 0.8

150 0.6

100 0.4

50 0.2

0 0
Non-OECD OECD Non-OECD OECD

In billions, USD In percent of GDP

Source: Crivelli, de Mooij, and Keen (2016).

12. While it is too early to tell what impact recent initiatives will have, the scope for profit
shifting remains substantial—and unlikely to diminish. The estimates above are ‘pre-BEPS.’ But
significant profit-shifting opportunities still arise—most notably, but not only, in relation to the allocation
of risk within multi-national enterprises (MNEs), the valuation of intangibles, and the avoidance or

13 On the drivers of tax uncertainty, and measures to reduce it, see IMF-OECD (2017 and 2018).
14 Appendix V provides more detail.
15 This reflects quite different methods and requires further examination.

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limitation of physical presence. With the increasing importance and salience of complex, intangible-and
technology-heavy business models, these difficulties will only increase. One sign that the fundamental
drivers of profit shifting have not been fully addressed is an increasing use of essentially arbitrary
quantitative limits—such as those under the BEPS interest limitation rules, or even the 10-percent return
on tangibles specified in the Tax Cuts and Jobs Act.

Table 1. Estimated Revenue Losses from Profit Shifting for the G-7
(Percent of Collected CIT Revenue)
Clausing (2016) Beer, de Mooij, and Liu Tørsløv, Wier, and Zucman
(2019) (2018)
Year of data 2012 2015 2015
Canada … ... 9
France 23 6 21
Germany 28 2 28
Italy 16 -6 19
Japan 18 3 6
United Kingdom … -12 18
United States 26 15 14
Source: IMF staff compilation based on cited papers.

Tax Competition Continues16

13. The BEPS project and other recent multilateral initiatives have focused on tax
avoidance rather than what is arguably an even greater concern: tax competition. Such
competition is most evident in trends in statutory rates of corporate income tax (CIT) (Figure 2),
though it takes other forms too (such as special tax incentives). The consequent revenue losses can
plausibly outweigh those from avoidance. OECD (2015e), for example, estimates an overall revenue
loss from avoidance of up to 10 percent of corporate income tax revenue; that would be equivalent
to a cut in the statutory rate of around 2.5 percentage points17—only about half of what has been
observed since 2005, making avoidance harder could result in tax competition becoming more
intense—particularly for real investments. Whether tax competition is set to intensify remains
unclear, though some see the reduction in the U.S. federal corporate income tax rate as likely to
stimulate rate cuts elsewhere.18

16 Appendix VI elaborates.
17 Assuming an initial CIT rate of 25 percent, which is around the median for high income countries (Figure 2).
18 Beer, Klemm and Matheson (2018) suggest possible rate reductions elsewhere of around four points. The GILTI

provision, however—acting as a minimum tax—may moderate this, for reasons discussed below.

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Figure 2. Trends in Statutory CIT Rates

Source: IMF staff compilation.

Note: Including average subnational rates.

14. Current initiatives, focused on ‘harmful tax practices’ (offering preferential tax
treatment to firms without economic substance),19 leave some open questions. The recognition
that preferential regimes are not necessarily damaging is consistent with developments in thinking
over the last decade. Substance requirements, however, bring their own difficulties: potential tax
savings may be so large that companies are willing to allocate whatever resources are needed to
pass a substance test, however unproductive they truly are in that use; and tax competition becomes
focused on attracting real activities. This reflects inherent limitations in addressing tax competition
only in the form of specific regimes; it is increasingly recognized that low/zero taxation have adverse
spillover effects.

Developing Countries Face Distinct Challenges

15. Progress has been made in areas important for developing countries20—but
complexity has increased, and profound vulnerabilities remain.21 The four areas of particular
concern identified in IMF (2014) have received attention since, but remain far from fully resolved
(Appendix VII). Given their vast complexity, however, it can be very hard for many developing
countries and small states to implement the new global standards and common approaches of the
BEPS package, or even to grasp their full implications. This, and dealing with the greater expertise of
multi-national enterprises, is a potential drain on scarce talent needed to address what can be more
pressing domestic tax issues. Tension arises if countries feel pressured, by the possibility of adverse
international “listing”, to divert resources to amend practices that likely have little spillover effect or
domestic benefit.

19 The BEPS minimum standard (OECD (2015c)) and the EU Code of Conduct on Business Taxation (European Council,

1998). ‘Substance’ means the presence of real functions, indicated for instance by the presence of employees.
20 Meaning low and lower middle-income countries.
21 See also Trepelkov, Tonino, and Halka (2017).

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16. The distinct problems faced by, and capacity limitations of, developing countries
require tailored responses. The main forms of profit shifting affecting them are less sophisticated
than those affecting more advanced economies, and tax incentives are an especially prevalent form
of tax competition.22 While external support can help develop capacity, attention is needed to the
rules and norms themselves. Capacity limitations put a premium on the use of simpler methods to
protect developing countries’ tax bases. Not least, their interests—since they host no major MNEs—
can be quite different from those of advanced economies. Divergent views are evident, for instance,
on source countries’ right to tax cross-border service fees.

Digitalization Poses Challenges23

17. Issues raised by digitalization have become a centerpiece of discussions on the future
of international corporate taxation.24 The context is the increasing use of digital technologies
throughout business and the rise of new business models, exemplified by a few well-known firms
heavily dependent on digital technologies (Figure 3)—many of them provide a service without
charge (though more accurately regarded as a form of barter: access to the service in return for
personal information provided in the act of using it).25 Many of these firms are highly profitable yet
have in many cases paid relatively little tax anywhere.26

18. Two central features widely associated with digitalization—less need for physical
presence to do business and, in some business models, unremunerated acquisition of
information from customers—are not inherently new. These are not the only tax-relevant
features of the business models often seen as an issue: they also, for instance, have highly valuable
intangible assets, creating problems in applying the arm’s length principle. But none of these
features is qualitatively new or unique. Pharmaceutical companies for instance, also often have
significant hard-to-value intangibles. Goods can be exported, and services provided, to a country in
which an enterprise has no physical presence—and under current rules this does not create a right
for that country to tax the associated profits. Information about customers has long had commercial
value, and user contribution—an aspect discussed below—can arise in ‘non-digital’ contexts.

22 Documented and discussed in IMF and others (2015).

23 Digitalization raises many tax issues beyond those for corporate tax: see Gupta and others (2017) and IMF (2018a).
24 Digitalization creates some practical issues for the VAT and customs, ensuring for instance that remote sellers

remit VAT. But it raises few significant conceptual issues, other than the question sometimes raised of the proper VAT
treatment of the barter-like transactions described above.
25 See also European Commission (2014).
26It is hard to establish the effective tax rates faced by these companies, but they have likely been substantially
increased by the TCJA, both in respect of previously unrepatriated profits and by the ‘GILTI’ provisions.

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Figure 3. The Rise and Demise of the Largest Ten Companies

600

500

400

300

200

100

0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Average market capitalization of the 1980 top 10 Average market capitalization of the 2017 top 10

Source: IMF staff compilation.

Note: The chart shows developments in the market capitalization of the largest 10 companies in 1980
and 2017. The largest in 1980 were: Exxon Mobil, General Electric, Coca-Cola, HP, IBM, Walt Disney,
Eastman Kodak, Ford, Intel, and du Pont. The largest in 2017 were: Apple, Alphabet, Microsoft,
Amazon, Facebook, Tencent, Berkshire Hathaway, Alibaba, Johnson & Johnson, and JPMorgan Chase.

19. They are, however, becoming far more pervasive and salient, suggesting a pragmatic
case for action. The functions of delivering goods or intermediating between buyer and seller have
become easier to perform remotely, and newer services such as the delivery of online content and
operation of social media require little if any physical presence. Whereas much traditional exporting
has been business to business, much of this newer business is business to consumer, and hence
more salient to consumers whose trust in the fairness of tax arrangements may be undermined by
the perception that their government receives little tax from firms so prominent in their daily lives.

THE DIGITALIZATION DEBATE

20. Dealing with the corporate tax implications of digitalization and new business models
is highly contentious, politically and intellectually. If there was any consensus in the initial
G-20/OECD report on digitalization,27 as in an earlier report by the European Commission (2014), it
was that attempts to isolate for special treatment a ‘digital economy’ (or ‘digital activities’) are
misplaced, given how pervasive these technologies are, and so unpredictable is their future
development. The implication was that measures seeking to ‘ring-fence’ a subset of firms or
activities would be inappropriate. However, policy in many countries has moved rapidly in the
direction of short-term measures while the search for a common approach continues at the OECD, a
final report to the G-20 being due in 2020.

27 OECD (2015b).

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21. Views on both the merits of the short-term measures adopted and proposed and the
need for fundamental reform to address digitalization differ widely. For some countries,
targeted action, pending a longer-term solution, appears to be a political imperative given domestic
views of under-taxation; for others, digitalization requires little change in current arrangements.
Some see proposed and enacted measures as merely a grab for revenue from a few prominent and
largely U.S. owned companies.28 Others see the challenges of digitalization point to the need for a
fundamental reformulation of international tax arrangements. The principles at stake are profound.

22. The principal argument used for departing from current norms relates to cases in
which user participation is inherent to the value of the product itself. In this view,29 there are
business models in which consumers do not simply derive some satisfaction from the act of
consumption but with that act provide some input that is fundamental to the commercial premise of
that model. By searching, for instance, they provide information that can shape advertising; by
posting on social media, they provide content that attracts other subscribers. Through such ‘user
participation’, they are “co-contributing to a business’ offering.”30 This then is seen as a form of
productive activity, akin to that traditionally associated with a physical presence, that should create a
right to tax in the country of the user but under current rules does not.31 Those rules, on this view,
therefore need adjustment, accepting this would be a fundamental departure from current norms.

23. A considerable problem with this approach is how to distinguish cases where users
create value from those in which they just consume. Implementation raises practical issues—in
defining precisely when the right to tax arises, and the income that then becomes taxable. These will
be hard to resolve without addressing a more fundamental point: so pervasive is the use of
(potentially monetizable) information generated by users—that is sent back to the manufacturer by
users of motor engines, for example, or of fridges—that drawing the line between cases in which
users are and are not contributors is inevitably fraught. This makes attempts to ‘ring fence’ particular
activities in this way highly problematic. While the underlying argument is based on users as
generating value, and so akin to a source-based claim, the wider the view taken of contribution, the
more the system resembles one that more generally attributes taxing rights to the destination or
“market” jurisdiction32—a direction of reform explored below.

24. A quite different (and less prominent) argument rationalizes taxation related to digital
business models as targeted to particular sources of location specific rents.33 The point is
clearest in relation to the information about themselves that consumers provide when, for instance,
they use a search engine. This has meaningful similarities to the extraction of a natural resource:

28 See for instance Hufbauer and Lu (2018).

29 Set out by the European Commission (2018a and b) and HM Treasury (2018a and b).
30 HM Treasury (2018b), pp. 9.
31 If the users were selling the information about themselves, their earnings would be taxable where they reside; but
if they are not explicitly remunerated, those earnings are implicit in those of the firm exploiting the information.
32 Wei (2018) stresses that user value can also be created in countries of ‘production’.
33 See in particular Wei (2018).

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information, in this view, is akin to, say, oil. Just as the rents associated with natural resources are
seen as a proper object of taxation where they are located, so might be the rents associated with
information about a country’s residents. The analogy with natural resources is not exact: information
is not a rival good, whereas oil is. But there are similarities: both are excludable, both might be seen
as collective national assets, and just as the value of crude oil increases as it is refined and
processed, the value of raw data increases as it is refined by algorithms and analytics. And critically,
both are unique to a particular location. The valuation issues may be greater in relation to
information (though they are not always trivial in relation to resources); but this raises issues of
practice rather than principle.

25. Implementing these approaches to taxing income associated with digital-heavy

business models would require significant changes to current norms and pose new challenges
for administration and compliance, making it an option only for the longer term. It would be
necessary to establish:

 A right to tax even when the multinational group has no resident entity or permanent
establishment—some form of ‘virtual permanent establishment’34—which requires reformulating
double tax agreements.35

 Rules for allocating the income to be taxed. The U.K., for example, proposes allocating ‘residual
profit’—a concept explained further below—partly by the value of user participation.36

For implementation (and beyond the need to identify taxpayers without physical presence), the
information that may be required (such as the volume of users and appearance of adverts) is not
currently collected by tax administrations. Much would need to be self-reported, and
administrations may seek some form of third party verification.

26. In the meantime, several countries have adopted or plan some form of ‘Digital
Services Tax’(DST) (Box 1). These vary significantly in detail, but have the common feature of
taxing turnover from specified activities rather than income.37 This partly reflects the difficulty of
identifying associated costs, but also seems intended to keep these taxes beyond the scope of tax
treaties.38 The ‘data as oil’ analogy, however, suggests a more positive view of turnover taxation, as

34The possible nature of such a test for ‘significant digital presence’ is outlined in European Commission (2018a);
similar criteria are in HM Treasury (2018b). Others suggest different criteria: see for instance Schön (2017) and Becker,
Englisch, and Schanz (2018). India has introduced a test of “significant economic presence” enabling taxation of
non-residents without physical presence (by virtue of sales made to/interactions with Indian consumers).
35The recent landmark decision of the U.S. Supreme Court in South Dakota vs. Wayfair Inc. et al may be the shape of
things to come: “Modern e-commerce does not align analytically with a test that relies on the sort of physical
presence defined [under earlier precedent]”.
36 HM Treasury (2018a) and OECD (2014).
37The administrative challenges are similar to those for the longer-term approach just described, but with simpler
calculation of the tax base itself.
38 OECD (2018) discusses design features bearing on the consistency of DSTs (or equivalent) with treaty obligations.

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analogous to the royalty that resource countries might wish to impose, whether as an imperfect
substitute when direct taxation of rents is difficult,39 and/or as a de facto export tax to exercise
market power that the individuals about whom information is extracted cannot assert individually.

Box 1. Varieties of Digital Services Tax

Prominent examples of actual/proposed DSTs are described in Appendix VIII. Key differences include:
The EU and U.K. proposals have similar scope—focused on social media, search engines and intermediation
services—but take different approaches to measuring user value. The EU takes a volume-based approach,
allocating revenue in proportion to how often an advert has appeared on users’ devices and the number of users
having concluded transactions on a particular platform, with the location of the user determined based on their
internet protocol (IP address). The U.K. in contrast envisages a value-based approach, looking for example to the
value of the advertising sales targeted at U.K. users, and the commissions generated by facilitating a transaction
with U.K. users. Questions remain as to how the definition of the user would determine the apportionment of
revenue from cross-border transactions, and how to apportion revenue derived from the sale of multinational data
sets.
Other countries (including India, Chile and Uruguay) have opted for withholding or ‘equalization’ taxes on
payments for advertising and other specified digital services made by residents to non-resident companies,
avoiding the need to apportion revenue attributable to domestic users. Simpler to design and administer, such
taxes risk avoidance by having related offshore entities purchase the services.
Some low-income countries (Benin, Tanzania, Uganda, and Zambia) have recently introduced taxes on the
use of certain digital services, though these are taxes not on the revenues of service providers but on access to
digital services, such as social media.

27. The efficiency effects of digital services taxes are not clear cut. The digital service tax
looks like a simple turnover tax, likely to be passed on to some degree in the price of the taxed
service. If the service, such as advertising, is itself used as business input then this becomes a
potential source of production inefficiency.40 However there are significant qualifications to this: (1)
If the marginal cost of providing the taxed service is low, then the digital services tax acts like a tax
on the firm’s quasi-rents: rents that are exclusive of costs sunk in establishing the business. The
primary impact may then be not on current pricing but on future investment; (2) The user
participation test means that the digital services tax applies in contexts with features of ‘two-sided
markets’ in which incidence effects are complex.41 While the potential revenue from digital services
taxes is significant, their efficiency effects remain unclear.

39In the extractives context, Boadway and Keen (2010) show that some royalty may be desirable if rent taxation is
vulnerable to cost-based profit shifting.
40To the extent that they reduce any tax-induced competitive edge foreign suppliers may enjoy over domestic (of
advertising targeted at domestic consumers, for instance) equalizing treatment between domestic and foreign
suppliers that will ease a production inefficiency.
41Firms may aim to shift some burden to the untaxed side: a tax on advertising creates an incentive to raise the price
charged (or reduce the subsidy provided) to users; the price of advertising services may even fall. On tax incidence in
two sided-markets, see Bourreau, Caillaud, and De Nijs (2016) and Kind, Koethenburger, and Schjelderup (2008 and
2010). A further consideration arises from the likelihood that using social media by final consumers is complementary
with leisure: which, on efficiency grounds, calls for relatively high taxation.

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28. Political pressures to introduce some form of digital service tax are strong in many
countries—but their uncoordinated proliferation creates complexity and jeopardizes tax
cooperation. Practitioners stress the compliance costs associated with divergences between the
emerging DSTs; the potential scope for disputes in identifying taxable activities; and the risk of
double taxation. What is evident and troubling, in any case is that the divergent approaches mark a
major departure from the incomplete but significant progress that the BEPS project has made in
taking forward thoughtful multilateralism in international tax matters.

29. The digitalization debate is emblematic of wider difficulties with the international tax
system, and its importance is largely in suggesting a need for more thoroughgoing reforms. It
shows that, while the general principle that tax be levied where value is created readily attracts
agreement, views can differ widely when it comes to deciding where exactly that is, the difficulty
being especially apparent for, but not limited to, digital business models. It is one which as is
increasingly widely acknowledged the arm’s length principle does not fully resolve. None of the
proposed solutions to the perceived problems from digitalization would deal with profit shifting and
tax competition.

ALTERNATIVE ARCHITECTURES
30. So fundamental are the challenges to the current international tax system that
alternative futures are now widely discussed—by policy makers, as well as academics and civil
society. After setting out criteria for doing so, this section evaluates four main alternative
international tax architectures.

A. Evaluating Alternative International Tax Systems

31. The BEPS objective of “taxing where value is created”42 is at best an incomplete
standard by which to assess international tax arrangements. There are circumstances of tax
planning in which it may be widely agreed that no value is being created. Beyond that however, the
phrase is far from providing the practical guidance needed to answer all questions: the digitalization
debate, as seen above, is only the most clear-cut instance in which there is evidently no agreement
on where value is created. More fundamentally, whenever value is the product of several
contributions, there is no unambiguous way to express that value as the sum of distinct
contributions.43 This objective also falls short as a standard of efficiency: if the place in which value is
created can be changed, it leaves open the possibility of distortions arising from differences in tax
treatment and of collectively damaging competition to attract the ‘value-creating’ activities. There is

42 Schön (2017), pp. 5 describes this as a “new mantra”.

43Grinberg (2018, pp. 19) summarizes: “the consensus academic view is that any exercise to define specific sources of
value creation is entirely subjective”.

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danger, moreover, that testing for value creation by the presence of production factors will lead to
the unproductive allocation of resources in search of tax savings.

32. Efficiency requires that rents—receipts above the minimum return required by the
investor—be taxed somewhere. Rents are an attractive tax base because they can be taxed
without distorting behavior: that is, without creating excess burden. Taxing rents has no impact on
investment for instance, and (since all costs of finance are deductible44) it eliminates problems of
both ‘debt-shifting’ (the use of intra-group loans to reduce lability) and ‘debt-bias’ (the incentive to
use third party debt, with significant risk to financial stability).45 Implementing rent taxes, however, is
not straightforward, partly because some costs (managerial effort, for instance) are hard to observe
and to provide deductions for. Moreover, many sources of rent—related to company-specific
knowhow, for instance—could be generated from alternative locations, so cannot be taxed without
fear of driving their generation elsewhere. There are some rents, however, specific to particular
locations; most obviously those associated with natural resources; deploying rent taxes in the
extractive industries is a standard IMF recommendation.46 Even with location specific rents, however,
the practical difficulty arises that standard avoidance techniques can be used to relocate their
apparent source across jurisdictions.

33. There are, however, few other robust principles for efficient international tax design,47
leading to a more pragmatic focus on identifying particular distortions. Various dimensions of
desirable tax neutrality can be identified: between alternative locations for outward investment
(capital export neutrality (CEN)), alternative sources of inward investment (capital import neutrality
(CIN)), and in the ownership of domestic assets (capital ownership neutrality (CON)). But it is
impossible to ensure all three without fully harmonized tax systems, and failing that, there are no
clear-cut results on the relative importance of each. Attention thus focuses more pragmatically on
specific signs of tax considerations dominating commercial ones or distorting competition.

34. There is even less agreement on standards of inter-nation equity—other perhaps than
the allocation of taxing rights over location specific rents to the jurisdictions in which they
arise. The case for allocating taxing rights over location specific rents to the location country seems
widely accepted—though putting this concept into legal language is challenging. It will, in any
event, be taken as given in what follows that source countries are to retain substantial taxing rights
in relation to natural resources. Beyond this, however, is a longstanding tussle for taxing rights
between ‘source’ and ‘residence’ countries—a critical issue for low income countries, which are
primarily ‘source’ countries. These two categories, however, are increasingly blurred, as it becomes
harder to tie down where profits are created and as corporate residence becomes increasingly
removed from economic fundamentals: corporate structures can be arranged to establish residence

44 Though different forms of rent tax achieve this is different ways, as will be seen.
45 See IMF (2009) and IMF (2018b).
46 IMF (2012).
47 See Appendix VII of IMF (2014).

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in a place advantageous for investment in third countries; and the residence of the parent
company—which can be, and often is, changed if the tax savings become large enough—is an
increasingly poor proxy for the residence of its shareholders.48

35. Critical concerns with any international tax arrangements are their vulnerability to
profit shifting and tax competition, touching on both inter-nation equity and efficiency. The
spillovers these can generate relate most evidently to inter-nation equity, through their impact on
the allocation of tax revenues across jurisdictions. Both raise efficiency concerns too. Companies
may, for instance, move real resources inefficiently in order to exploit profit shifting opportunities.
There is potential inefficiency too in terms of governments’ financing decisions: by reducing tax
revenue, these spillovers ultimately create a need to either deploy other tax instruments that are
more distorting (or inequitable) or cut public spending.

36. The importance of the corporate income tax to low income countries and their greater
vulnerability to profit shifting warrants special attention. Lower income countries tend to be
somewhat more reliant on the corporate income tax as a source of revenue than are other countries
(Figure 4). Moreover, any reduction in their corporate income tax revenue may be hard to replace: of
their main revenue sources, the VAT in many cases is already under stress, the personal income tax
remains weak and reliance on trade taxes is already high.

Figure 4. Corporate Income Tax Revenue by WEO Income Group 1990-2017

(Excluding Resource-Rich Countries,
p and in percent of Total Tax Revenue)
18

16

14

12
% Total Tax Revenue

10

0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Year

Advanced Economies Low-Income Developing Countries Emerging Markets

Source: Revenue Longitudinal Database (WoRLD).

37. Ease of administration and compliance are key concerns, and closely related to
assuring certainty in tax matters. The considerations here are broadly as in other areas of taxation,
including for example, the simplicity and clarity of obligations, the scope for self-assessment, the
ability to identify taxpayers, and the ease of verification and enforcement.

48For instance, about 54 percent of U.K. shares and 35 percent of US shares were held by foreigners at end 2016
(Office of National Statistics and Rosenthal (2017)).

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38. Legal commitments can also affect the viability of proposed reforms, whether in the
nature of hard law of (in particular) double tax agreements, WTO rules, and EU law, or softer rules
such as BEPS minimum standards and other agreements.

39. The evaluation of a scheme may be quite different depending on whether its adoption
is multilateral or unilateral. It will be seen below, for example, that there are schemes that
eliminate profit shifting if adopted globally but exacerbate it if adopted unilaterally. And multilateral
adoption would imply some consensus on the need to overcome legal obstacles.

40. Though not among the criteria, how schemes affect national tax revenues is of evident
interest in shaping the debate. The accounts that follow thus also present such (often limited)
evidence on this as there is.

B. Minimum Tax Schemes

41. “Minimum taxation” refers here to schemes ensuring that profits are subject to some
minimal level of taxation49—and so target, primarily, profit shifting. These can apply to
outbound and/or inbound foreign direct investment; both are envisaged in a proposal by France
and Germany.50

Minimum Taxation of Outbound Investment

42. Minimum (residence-based) taxation of outbound investment has long existed in the
controlled foreign company (CFC) rules of many developed countries—for which both BEPS and
the EU Anti-Tax Avoidance Directive (ATAD) envisage a heightened role. These rules vary widely, the
common feature being that some types of income earned by foreign subsidiaries51 are taxed
immediately to the parent, rather than only on remittance through dividend payouts (generally with
credit for foreign taxes paid). BEPS Action 3 recommends the adoption of controlled foreign
corporation rules, and makes design recommendations52 (but does not set any minimum standard),
with application when effective tax rates are “meaningfully lower” than those applying to the parent.
The anti-tax avoidance directive mandates a controlled foreign corporation rule which tests the
difference between tax paid and that which would be paid in the EU member state of the parent.

43. Under a worldwide tax system, controlled foreign corporation rules are essentially an
anti-deferral device. They ensure that tax is not deferred by retaining profits in foreign subsidiaries
subject to low or no tax.

49 This is distinct, for instance, from agreement on minimum statutory tax rates.
50Franco-German joint declaration on the taxation of digital companies and minimum taxation (December 2018). On
taxes of the kind discussed here, see also Grinberg (2018).
51 Some countries apply such rules only to corporations; others include ownership by individuals as well.
52 OECD (2015b).

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44. The move toward territorial taxation in almost all advanced economies strengthens
the case for some form of minimum taxation on foreign earnings. Territoriality means that
active business income earned in foreign subsidiaries (sometimes also permanent establishments) is
taxed only by the source country. This creates an incentive to make domestic income appear to arise
in low tax jurisdictions abroad, and so escape taxation at home. Charging some minimum tax on
income from abroad can then provide a backstop, without which territoriality can jeopardize
domestic taxation.

45. The U.S. “Global Intangible Low Taxed Income” (GILTI) tax, introduced by the Tax Cuts
and Jobs Act, is a minimum tax on outbound foreign direct investment returns (Appendix IV).
A principal rationale was to minimize the opportunity, heightened by moving to territoriality, to shift
intangible assets and their associated income to lower taxed jurisdictions abroad. It imposes a U.S.
minimum tax on the defined term “global intangible low taxed income”—profits above a 10 percent
deemed return on tangible assets located abroad—at 10.5 percent (if no tax is paid abroad), with
U.S. liability wholly eliminated if the foreign tax on that income exceeds 13.125 percent. One
estimate is that this provision will increase U.S. corporate income tax revenue by about USD 8
billion.53 The structure of and incentives created by the global intangible low taxed income tax are
complex,54 but this new approach has heightened awareness of the potential benefits of effective
minimum taxation of outward investment.

46. Variants of this approach can be envisaged. Rather than testing by reference to tangible
assets, one might simply tax any income of foreign branches or subsidiaries regarded as
insufficiently taxed;55 and the test might be applied country-by-country to eliminate avoidance by
pooling income across high and low-tax foreign jurisdictions.

47. The spillover effects of minimum taxes on outbound investment are broadly positive,
including reduced pressures on source countries to engage in tax competition. In effect, they
strengthen an element of worldwide taxation56 in a world with increasingly territorial systems. For
higher tax countries, they protect against low taxes abroad by reducing their benefit to the investor.
By the same token, however, they reduce the benefit to source countries of offering those low tax
rates. Minimum taxes on outbound investment can thus have a strategic effect of limiting the
aggressiveness of tax competition, which can be of benefit to those source countries themselves as
well as others. Any such induced increase in effective tax rates in low tax and source countries may
then also indirectly benefit other high tax countries. One risk of strengthening residence-based
taxation in this way, however, is a possible inducement to ‘invert’: that is, relocate the parent

53 Clausing (2018a).
54 See for instance Dharmapala (2018) and Chalk, Keen, and Perry (2018).
55 For EU members, inclusion of domestic subsidiaries would be required.
56 This was one of the reform options considered in IMF (2014).

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company to jurisdictions not imposing such a charge.57 The TCJA includes stern measures to
discourage this; common adoption would alleviate the problem.

48. The diminished scope for profit shifting simplifies administration and compliance, and
legal impediments are modest. There are complexities for tax authorities: for instance, in
identifying tax paid abroad, and verifying that it is not refunded or credited against some other tax;
and effective exchange of information arrangements will become even more critical. But these have
proved manageable. The approach can be designed to be consistent with current norms (including
double taxation agreements), with required domestic law changes capable of leveraging off existing
controlled foreign corporation rules—though a common design approach would be preferable to
reduce complexities and compliance burdens.

49. An important design issue is the rate at which the minimum would be set. The GILTI
provision, for example, sets a minimum at half the domestic rate. Setting a minimum below the
domestic rate in this way reduces, but does not remove, a potential distortion favoring investment
abroad. Charging earnings abroad at the domestic rate—establishing a pure worldwide system
without deferral—would be consistent with the principle of capital export neutrality. Setting a lower
rate is to some degree a compromise with principles of capital import neutrality and capital
ownership neutrality, leaving a substantial role for the source country rate in anchoring the final tax
paid by investors from all countries. Without the theoretical guidance between these principles
suggest a compromise may have merit but leaves open precisely where the balance is best struck.

Minimum Taxation of Inbound Investment

50. The Base Erosion Anti-Abuse Tax (BEAT) of the Tax Cuts and Jobs Act is a minimum
tax on inbound investment—and a blunt one. Companies resident in the U.S. pay whichever is
greater: (1) Their liabilities under normal rules or, (2) Tax charged at a lower rate but on a base that
differs from the normal base in not allowing deductions for items (such as interest, royalties, and
management fees) paid to related parties abroad that are commonly associated with profit
shifting.58 The latter element thus sets a minimum charge that limits the extent to which the tax
base can be eroded by such payments. The BEAT goes much further than the BEPS actions on
transfer pricing and interest stripping, applies regardless of the rate of tax applicable in the foreign
country on receipt of the payments in question, and applies to a broad range of payments. As with
the GILTI, so too the base erosion anti-abuse tax has prompted wider interest in schemes of broadly
the same kind.

51. Less blunt alternatives can be crafted, notably by denying a deduction for certain
payments made to related parties or removing the entitlement to treaty benefits unless the taxpayer
can demonstrate that those payments were subject to a minimum effective tax rate abroad.59

57 This can itself stoke tax competition, Clausing (2018b).

58 More detail is in Appendix IV.
59Implementing such a test—which could be defined in various ways—could be complex and would need
underpinning by effective EOI arrangements.

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Implementation is harder if the minimum is conditional on tax paid abroad, though the legal issues
are more navigable. The former is likely a price worth paying to limit distortions (at least for
developed countries). The latter requires consistency with current norms, such as those on non-
discrimination (meaning provisions should apply equally to like domestic transactions). And where
implemented as a residence-based measure, this can be designed consistent with existing DTAs.

52. Effective though such rules can be, they have an inevitable element of arbitrariness. In
taking the nature of some payment as a proxy for its potential abusiveness, they risk capturing
genuine business transactions and so cut through rather than resolve those vulnerabilities. This
arbitrariness may, nonetheless, be a price worth paying for resolving prominent difficulties while
avoiding the need for more thoroughgoing reshaping of the international tax order.

Minimum Taxes for Low Income Countries

53. For low income countries, simple measures protecting against base erosion on
inbound investment can play a critical role—as part of the core system, not an alternative
minimum. Few substantial multi-national enterprises are headquartered in low income countries,
but many multi-national enterprises operate there—making inbound rules of the essence, with
simplicity the key to effectiveness in an environment of constrained capacity. This calls for
straightforward measures of base protection as part of the core system, combined with the
minimum taxes (directed mainly at domestic avoidance and evasion) that many developing
countries already have—and which are often recommended in IMF technical assistance.60

54. One approach is to cap the deductibility of certain expenses to related parties. Many
low income countries have provisions of this kind: Côte d’Ivoire, for instance, denies
intragroup royalty payments and service fees exceeding 5 percent of turnover.

55. A broader rule denying local deductions for base-eroding payments not subject to
minimum effective taxation in the hands of the recipient can be appealing for low income
countries. Details (relating to carry forward, for instance), could naturally vary with countries’
circumstances; and placing the onus on the taxpayer to prove that adequate tax is paid by the
recipient is even more important in the low income country context. Rules of this kind could be
designed to be consistent with existing double tax agreements. A similar function could be served
through final withholding taxes at relatively high rates, but the ability to impose these could be
constrained by existing double tax agreements, unless amended or overridden. That could mean: (i)
Not offering reductions in withholding rates under applicable double tax treaties; and/or (ii)
Imposing withholding on certain payments to which they have not traditionally applied. An example
of the latter is found in the new UN model treaty provision that would permit withholding on cross
border payments for technical services.

60In Latin America, these minimum taxes are often based on gross or net assets; in sub-Saharan Africa, they are
commonly based on turnover. Best and others (2015) analyze the impact and merits of such a scheme in Pakistan.

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56. A more substantive issue for low income countries is whether such an approach might
be used as well as conventional transfer pricing, with possible expansion to cost of goods
sold.61 Use is also sometimes made of optional “safe harbors”: publicly set minimum profit margins
for defined sets of transactions, which are deemed to comply with the arm’s length principle.
Taxpayers do not need to produce a transfer pricing study, nor search for comparable market
transactions; they simply need to show a profit margin for qualifying transactions to fall within the
safe harbor level. The key for a successful safe harbor is that it targets homogeneous and relatively
simple transactions and the minimum profit margin is not set to be a tax benefit.

57. Such a rule could be combined with a “residual profit split” method, of the kind
discussed below. For example, a regime of denying deduction for some cross-border payments
made for the use of inputs within low income countries could be related to requiring a “normal”
return to those inputs to be taxable there.

58. Possible adverse effects on investment need to be borne in mind, and might be eased
by some coordination in adoption. Blunter tools ease administration, but run a greater risk of
impeding legitimate payments and discouraging investment. Countries that adopt such measures
unilaterally may consequently make themselves more exposed to competition from jurisdictions that
do not adopt them. Coordinated adoption could help limit the risk, that each country might see in
acting alone, of diverting investment elsewhere.

Summary Evaluation: Minimum tax schemes can be powerful in addressing profit shifting, and can
dampen tax competition. They face relatively modest legal impediments, though administration can
be complex. On inbound investment, they can be especially appealing for lower income countries.

C. Border-Adjusted Profit Taxes

59. Several alternative architectures involve some element of ‘destination-based taxation’:

the allocation of some taxing rights to the jurisdiction in which the purchaser is located.62 No
such taxing rights are allowed under current norms, and their possibility was barely considered
before the U.S. House proposal mentioned above. Now they are part of the policy debate, with
shades of destination-based taxation evident in recent developments. The Tax Cuts and Jobs Act, for
example, applies a reduced rate to export earnings and limits some deductions for payments
abroad. And the notion of user participation as creating a taxing right, though conceptually quite
distinct, in practice allocates some taxing rights to jurisdictions in which final users of a product are
located. Indeed, and though doubtless unintended, the call to tax where value is created might seem
to imply some taxing rights in the destination country since there is no value without buyers.

61 Measures affecting trade in goods also need to be carefully designed with regard to applicable WTO rules.
62 Destination rules might follow the principles of the OECD’s International VAT/GST Guidelines.

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60. Border adjusted profit taxes are a special form of destination-based taxation, marked
by the exclusion of exports from the tax base and the inclusion of imports.63 In this respect
they are just like the VAT, which excludes exports from tax by zero-rating them64 and fully taxes all
imports; the key difference is that labor costs are deducible under a border adjusted profit tax, but
not under the VAT. (Destination taxation, it should be noted, can take forms other than border
adjustment, such as the use of sales as one factor in allocating a multi-national enterprise’s overall
profit, as discussed below).

The Destination-Based Cash-Flow Tax

61. The Destination-Based Cash Flow Tax (DBCFT)65 combines border adjustment with
‘cash flow’ treatment (that is, immediate expensing of investment without deduction of
interest). In a closed economy, cash flow taxation means that the government takes a share of all
receipts and (by allowing them to be fully deductible) bears the same share of all costs. The
government only raises revenue, in present value, to the extent that returns are above normal: the
tax thus falls only on rents.66 Destination basing ensures that the same applies in an open economy.
Receipts and expenses may then arise in different jurisdictions. Suppose, for instance, that exports
from the home country are taxed in the destination country at a higher rate than costs are deducted
at home. It might seem that investment at home will be discouraged. If these taxes are applied
generally, however, prices and/or the exchange rate can adjust so as to offset this effect. A
depreciation of the home currency (or increased prices abroad) can ensure that net receipts in
domestic currency are unaffected by the difference in tax rates, 67 and investment decisions will be
undistorted. Complexities arise in relation to financial flows, especially across borders: broadly,
destination- based cash flow tax proposals envisage disregarding them.68 Being a rent tax, the
destination-based cash flow tax leaves both investment and finance decisions undistorted: debt bias,
for instance, is eliminated.69

62. The DBCFT is equivalent to a broad-based single rate VAT combined with a wage
subsidy at the same rate. Movement towards a DBCFT thus has similarities to increasing the VAT
rate while reducing wage taxes. Conversely, the demise of the traditional CIT and increased reliance

63 For business purchasers, imports might either be taxed but deductible or simply non-deductible.
64 That is, providing full refund for any taxes paid on inputs
65 Proposed by Bond and Devereux (2002), further detail is in Auerbach and others (2017a), and an analytical
treatment in Auerbach and Devereux (2018).
66Cash flow taxation could also be introduced without shifting to a destination base, but tax competition pressures
countries toward lower tax rates.
67 Table 2 of Auerbach and others (2017a) illustrates the point. To see why domestic prices and/or the exchange rate
are expected to respond to adoption of a DBCFT, note that, levied at rate , border adjustment acts to raise the price
of imports purchased by final consumers by the factor 1 ; this can be offset, and relative prices left undisturbed,
if domestic prices and wages rise by the same factor or the currency appreciates by the proportion / 1 .
68 See Auerbach and others (2017).
69 Here as elsewhere, we abstract from possible distortions through personal taxation.

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on the VAT combined with a reticence to raise wage taxes—a direction in which many countries
have been heading70—has similarities to moving towards a DBCFT, but with the important difference
that real-world VATs are far from the single rate/broad base of an idealized DBCFT.

63. The incidence of a DBCFT would fall largely on recipients of rents in the adopting
country. If adjustment takes the form of an increase in domestic prices and wages, non-residents
are wholly unaffected, so the burden falls on domestic rent recipients and those on fixed nominal
incomes. If adjustment is in the form of an appreciation of the adopter’s currency, domestic wage
earners are again unaffected; while non-residents receiving rent income generated by activities in
the adopting country gain an increase in receipts in their home currency, this offsets the tax paid.

64. Adoption of a DBCFT (even unilateral) is not expected to affect trade. Unlike a tariff, a
DBCFT does not create a preference for domestic production over imports: all sales to final
consumers, imported or domestically produced, are taxed, and all domestic costs are deductible
whether used to produce for exports or for the domestic market. In a frictionless world, changes in
the real exchange rate immediately undo the border adjustment. In practice, sticky prices and/or
pricing in the currency of a DBCFT-adopting country would mean slower adjustment, but the effects
are expected to be small and fairly brief.71

65. Turning to evaluation, the principal and substantial merits of the DBCFT are that,
adopted universally, it would largely eliminate both profit shifting and tax competition:

 Since both exports and imports for business use are excluded when calculating the tax base—in
every country, with universal adoption—manipulating the apparent prices of such transactions
does not affect tax liability. With financial flows excluded from the base, opportunities for debt
shifting also vanish.72

 Tax liability under the destination-based cash flow tax ultimately turns only on the treatment of
the sale to final consumers: tax on intermediate transactions ultimately does not ‘stick,’ since the
purchase is deductible for the buyer. And to the extent that the location of the final consumer is
fixed (people being relatively immobile) there is no scope for seeking to attract tax base or the
activities that generate it.

Just as profit shifting and tax competition are minor issues under the VAT,73 so they are expected to
be under a destination-based cash flow tax.

70 Levels of and changes in statutory CIT and standard VAT rates have indeed been negatively correlated.
71 See Auerbach and others (2017a) and Buiter (2017). Barbiero and others (2018) show in a DSGE model that, while

there is no impact under local currency pricing, under U.S. dollar pricing DBCFT adoption by the U.S. would depress
exports and imports by up to 0.3 percent, though the impact would largely expire after 10 quarters.
72 Auerbach and others (2017b) elaborate.
73 Except in the case of cross-border shopping when indirect tax rates vary widely and for small high-value items.

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66. Adoption by only a subset of countries, however, could put intense pressures on
others. If only some countries adopt a destination-based cash flow tax, those maintaining an origin-
based system would experience dramatically increased incentives for outward profit-shifting, since
any profit shifted to a destination-based cash flow tax country would face a tax rate of zero.
Matching adoption of a destination-based cash flow tax is one possible response, though not
necessarily the best as that foregoes the opportunity to extract revenue from non-residents. The
potentially large shifts in exchange rates could also strongly affect international investment positions
of other countries, depending on their currency composition.

67. For resource-rich countries, a destination-based cash flow tax—and destination

taxation more generally—should be supplemented by source-based taxes focused on
capturing any location specific rents. The incidence of the destination-based cash flow tax is on
domestic residents, and the likelihood of trade surpluses, and hence revenue losses, is much higher
in resource-intensive countries. For resource-based (and other) location specific rents, origin-based
taxation is in principle efficient (albeit subject to implementation challenges) and can moreover
extract revenue from nonresidents. This need not though impede destination-based cash flow tax
adoption: rent taxes and other charges common in the extractive industries could be raised to
compensate for any revenue shortfall, though the sector will then continue to face pressures from
profit shifting.

68. Recent estimates74 suggest that, at unchanged tax rates, global DBCFT adoption would
mean significant short-term changes in national tax revenues (Figure 5), with little change of
the overall level.

Figure 5. DBCFT and CIT Revenues

(Averages over 2002-2011)
CIT Revenue DBCFT Revenue
15

10
Percent of GDP

‐5
KAZ

CYP

IRL

HRV

ESP
POL

EST
KOR

BGR

GBR

DEU

USA
GRC
DNK
SVN

HUN
SVK

BEL

COL

CAN

ITA

NZL
SWE

TUN

HND
BOL

MLT

MEX
GTM
MAR

LTU
AUS
LUX

AUT
NLD
ROM

JPN

PRT

LVA
CHN

CHE

CZE
CHL

FIN

FRA

ISL
NOR

UKR

Source: Hebous, Klemm, and Stausholm (2019).

69. Figure 6 illustrates characteristics associated with greater likelihood of a short-term

revenue gain from global adoption.75 Reflecting an impact driven more by destination-basing
than by cash flow taxation, these include:

74 The results presented in this section are from Hebous, Klemm, and Stausholm (2019).
75 Each of these factors proves significant controlling for the others, though somewhat less so for income per capita.

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 Trade deficits: With imports taxed under the destination-based cash flow tax and exports
exempt, trade deficits are associated with higher revenue.

 Limited resource revenues.

 Low per capita income: This is surprising—one might have expected such countries to lose,
given their role as locations of production—but may reflect extensive avoidance under the
current system (the destination-based cash flow tax estimates assume full compliance).

70. These short-term effects may however be reversed over time, and/or offset by
changing the tax rate. Intertemporally, the effects may become smaller as trade balances adjust: to
the extent that trade balances over time, the revenue effect, in present value, is zero. Countries with
large positive initial international investment positions, on the other hand, which can finance future
trade deficits could gain in the long term (Auerbach, 2017). Even leaving that aside, the absence of
pressures from profit shifting and tax competition under a DBCFT mean that the rate of tax can be
adjusted as need be to maintain revenue without fear of adverse effect through those routes.

Figure 6. Factors Shaping the Revenue Impact of the DBCFT

Revenue Gain Revenue Loss
10

5
Revenue Change

-5

-10
-40 -20 0 20 40
Trade Balance
h i
CIT revenue DBCFT revenue CIT revenue DBCFT revenue
5
4

3
3
Percent of GDP
Percent of GDP

2
2

1
1

0 0
Developing Advanced Non-Resource-Rich Resource-Rich

Source: IMF staff estimates.

Note: Resource rich (i.e. resource-related share of exports more than 20 percent): AUS, BOL, CAN, CHL, CCK, KAZ,
MEX, NOR.

71. The adverse spillovers from unilateral adoption of the DBCFT could be large, while
global adoption could be difficult to agree on given major redistribution of revenues. Hebous,
Klemm, and Stausholm (2019) estimate that adoption by a large integrated economy such as the
U.S. could cause neighboring countries to lose about 40 percent of their tax revenue from multi-

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national enterprises. Multilateral adoption could limit these spillovers, but the potentially large
changes in national tax revenues create their own obstacles to global adoption.

72. Implementing a DBCFT would be relatively straightforward, the primary issues arising
in relation to refunds. Almost all tax administrations are familiar with border adjustment through
the VAT (though implementation under the destination-based cash flow tax—on the basis of
accounts rather than invoices—would be different);76 and deduction of wage costs is standard.
Difficulties would arise in identifying and bringing into tax sellers with no physical presence (mainly
for business to consumer business)—but so they increasingly do under the VAT.77 The deductibility
of wages, however, means that refunds would be more prevalent than under the VAT, amplifying the
challenge of protecting against fraud while ensuring prompt payment to honest businesses.

73. There are significant legal issues associated with the destination-based cash flow tax
potential inconsistencies arising with:

 WTO rules—despite its being economically equivalent to a VAT plus wage subsidy, each of
which is WTO-compatible. Views differ on whether a destination-based cash flow tax could be
drafted to avoid this risk.78

 Double taxation agreements—which absent physical presence do not allocate any taxing
rights to the country of the final sale. If the destination-based cash flow tax were held to be
within their scope, double taxation agreements would need amending.

74. This fundamental treaty issue arises for any scheme creating an inherent liability to
profit taxation in the country of final sale—as several of the options discussed below do.

A Destination-Based Allowance for Corporate Equity/Capital (DBACE)

75. A Destination Based Allowance for Corporate Equity (DBACE) faces fewer transitional
issues than the destination-based cash flow tax but might be less effective at preventing
profit shifting. The Allowance for Corporate Equity (ACE) form of corporate income tax retains
interest deducibility but also provides a deduction for a notional return on equity. It too is a tax on
rents, and it too could be border-adjusted.79 With appropriate choice of the notional rate, this
destination-based allowance for corporate equity would be equivalent in present value to a
destination-based cash flow tax.80 A destination-based allowance for corporate equity would raise
fewer transitional issues: it avoids the need for arrangements relating to the initial capital stock (as

76 That is, the equivalence is with a ‘subtraction-based’ VAT, with which there is little practical experience.
77 Approaches developed in the VAT context—simplified registration requirements and ‘one-stop-shop’ regimes for
firms selling into multiple jurisdictions—could also be used for the DBCFT.
78 See for instance Schön (2016) and Grinberg (2017).
79 See Hebous and Klemm (2018).
80 Assuming no allowance for pre-introduction capital under the ACE.

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depreciation is maintained) and debt stock (as interest deductibility remains).81 To the extent that
the notional rate is inappropriate, however, a destination-based allowance for corporate equity,
while reducing profit-shifting incentives and tax competition, would not wholly eliminate them:
inter-company loans at inflated interest rates remain possible, for example (unless deductibility of
interest on related party loans were denied).82 While a destination-based allowance for corporate
equity may thus be less effective than a destination-based cash flow tax, it nonetheless has many of
the same advantages—and could be a stepping stone towards it.83

Summary evaluation. Universally adopted, the DBCFT is robust against profit shifting and tax
competition; adopted unilaterally, it can aggravate both. Implementation can draw on experience
with the VAT, but there are significant legal questions such as those relating to consistency with
WTO rules and double taxation agreements. Implications for developing countries remain unclear,
but, with source taxation retained for natural resources, these are not necessarily adverse.

D. Formula Apportionment

76. Under formula apportionment (FA), accounts of all a company’s affiliates are
consolidated to generate a unitary tax base that is apportioned across jurisdictions on a
formulaic basis. Jurisdictions then apply their own tax rate to the apportioned base. Subnational
business taxes commonly work by FA, notably in Canada, Germany, Japan, and the U.S. In Canada,
for instance, the unitary base is apportioned across provinces—by commonly agreed rules—payroll
and sales, with special weights or formulae applying to certain sectors (such as insurance, banking,
and transportation). The provinces retain autonomy to apply their own credits to the apportioned
tax base. In the U.S., states can choose different weights for assets, payroll, and sales; and these may
vary by sector; Alaska, for instance, uses an origin-based sales factor for extractive industries.

77. The conceptual and practical difficulties in applying the arm’s length principle have
led to proposals to apply FA at the regional or global level. The subnational experiences indicate
that, as economic integration proceeds, formula apportionment presents itself as better suited than
the arm’s length principle for dividing profits of related companies across jurisdictions. In that spirit,
the European Commission has proposed a ‘Common Consolidated Corporate Tax Base’ (CCCTB) for
the EU.84 A two-step approach to implementation is envisaged. First, a uniform common tax base is

81 It would also generally be less volatile.

More subtly, Hebous and Klemm (2018) show that if the notional interest rate is not set at the correct level, there
82

would be incentives to change the global distribution of debt, and even to manipulate transfer prices.
83Closely related to the DBACE would be a Destination-Based Allowance for Corporate Capital (DBACC), which would
apply a common notional return on all capital, including debt (Kleinbard, 2005). Its advantage is in eliminating any
distinction between debt and equity finance. Like the DBACE, it only eliminates transfer pricing manipulation and tax
competition provided the notional interest rate is set at the correct level.
84European Commission (2016a). This re-launched, with modifications, a 2011 proposal. For analysis, see Bettendorf
and others (2010); Spengel and others (2011), and European Commission (2016b).

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established across member states. Second, EU-wide taxable profit is apportioned across member
states by three equally-weighted factors: assets, sales by destination and labor (in turn equally
weighting payroll and employees). Worldwide formula apportionment has also been proposed by,
for example, the Independent Commission for the Reform of International Corporate Taxation (2018)
and Picciotto (2016). Support for such proposals often reflects a view that developing countries
stand to benefit from formula apportionment,85 given the importance to them of production
activities. Whether this is indeed so, is discussed below, but evidence is sparse.

78. Formula apportionment would greatly reduce the scope for profit shifting, but
introduces other difficulties and is not immune from—might even worsen—tax competition
over real location decisions. By taxing multi-national enterprises on a consolidated basis, formula
apportionment eliminates scope for profit shifting through transfer pricing and other devices,
cutting a swathe through the problems of the arm’s length principle. It would induce potential
distortions of corporate structures: combining two independent firms would generally change their
combined tax liability;86 the arm’s length principle in principle avoids this, but in practice the current
system is far from neutral in this respect. Formula apportionment does not, however, eliminate risks
of tax competition if the factors used for apportionment are mobile. Indeed, if production factors
are used as weights, tax competition may become more intense, because the revenue gain from
attracting such factors comes not from an increase in local activity, but from being allocated a larger
share of the multi-national enterprise’s overall profit.87

79. The weighting factors used for apportionment determine the distributional and
efficiency effects of formula apportionment. By allocating the consolidated tax base using
proxies for substantial economic activities, formula apportionment can align the tax base closely
with some obvious fundamentals—where production factors are located, for example, or consumers
are based. Ideally, these factors should be easy to verify (to avoid manipulation by companies) and
relatively unresponsive to tax differentials (to minimize allocative distortions and tax competition).
Commonly used apportionment factors are:

 Production factors. Payroll, employment and assets are commonly used. Payroll would be
difficult to misrepresent, and much labor is relatively immobile. For tangible assets, valuation can
be non-trivial but there are commonly used methods; they (and some skilled labor) are though
relatively mobile, so that differences in tax rates across jurisdictions will distort their allocation.
Intangible assets are usually excluded because they are hard to value and relatively easy to
relocate; to the extent, however, that intangible assets derive from employment (R&D workers)
or tangible investments (such as laboratories), they are captured by those other factors. If

85 See, for example: [Link]

86 Gordon and Wilson (1986).
87Nielsen, Raimondos-Møller, and Schjelderup (2010). These issues are discussed further in McLure and Weiner
(2000), Avi-Yonah and Clausing (2008), Altshuler and Grubert (2009), and Clausing (2016).

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desired, proxies could also be used in the formula for the value generated by the users of digital
services and platforms, although how to best measure this remains unsettled.88

 Third party sales. These can be measured on either an origin basis (location of the seller) or on
a destination basis. Apportioning by the latter has several of the advantages of destination-
based taxation discussed above, but risks arise in the formula apportionment context through
the channeling of sales through low-margin unrelated firms based in low-tax countries.89

80. Changes in the tax base from adopting formula apportionment can be significant—
with modest but mostly positive effects for emerging market economies. Global revenue might
increase under formula apportionment to the extent that the tax base is reallocated from low-tax
countries (to which profits are currently shifted) toward high-tax countries. But it might also
decrease, since losses can be immediately offset against the profits of affiliates. The net effect on
global tax revenue is likely to be slightly positive, and the distributional effects can be large.90 Figure
6 illustrates this, showing results from simulations (described in Appendix IX) based on two datasets:
aggregate data on U.S. multi-national enterprises, and firm-level data on global multi-national
enterprises. The results are no more than illustrative: they differ significantly between the datasets,
and coverage of developing countries is very sparse. But there are some consistent messages:

 Advanced economies are more likely to gain revenue if apportionment is by value added, payroll
or sales, and somewhat less likely to benefit if it is by employment;

 ‘Investment hubs’ are likely to experience significant reductions in tax base;

 Emerging economies tend to benefit from formula apportionment, although this is clearest for
apportionment by employment or sales, and less so if by value added or payroll;

 Developing economies may benefit if apportionment is largely by employment.

81. It would be challenging to secure international agreement on a common tax base.91 A

unitary group needs to be defined and its consolidated tax base calculated on a common set of
rules (following, for example, the International Financial Reporting Standards). Some flexibility could
be achieved by allowing countries to modify their apportioned share of the unitary base (by for
instance offering additional R&D deductions), but with the downside of creating additional
instruments for tax competition.

88 In its draft Directive the EC notes that the CCCTB rules would need amendment to capture digital activities.
89 This issue does not arise under the DBCFT/ACE/ACC, since cumulative liability depends only on the location of the

final purchaser, assumed immobile.

90 See for instance Devereux and Loretz (2008), Hines (2009), Cobham and Loretz (2014), and IMF (2014).
91The appropriate choice of base is not explored here, beyond noting that the tax could be shaped as one on rents
by structuring it as an ACE (as in the early proposal of European Commission, 2016c) or a cash flow tax.

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Figure 7. Tax Base Effect of Formula Apportionment

(in median impact per group, percent change)
For U.S. MNE Profit... For Global MNE Profit...
200 40.0

30.0
150
20.0

100 10.0

0.0
50
‐10.0

0 ‐20.0

‐30.0
‐50
‐40.0

100
‐50.0

‐60.0
150 G5 European investment Advanced economies Large EMEs All developing countries
G7 Investment hubs Advanced economies Large EMEs Developing countries hubs

Assets Payroll Employment VA Sales CCCTB Cobb‐Douglas Employment Value added

Source: IMF staff analysis based on data from the BEA and ORBIS. See Appendix X.
Note: G-5 = France, Germany, Italy, Japan, U.K.; G-7 = G5 + Canada, U.S.; European investment hubs = Ireland,
Luxembourg, Netherlands, Switzerland; Investment hubs = European investment hubs + Bermuda, Hong Kong
SAR, Singapore, U.K., Caribbean; Large EMEs = Argentina, Brazil, China, India, Indonesia, Mexico, Russia, South
Africa, Turkey, UAE. For other advanced economies and emerging market economies, see Appendix X.

82. And it would likely be even more challenging to secure agreement on the
apportionment formula. Allowing countries to choose their own, as practiced at state level in the
U.S., can lead to either more or less than 100 percent of total profits being allocated somewhere,
and divergent weights evidently complicate implementation. It can also induce tax competition
through the choice of weights: U.S. states, for instance, have moved away from using payroll and
assets, towards a larger weight for destination-based sales, presumably to attract employment and
assets. As experience with the European Commission’s common consolidated corporate tax base
proposal makes clear—and the results above illustrate—countries have such substantially different
interests that agreeing on a common apportionment scheme would be extremely difficult.92

83. Agreeing on regional formula apportionment among relatively homogenous countries

might be easier, but maintains current vulnerabilities in dealing with third countries. Under
the common consolidated corporate tax base proposal, for instance, companies would consolidate
only their profits earned within the EU, using the arm’s length principle to allocate relative to non-EU
affiliates. This can significantly limit the benefits of formula apportionment and raises questions
regarding the application of member states double taxation agreements with non-EU countries.93

84. Formula apportionment might be simpler to administer and comply with than the
current system, although this depends on its design and generality of application. So far as
transfer pricing issues are eliminated, formula apportionment would bring simplification and a likely
reduction in compliance and administrative costs.94 But complexities may arise too: for instance, with
the definition of a unitary group. Agreement on apportionment factors and accounting rules will be

92The Canadian FA arrangements, which—unlike those in the U.S.—emerged with central coordination, have proved
robust against pressures toward sales-only apportionment (Weiner, 2005). They have also been supported by an
equalization system that moderates their incentives to engage in tax competition (because gains obtained from
attracting a larger portion of the tax base are partly offset by transfers to other provinces: Smart (2007)).
93 Schön (2007).
94 Transfer prices will, however, still need to be determined for trade purposes.

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key to simplicity, and the need for cross-border cooperation enhanced: countries will seek
assurance, for instance, that apportionment factors relating to activities outside their jurisdiction are
properly calculated. Country-by-country reporting (a BEPS minimum standard) might help, but is
currently not designed for this purpose and only applies to the largest MNEs.

85. There may also be legal obstacles (beyond those associated with destination taxation)
to introducing formula apportionment in relation to existing treaties, which are built on
separate accounting concepts. One suggestion is that treaty partners agree to interpret their treaties
to accept the apportionment approach as being a feasible and administrable approximation to the
arm’s length principle.95

Summary Evaluation: Formula apportionment addresses profit shifting, but, depending on the
method of apportionment, scope for tax competition remains. Legal issues arise from the need to
establish new norms, but administrative challenges are modest. The revenue gain for developing
countries may be modest (at best) unless apportionment attaches heavy weight to employees.

E. Sharing Residual Profit

86. Much discussion and several recent proposals center around a distinction between
‘residual’ and ‘routine’ profit. The terms are often used loosely, but broadly:

 By ‘routine profit’ (a term of transfer pricing art) is meant an acceptable return to some activity
or function—broadly equivalent to a normal return (that is, the minimum required) on the
underlying activity (assembling a product’s subcomponents, or providing warehousing). How
this is currently calculated in practice is context-specific, the general aim being to identify the
return earned by an entity undertaking that activity on an outsourced basis. For activities intense
in capital assets, it might be calculated by applying some notional return to those assets based
on comparable third-party experiences; in other cases, a markup, based on financial statements
of comparable independent companies, is applied to purchases from third parties and labor
costs. The application of ALP methods in calculating routine profit is widely, though not
universally, regarded as reasonably effective and robust against manipulation. Some of the
schemes that have been proposed, however, simply apply common markups to all cases.

 By ‘residual’ profit is meant the excess of aggregate profit over routine profit. To the extent that
routine profit can be identified with a normal return on investment, residual profit is identified
with rent. It will tend to include that part of profit which—due to intangibles or risk-bearing, for
instance—is hardest to allocate across jurisdictions by standard transfer pricing methods. 

95 Avi-Yonah, Clausing, and Durst (2009).

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87. OECD guidance96 allows allocating residual profit in relation to specific transactions
and case-by-case. It envisages use of the ‘profit split’ method97 when both sides of a transaction
make unique contributions that are hard to value—though only in relation to specific sets of
transactions and with the method of calculation differing according to facts and circumstance.

88. In contrast, recent proposals envisage apportioning residual profit on a unitary basis—
so are ‘hybrids’ combining elements of formula apportionment and the conventional arm’s
length principle. Their common structure is that routine profits are allocated for taxation where the
associated costs (purchases from third parties) are incurred while residual profits are allocated (to
some degree, if not wholly) on some formulaic basis. Countries may then choose to tax these two
elements—routine profit earned in their jurisdiction, and the residual income they are allocated—at
different rates. We refer to this family of schemes as ones of Residual Profit Allocation (RPA).

89. Residual profit allocation proposals differ widely, notably but not only in the proposed
allocation of residual profit. Examples include:

 HM Treasury (2018b) envisages allocating residual profit of certain highly digitalized business
models in part by some indicator (perhaps based on revenue or the number of active users) of
the value created by user participation.

 The U.S. has proposed allocating residual profit attributable to ‘market intangibles’98 (such as
trademarks and brand recognition) to the market country with which they are associated.99

90. Others apportion residual profit in their entirety:

 An early proposal100 was to calculate routine profit by applying an agreed markup on third party
costs and apportion residual profit by destination-based sales.

 A recent alternative apportions residual profit by destination-based sales less third-party costs
(inclusive of the routine return) associated with them.101 One appealing feature of this scheme—
making it more familiar to practitioners—is that the final allocation can be reached not only by
apportionment but by intuitive hypothetical transfer pricing adjustments.

96 OECD (2018).
97 Formally, the ‘transactional profit split method’.
98 As opposed in particular to ‘product’ or ‘trade’ intangibles reflecting for example R&D and product design.
99 See, for example, reported comments made by U.S. Treasury officials at the 31st Annual Institute on Current Issues
in International Taxation, held December 13–14, 2018 in Washington, D.C. Grinberg (2018) provides a detailed
assessment.
100 Avi-Yonah, Clausing, and Durst (2009).
101 This is the ‘Residual Profit Allocation by Income‘ (RPA-I) of Auerbach and others (2018). A merit of this relative to
fully sales-based allocation is that it allocates less residual profit to jurisdictions that are costlier to serve.

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91. There have been several other residual profit allocation proposals in recent years,
differing in important ways.102 One might even interpret the US global intangible low taxed
income and foreign derived intangible income provisions of the Tax Cuts and Jobs Act as a form of
residual profit allocation applied to income earned outside the U.S. (including by exporting),
deeming a routine return of 10 percent on tangible assets (wherever located) and allocating half of
the implied residual to the U.S.

92. The implementation issues raised by these proposals differ, but commonly include a
fundamental change of principle in extending taxing right to destination or ‘user’ countries.
The U.K. proposal, for instance, raises the practical issue of how to quantify user value, and leaves
open the allocation of other sources of residual profit. Schemes that allocate partly by destination
face the possibility, as under standard formula apportionment, of avoidance by multi-national
enterprises selling final products to third party distributors in low tax jurisdictions. And schemes that
operate on a product or product line basis can add their own complexities and opportunities for
manipulation by strategic choice of product groupings. A common feature of many such schemes,
however, is that they envisage taxing rights being established even in the absence of a traditional
permanent establishment. This is a fundamental shift of principle, likely to require, for instance,
amendment of existing tax treaties—either to create a ‘virtual permanent establishment’ as
discussed above or to establish a generalized right to tax in the destination country.

93. Residual profit allocation schemes substantially eliminate opportunities for profit
shifting, but do not eliminate distortions or, depending on design, fully address tax
competition concerns. Scope for profit shifting is limited to routine profits; but the presumption is
that the arm’s length principle can identify these reasonably accurately. The taxation of normal
returns retains a distortion inherent in most current corporate income taxes; and the element of
origin taxation in doing so creates incentive for tax competition to attract mobile routine activities.
The force of this consideration may be modest, however, in that competition is only over a normal
return, not rents. There may, nonetheless, be a case for adopting minimum tax rates on routine
profits, while maintaining national discretion over rates applied to residual profits, especially if the
latter were allocated by some relatively immobile quantity, such as destination-based sales.
Incentives to compete to attract residual profit depend on the apportionment formula, with an
element of formula apportionment in residual profit allocation schemes meaning that the same
forces potentially encouraging tax competition between governments (and game-playing by firms)
identified above remain. They are lessened to the extent of apportionment by destination-based
sales or user participation.

94. Little thought has been given to the implications of residual profit allocation proposals
for developing countries. The interest in allocating residual income has come largely from the
desire of advanced countries whose companies create valuable intangibles and whose users are
seen as generating considerable value to ensure these contributions are reflected in their tax base.

102 In, for instance, the calculation of routine profits, crediting arrangements for taxes on routine and residual profit,

the precision of the proposed allocation of residual profit and in whether applied company-wide or by product.

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Much of course, depends on how residual profit is apportioned. For resource-rich countries, and as
with formula apportionment, it seems reasonable to suppose that as a matter of both principle and
practical politics, associated residual income will be allocated largely where the underlying resources
are located. For non-resource rich developing countries, allocating residual profit by final sales is
likely to be less advantageous than allocation by some indicator of activity—but, for those with
trade deficits, not necessarily wholly adverse. It may be, moreover, that tax avoidance by multi-
national enterprises means that residual profits—and even routine profits—are little taxed in these
countries, but largely shifted to low tax jurisdictions. To the extent that residual profit allocation
strengthens their ability to tax routine profit, it may on this account ultimately be to their benefit.
The calculus of national gain or loss from alternative schemes, however, is ultimately an empirical
and country-specific matter.

95. Empirical evidence on the level and distribution of residual and routine profits—across
both countries and forms—is scant, hampering the evaluation of residual profit allocation
proposals. Highly tentative empirical analysis reported in Appendix X, suggests, however, that:

 Residual profit is highly concentrated among a small number of firms: about one-third of all
residual profits accrues to the largest one percent.

 ...and is also concentrated among firms headquartered in a few economies (notably the U.S.,
U.K., Japan, China, and Hong Kong SAR).

 Many multi-national enterprises appear to have negative residual profits (this may be an artefact
of assumptions behind the calculations, but highlights the practical issue of how to apportion
residual losses).

 Many countries may currently collect less revenue than they would by fully taxing routine returns
(Figure 8).

Figure 8. Excess of Current CIT Bases over Routine Return

0.4
0.3
0.2
Residual Profits/GDP (%)
0.1
0
‐0.1
‐0.2
‐0.3
‐0.4

Lithuani a

Germany

Korea
Hungary
Mexico
Armenia

Canada

Mal ta
Spain

Portugal

Japan

Ireland
France
Kazakhstan

Croatia

Lat via

Romania

South Africa
Finland
Czech Republic

Nether lands

Luxembourg
Ukraine

Kuwait

Egypt
Saudi Arabia

Australia
Hondur as

United Kingdom
Italy

Slov ak Republic

Chile
Azerbaijan

Slov enia

Serbia
Sweden

Poland

Norway

Cyprus
Greece
Mongolia

Estonia

Bulgaria

Switzerland
Kyrgyz Republic

United States

Belgium

Denmark
Austria
Iceland

New Zealand

Source: IMF staff calculations.

Note: Numbers are for 2017 or latest available year if 2017 unavailable.

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96. Reducing profit shifting under residual profit allocation would benefit many countries,
but the effect on the distribution of tax revenue may be dominated by how residual profit is
allocated. Illustrative modeling in Appendix X, taking the example of wholly sales-based residual
profit allocation, suggests that effects through reduced profit shifting may be modest relative to
those from reallocating residual profit. Empirical understanding of patterns of routine and residual
profit, and the impact of alternative residual profit allocation schemes remains limited.

97. Cross-country coordination would be needed for generalized adoption of residual

profit allocation schemes—though whether more or less than for outright formula
apportionment is unclear. Whereas the adoption by one large country of a destination-based cash
flow tax, for instance, would generate strong incentives for others to follow suit, it is not clear there
would be similarly spontaneous coordination on any residual profit allocation scheme. A high tax
jurisdiction that barely manages to tax even routine profit might have an incentive to join a
destination-based residual profit allocation scheme if it has a significant domestic market, since it
would then be allocated some part of the residual profit currently shifted elsewhere. But a low tax
jurisdiction with no significant domestic market may prefer not to join if participation required it to
raise the rate it applied to routine profits. Countries would in any case differ in their preferred
apportionment, creating the same difficulties as noted above for formula apportionment.

98. The implementation and legal issues raised by residual profit allocation follow from its
nature as a hybrid. Essentially the same issues as for formula apportionment arise in the sharing of
residual profit. And the familiar tension arises between simplicity and accuracy: calculating routine
profits by applying general markups, for instance, is easier, but cruder, than doing so through case-
by-case application of the arm’s length principle.

99. The current focus on residual income and its allocation provides a constructive
framework for progress. Views will differ on the appropriate apportionment and much detail and
empirical understanding remains to be developed. Nonetheless, this focus signals a recognition that
the arm’s length principle has proved capable of dealing with relatively straightforward operations,
but not of addressing the full complexities of transactions within modern MNEs. While preserving a
significant element of source taxation, the RPA approach thus provides a framework within which
substantial progress might be made while retaining familiar elements of current arrangements.

Summary Evaluation: Residual profit schemes can effectively address the main forms of profit
shifting, though scope for tax competition remains, including in relation to routine profits.
Administration requires the additional step of dividing profit into two components, but the scheme
retains significant features of current norms and practice making legal implementation less difficult.
Secure taxation of a routine return could be attractive for many developing countries.

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F. Summary

100. The considerations set out above do not lead to endorsement of any specific proposal. They can
only guide the further analysis and debate needed of precisely defined options. In that spirit, Table 2 provides
an impressionistic summary evaluation of the schemes discussed above—assuming general adoption.103

101. Table 2 is to be interpreted with great caution:

 There is wide variation not only between but within these classes of scheme: introducing an element of
destination-based apportionment into formula apportionment, for instance raises a distinct set of legal
issues; and minimum outbound taxes that condition on taxes paid abroad are less simple but also less
distorting than those which do not.

 Schemes may be combined, and sequenced, in differing ways: formula apportionment could be combined,
for example, with minimum taxes; and residual profit allocation schemes could lead to full formula
apportionment.

 The implications of unilateral adoption could be quite different to those of universal adoption.

102. No scheme is without difficulty, and any assessment will ultimately depend on the weights
attached to the various criteria used. But some general les sons emerge:

 Other than the minimum tax schemes, all variants extend the notion of taxable presence beyond current
norms.104

 Expanding the notion of permanent establishment within the current architecture would have a modest
impact on profit shifting and tax competition; and how profits would be attributed remains unclear.

 The destination-based cash flow tax scores very strongly on protection against both profit shifting and tax
competition, and well on practical implementation; but its impact on low income countries remains
uncertain, and raises distinct WTO issues.105

 Minimum tax schemes achieve a good deal, including in protecting the tax base of low income countries in
a simple manner—although at the risk of creating distortions, including in violating capital export
neutrality. Since they face only modest legal obstacles, when well designed, they can be implemented
relatively quickly, perhaps as a transition to more fundamental change.

 Residual profit allocation and formula apportionment achieve progress by renouncing, to

differing degrees, the arm’s length principle. The former has practical appeal, given the current
state of international tax arrangements and debate, as a hybrid of the two. Residual profit

103 It is also assumed that natural resources and other sources of LSRs remain subject to source-based taxation.
104 The minimum approach would too if extended to include a user/destination-based element.
105 With global adoption, the significance of this would be moot.

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allocation is more challenging to administer, since it involves an additional step in identifying a

routine return, but marks out a clear minimum tax base for low income countries. Global
adoption, as envisioned here, would require substantial agreement on the apportionment
formula, which may be easier to secure with country rights firmly protected under residual profit
allocation.

103. All alternatives can accommodate approaches to digitalization of the kind envisaged
in the long-run solutions described above—subject to broadly similar issues arising in defining
presence and establishing the value of user participation. Minimum tax schemes could be overlain
on such arrangements, and user participation used as an apportionment factor under formula
apportionment/residual profit allocation. Under the destination-based cash flow tax, earnings on
barter-type arrangements would net out to zero if implicit prices paid on the two sides are regarded
as equal, but questions arise if they are not.106

Table 2. Summary of Broad Approaches, Assuming Global Adoption /1

Protection against: Ease of implementation: Suitability to

circumstances
Profit Tax Competition Practically Legally LICs
Shifting
Current arrangements
Digital PE/significant
economic presence
Minimum taxation /2 /3
DBCFT
FA /5 /4
RPA /6

Key:

Medium Medium
Low Low Medium High High

Notes:
/1 Source taxation is assumed to continue in the extractive industries.
/2 Minimum tax on both outgoing and inbound investment.
/3 Benefit mainly from inbound minimum.
/4 Gain most sure if apportionment largely by employment.
/5 Assumes apportionment partly by sales, all countries using the same formula; normal return assumed to be taxed.
/6 Robustness greater the more is apportionment by destination-based sales.

106 Devereux and Vella (2017).

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GOVERNANCE OF THE INTERNATIONAL TAX SYSTEM

AND THE ROLE OF THE INTERNATIONAL FINANCIAL
INSTITUTIONS
104. Smooth functioning of the international tax system requires much consensus—and the
alternative architectures above likely require, to differing degrees, more than yet seen.
Unilateral and uncoordinated measures of the kind that have begun to emerge threaten to descend
into disorder. A coordinated approach is needed to minimize adverse spillover effects in addressing
the challenges set out above. To this end, all the alternative futures sketched above require more
cooperation than has yet been achieved, though to varying degrees. Movement towards minimum
tax schemes, for example, requires far less coordination than would agreement on the weighting to
be used in some mechanical split of profits. While the urgent priority is to sustain the increased
cooperation in international taxation recently achieved, securing a coherent and productive future
for the corporate tax requires deepening it still further.

105. Countries prize their sovereignty in tax matters but accept constraints on it, in both
hard law (through the WTO, regional agreements, bilateral double taxation agreements) and soft law
(for example in relation to exchange of information and BEPS). They also enter into multilateral
arrangements107 that enhance their ability to assert sovereignty in administering their tax laws. What
is lacking is a comprehensive framework for agreeing and enforcing common views on core aspects
of rates and/or bases of taxation as they operate internationally—matters that need to be addressed
head on.

106. There are fundamental obstacles to deep agreement on international tax issues. That
there is no “World Tax Organization” (though this has had its advocates)108 likely reflects not simply
concerns with sovereignty but structural considerations making it harder to reach international
agreement in the tax area than, for example in relation to trade. One is the absence of principles for
international taxation as powerful as the case for trade liberalization. Another is that while in trade
policy it is the actions of large countries that shape the outcome, in the context of tax competition
small countries can clearly have considerable influence. Effective agreement must, somehow,
embrace not just a few large players but a large number of potentially small ones. With winners
from tax competition as well as losers, side payments (or coercion) may109 be needed to bring about
coordinated action that benefits all. Coordination among a subset of countries can be helpful,
particularly aligning countries around good practices. But it can be less effective in dealing with tax

107Including the Multilateral Convention on Mutual Administrative Assistance in Tax Matters and other agreements
to enhance the effectiveness and efficiency of their operations (such as those of the World Customs Organization).
108 Notably Tanzi (1995).
109Though not always: there are, for instance, cases in which agreement on minimum tax rates can benefit even
those countries thereby obliged to increase their rate: see Keen and Konrad (2013).

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competition, since constraining competition within the group may make its members more
vulnerable to tax competition from those outside110—creating an incentive not to participate.

107. Developments in tax cooperation are driven by the most advanced economies—
causing some unease. A caricatured view of international tax history in recent decades is that “the
United States takes the lead, the OECD and its members reach a compromise, and the rest of the
world follows the OECD.”111 It was doubtless natural that the advanced economies, intensely
engaged in cross-border investment for decades and with unmatched expertise, play a lead in the
evolution of international tax norms. But increased awareness of how important international tax
issues are to the revenue prospects of developing countries has led many, including in civil society,
to the view that the system over-protects residence countries’ rights relative to those of source
countries. All this creates some unease with the shaping of the system by advanced economies,
whose interests sometimes align with those of LICs (in relation to low tax jurisdictions, notably)—but
sometimes do not. It can be difficult for non-EU members to accept, for instance, an EU listing
process that imposes EU and OECD standards on non-EU members that were not involved in setting
them.112 Substantively too, standards developed for more advanced economies do not necessarily
translate easily to the circumstances of developing countries. Some may have difficulty, for example,
meeting the standards required to benefit from country by country reporting. More generally, it is
important to recognize that, given their deeper challenges in mobilizing revenue, international tax
issues are not necessarily such a priority for low income countries as for advanced/emerging
economies, and to ensure that pressures to comply with standards driven by those countries do not
distract low income countries’ scarce talent and resources away from more pressing revenue needs
and wider reform efforts.

108. Addressing current problems requires more effective and inclusive cooperation than in
the past—developing which is very challenging. Locating the lead institutional responsibility in
international taxation has proved highly contentious: a major disagreement at the 2015 Addis Ababa
Conference on Financing for Development, for instance, was on whether to upgrade the UN113
Committee of Experts on International Cooperation in Tax Matters to an intergovernmental body
(with members representing their respective governments), a proposal supported by many
developing countries and by some tax activists and academics.114

110Konrad and Schjelderup (1999). Building on this, Konrad and Thum (2018) argue that the regional tax coordination
can plausibly be a stumbling block rather than a stepping stone to global agreement.
111 Li (2002), pp. 867.
112This is not to say that some degree of pressure to induce cooperation is inappropriate: indeed, it can help to
overcome free-rider problems in a way from which even those pressured may benefit. But the perception of
legitimacy and inclusiveness can suffer. See for instance Oxfam (2017).
113The UN is traditionally seen as particularly protective of the rights of developing countries: see for instance
Lennard (2009).
114 See, for instance, Statement of Egypt on behalf of Group of 77 and China to the ECOSOC Special meeting on

International Cooperation in Tax Matters (New York, May 18, 2018)

[Link] [Link]

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109. The creation of the OECD’s Inclusive Framework (IF) is a positive development. It
embodies effective features in operating through soft law standards, supported by mechanisms to
ensure effective global implementation. The mechanisms also avoid the legal complexity associated
with developing a body based on “hard” obligations (for instance, based on one-country-one-vote
or quota-based systems). The “soft” law approach115 also lends itself to a consensus-based
mechanism.116 These features mean the Inclusive Framework holds potential of enhanced
cooperation beyond the implementation of BEPS for which it was created. Realizing the full potential
of the IF would, however, require taking on issues not covered by BEPS but of particular interest to
developing countries, such as the issue of service fees raised above. More generally, it would mean
engaging with the possibility of more fundamental reforms, including those outlined above.

110. Not all, however, see the Inclusive Framework as adequately accommodative of the
views and circumstances of non-G-20/OECD countries. While the Inclusive Framework places all
members on an equal footing for the BEPS implementation, they were not on an equal footing when
those standards were set. The weight attached to the distinct circumstance and interests of lower
income countries—on both agenda-setting and in outcomes reached—is likely to be limited,
moreover, by both the lesser capacity of many to engage on the highly technical (and fast-moving)
issues at stake and the dispersion of bargaining power among them. The former calls for external
support; the latter perhaps for the formation of ‘like-minded groups’ among them.117

111. The IMF has important contributions to make. International tax issues arise frequently in
the country-specific advice and the training that the Fiscal Affairs and Legal Departments offer to
over 100 members each year. Advice is country-specific, though there are common themes
(including not least the importance for low income countries of securing the tax base on inbound
investment). Increasing attention is also being paid to these issues in bilateral surveillance, often
focused on spillovers. Since 2016, such analyses in the context of Article IV consultation have been
undertaken for Belgium, Canada, Denmark, Egypt, France, Hong Kong SAR, Indonesia, Iran, Ireland,
Jamaica, Kenya, Malaysia, Mali, Nicaragua, Peru, Switzerland, Tanzania, the Philippines, the U.S., and
Uganda—with more in process. Topics include: the overall treatments of capital income, the impact
of the recent US tax reform, the effects of double taxation agreements for low income countries, and
the use of withholding on cross border services. Those analyses, along with others undertaken in
capacity development and new analytic work, are providing regional synthesis papers on
international corporate taxation issues for advanced European countries and for sub-Saharan African

development/2015/jun/25/ten-reasons-why-european-governments-should-back-global-tax-body; and Avi-Yonah

and Xu (2017).
115 Underpinned by a functioning dispute settlement mechanism, with supporting mechanisms to encourage

countries to abandon practices inconsistent with the agreed soft law principles.
116 A soft law approach can, however, be “vulnerable to political whims” (Cockfield, 2018, pp. 225).
117 As proposed by Rosenbloom, Noked, and Helal (2014).

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countries, with similar work having been done in Asia.118 The Fund also produces guidance
materials,119 and its conceptual and empirical contributions are much noted.

112. Research and data gaps continue to hamper full understanding of the distinct
circumstances of developing countries, and hence the appropriate tailoring of international
tax arrangements. There has been recent progress, but coverage of developing countries in
standard data sources remains low—as evidenced by the small number included in the exercises
reported above. The information that will be obtained from country-by-country reporting can
clearly be helpful in this regard. More generally, increased access to and use of micro-level tax
administration data, including in the wider academic community, is critical for further advance. Its
potential value has been shown in relation to the VAT, for instance, by the IMF’s RA-GAP program.120
Similar work on international tax matters for low income countries remains in its infancy.

113. A fuller role could be played by the Platform for Collaboration on Tax (PCT).121 The
current institutional environment for international tax cooperation has critical roles dispersed
through several international and regional organizations,122 with important functions performed by
all Platform partners. None has all the attributes required to enable effective and inclusive tax
cooperation—but each has some. The OECD and UN have expertise in multilateral standard setting.
The IMF and World Bank are leading providers of capacity building not only in international taxation
but, and as part of their engagement with their members, revenue and spending systems more
widely. Together with the UN, they also have an inherent inclusiveness from their broad membership
and mandates. Reflecting these comparative advantages, the PCT was established as a central
vehicle for its partners’ enhanced cooperation, enabling them to develop a common approach,
including regarding spillover analysis and advice, deliver joint outputs, and better respond to
requests for a global dialogue on tax matters. The PCT is not intended to set standards or monitor
implementation, but, for example, to “identify and analyze emerging international tax issues,
especially those of interest to developing countries—including with a view to possibly bringing them
to the attention of the Inclusive Framework.”123 A more purposive engagement of the PCT with the
work of the IF might help to build the inclusive and informed engagements—and shared
understanding—needed for substantial and consensual progress to be made in strengthening the
international tax system. Indeed, some respondents during the consultations for this paper
expressed a desire for the PCT to play a more prominent role in the international tax dialogue.

118 Underlying a regional ASEAN conference in 2017.

119 One example being Waerzeggers and Hillier (2016).
120 Hutton (2017).
121Formed in 2016, the PCT brings together the IMF, OECD, World Bank, and the UN:
[Link]
122 Including in particular the regional tax administration organizations, several now gathered into the Network of Tax

Organisations, facilitated by the International Tax Compact.

123 PCT (2016), Box 1, pp. 4.

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114. A more comprehensive multilateral approach is needed. There are good grounds to be
skeptical that a new and more comprehensive governance framework for international corporate
taxation will emerge soon. Nonetheless an approach more universal in its full inclusion of countries
and its coverage of fundamental policy issues is needed as it becomes increasingly apparent that the
current approach cannot deal adequately with mutually harmful spillovers and distortions from
uncoordinated policies. There is scope and need to build on the progress that has been made. The
Inclusive Framework and the PCT, for example, can do more to ensure that the concerns of lower
income countries are placed firmly on the international tax reform agenda.

ISSUES FOR DISCUSSION

115. Directors may wish to discuss the following issues:

 Do Directors agree that the international corporate income tax system requires substantial
reform, as described in the section “Taking Stock,” paragraphs 6-19?

 Do Directors believe that ‘digitalization’ requires specific tax solutions, or rather that it is
impossible/undesirable to ring-fence “digital” activities or firms, as discussed in the section “The
Digitalization Debate,” paragraphs 20–29?

 Do Directors agree that IMF advice should reflect the potentially differing impacts on low-
income countries of possible approaches to reforming the tax architecture, as discussed inter
alia in paragraphs 15-16, 36, 53-58, 67-69,80-81, 94-95, and 102?

 Do Directors have views on the alternative architectures described in the paper, and do Directors
agree with staff’s analysis of those alternatives, as discussed in the section “Alternative
Architectures” and summarized in Table 2?

 Do Directors agree that more country specific taxpayer-level information is needed to analyze
the impacts of international tax arrangements, especially for developing countries, as suggested
in paragraph 111? If so, do Directors see a role for the Fund in encouraging the collection and
analysis of such data?

 Do Directors feel that current governance arrangements in international taxation are adequate
and equitable, as discussed in paragraphs 103-113? What role do Directors see for the PCT in
the area of international tax?

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Appendix I. Consultation
1. There has been considerable interest in this project. Written comments were sought
online (responding to questions covering the topics addressed in this paper), and 11 detailed
submissions totaling more than 100 single spaced pages—some representing views of multiple
CSOs—were received.1 Direct consultations also took place, including: in a non-confidential East
Africa regional outreach event held in November 2018 in Tanzania;2 a series of meetings with
stakeholders in several European countries in September 2018; and meetings in China and Japan in
October 2018. Informal discussions were also held with several academic economists, policy advisors
and legal experts. A brief summary of main points and views follows.

2. Many respondents and participants felt that the BEPS project, while useful in several
ways suffered from two serious flaws: (1) Continued reliance on the ALP, which was very widely
3

seen as no longer suited to modern economic structures; as relying on the “economic fiction” of
separate entities; as increasingly complex; and as inappropriate, disadvantageous to, and hard to
implement by LICs; and (2) Essentially all respondents from developing countries and CSOs noted
the deliberate avoidance of considering the balance between source and residence taxation, seen as
failing to respond to the needs and interests of developing countries. Several CSOs noted the need
for an inclusive process that would go beyond the G-20 and not exclude options for deeper reforms.

3. Many respondents and interlocutors noted that tax competition is likely to intensify,
with significant spillovers on developing countries.

4. Essentially all agreed that increased digitalization of the economy significantly

exacerbates the problems in the current international tax framework. Unilateral measures, such
as turnover taxes, were generally viewed by CSOs, LICs—and some others—as unhelpful.

5. CSOs, and some developing country representatives, proposed that:

 Unitary taxation would be simpler, more effective and more equitable than the ALP. But
appropriate—and substantially agreed—apportionment factors would be required. Some noted,
however, that unitary taxation would not eliminate tax competition without consistent
apportionment factors and perhaps only combined with….

1 Comments are available online.

2 More than 2 dozen participants included representatives from the following organizations: Uganda Ministry of

Finance; Uganda Revenue Authority; Zambia Revenue Authority; Malawi Ministry of Finance; Rwanda Revenue
Authority; Tanzania Ministry of Finance; Tanzania Revenue Authority; Civil Society for Poverty Reduction (Zambia);
Oxfam in Kenya; Tax Justice Network Africa; National Taxpayers’ Association (Kenya); Natural Resource Governance
Institute (Tanzania); CSBAG (Tanzania); PwC; EY; KPMG; B&E Akolaw (Tanzania); FB Attorneys (Tanzania).
3 Though some noted that the implementation of even some of these welcome BEPS measures, such as the minimum

standard of CbC, encounter capacity constraints in many developing countries.

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 …a general minimum tax. A minimum tax alone could constitute an option for a partial fix
within existing arrangements, but would not address the system’s deeper flaws.

 Some felt that residual profit allocation methods—if suitably and simply designed, and again
mentioning minimum taxes—could constitute a significant improvement, and possibly create a
path to later adoption of formula apportionment.

 Destination-based taxation was seen as essentially mimicking the value added tax and was
opposed by all CSOs and LICs, as well as some academics.

 These groups also generally opposed imposing the CIT only on economic rent.

 An inclusive global governance for setting international tax standards and advancing
international collaboration was viewed as needed. Most CSOs favored a regime under the
auspices of the UN.

6. Government officials from developing countries also highlighted:

 Tax treaties’ risks for source countries, particularly with investment hub countries.

 Challenges faced in taxing cross border service payments.

 The need to attribute the taxing rights of LSRs to source countries.

7. Some government officials from developed countries noted that:

 A minimum tax could be used to strengthen the current international tax framework.

 A residual profit split method has potential merits.

 Digitalization requires recognizing the value created by consumers and users; ultimately a
global solution, rather than interim measures, is needed.

8. Some business representatives noted that:

 The G-20/OECD BEPS project has increased complexity.

 A residual-profit method could be better suited than current arrangements to cope with a
greater global business integration and group risk diversification.

 Withholding taxes are often relatively high in developing countries—speaking to the value
of DTAs—and DTAs frequently do encourage FDI in LICs.

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Appendix II. The International Tax Framework—Core

Elements and Concepts
Core elements of today’s international tax architecture—much of which dates back to a 1923
League of Nations report1—include:

 The principle of arm’s-length pricing (ALP), by which transactions between entities within an
MNE are to be valued for tax purposes at prices to which independent parties engaging in the
same transaction in similar circumstances would agree.

 Net Income from business activities of a corporation is allocated first to the “source”
country in which it is generated, with a residual right to tax in the country of residence of the
company, generally with a credit for taxes paid in the source country to relieve double taxation.2
The right to tax “passive income,”—e.g. interest, royalties, dividends—is generally allocated to
the country of residence of the recipient company, it having been thought harder to locate the
“source” of such income.

 Taxation of business profits by the source country, however, requires that there be “nexus” in the
form of a permanent establishment (PE), which requires a substantial degree of physical
presence in a country.3

 Corporate taxation of foreign income is deferred until repatriation to the resident company, with
Controlled Foreign Corporation (CFC) rules often adopted in order to bring into tax in the
residence country that income, especially passive income and sometimes low-taxed other
income, earned by foreign subsidiaries of the resident company abroad.

 Double Tax Agreements (DTAs), generally bilateral, aim to allocate the tax base across
countries consistent with the broad principles. While avoiding overlapping claims to tax income
they now also recognize risks of ‘double non-taxation.’ The treaty network has expanded
massively in the last 25 years or so, there now being more than 3000 DTAs, and the network has
grown to encompass relations between developing countries (generally ‘source only” and capital
importing) and advanced economies.4

1 Report on Double Taxation submitted to the Financial Committee—Economic and Financial Commission Report by
the Experts on Double Taxation—Document E.F.S.73. F.19 (April 5th, 1923)—Vol. 4 Section 1: League of Nations.
2 Increasingly, residence countries are giving up the residual right to tax business profits by providing an exemption.
3 This physical presence requirement has a parallel within the U.S. subnational tax regime in the form of “nexus.”
4 See Figure 3 in IMF (2014).

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Appendix III. Multilateral Measures—BEPS and ATAD

The BEPS Outcomes1

In four areas there are minimum standards, the expectation being that domestic law and/or
treaties will be amended so as to adopt them:

 To counter treaty shopping2 by including in treaties either limitation of benefit or more general
principle purpose test provisions (see Appendix VII) so as to restrict access to benefits.

 On transfer pricing and country by country reporting, MNEs with group turnover over €750
million are to make available general information on their activities to all countries in which they
are active, and to provide certain prescribed information on their assets, employees, pre-tax
profit, and tax paid and accrued in each jurisdiction (shared by the parent country consistent
with information exchange agreements).

 In relation to harmful tax practices, a particular focus on ‘patent boxes’ led to a ‘nexus’
principle that preferential regimes should only be offered conditional on substantial underlying
activity (see Appendix VI); rulings that raises BEPS concerns are to be shared automatically.

 For dispute resolution, measures to ensure timely and good faith outcomes.

In some areas, guidance is captured by amendments to core OECD reference documents

 The definition of a permanent establishment in the OECD Model Tax Convention is widened so
as to include, for instance, commissionaire arrangements (under which an agent undertakes
sales without being the owner of the product) and to address avoidance of PE status by
fragmentation of activities.

 On transfer pricing, the OECD Guidelines are amended, notably to address artificial transfer of
risk within groups and difficulties associated with intangibles (clarifying that taxation need not
follow legal ownership), and with some guidance in dealing with hard-to-value transactions.

In others, the outcome is guidance on a common approach, with an aspiration of convergence:

 On hybrid mismatch (the potential difficulty arising when an entity or instrument is regarded
differently in different countries (debt in one, equity in the other, for instance), rules are
envisaged to ensure that deductions not be given unless the associated income is taxable to the
recipient (albeit possibly, as a matter of policy, at zero rate).

1 Digitalization aspects are discussed in the text.

2 Meaning the artificial structuring of activities to exploit favorable treaty provisions such as low withholding tax

rates: see Box 2 of IMF (2014).

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 Interest deductions to be limited to 10-30 percent of earnings before interest, taxes,

depreciation and amortization (EBITDA), with carry forward of unused deductions or allowances;
but with possibility of increasing deductions up to the group-wide ratio of interest to EBITDA.

 Recommendations are given on details of Controlled Foreign Corporation rules—to ensure, for
instance, that tax is not inappropriately deferred and credit is given for any foreign taxes actually
paid….

 …and on provisions for mandatory disclosure of aggressive tax planning to enable the
authorities to identify and address emerging risks.

Some recommendations, and the minimum standards in particular, will require domestic law
reform and treaty changes. To facilitate this:

 The Inclusive Framework on BEPS was established to facilitate the implementation and
monitoring of agreed BEPS measures. Data is being gathered to assess the impact of the global
implementation of the BEPS measures, and a peer review process has already begun to ensure
effective implementation of the minimum standards. Significant progress has been made on
combatting harmful tax practices (255 preferential tax regimes have been examined, with 134
being revised or abolished), country by country reporting (over 1,800 reporting relationships
have been established, with exchanges started in June 2018) and dispute resolution (with
improved resolution of Mutual Agreement Procedure cases).

 A multilateral instrument was developed and entered into force on July 1, 2018 enabling
simultaneously modification of covered treaties to combat treaty-based BEPS concerns such as
treaty shopping once the ratifications of approximately 85 signatories become effective over
time.

Further and ongoing work has been undertaken to flesh out various aspects of the broad BEPS
outcomes, including: use of the transactional profit split method, application of the interest
limitation rules for the banking and insurance sectors, and transfer pricing issues for commodities,
hard to value intangibles and financial transactions. A series of ‘toolkits’ is being developed, by the
PCT, including for application of some of the BEPS outcomes in the special circumstances of
developing countries.

The Anti-Tax Avoidance Directive (ATAD)

The table below summarizes the main features of the ATAD, adopted in 2016, compared with the
BEPS minimum standards.

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Appendix Table 1. Key Features of ATAD

BEPS Action/
ATAD Measures Minimum Description
Standard?

ATAD prescribes an earning-stripping rule that

denies interest deductions if the ratio of net
Interest limitation rule Yes/No
interest payments to EBITDA exceeds 30 percent.
Unused deductions can be carried forward.

EU member states must implement CFC

Controlled foreign
Yes/No legislation in their national laws incorporating
company (CFC) rule
certain legal design features.

This rule counters tax planning that exploits

differences in countries’ legal characterization of
an entity or a financial instrument (leading to
double deductions or a deduction without an
Hybrid mismatches rule Yes/No
equivalent income inclusion). The rule was
extended in March 2017 to also cover
arrangements between EU and non-member
states (ATAD II).
Non-genuine arrangements that are put in place
for the main purpose of obtaining a tax
GAAR No/No advantage that defeats the object or purpose of
the applicable law should be ignored when
determining a tax liability.
EU member states must apply an exit tax to
prevent companies from avoiding tax in the
Exit taxation No/No
country of origin by moving their tax residence or
closing a PE.

Source: IMF staff compilation.

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Appendix IV. International Provisions of the TCJA

1. Prior to reform, the U.S. taxed the worldwide income of U.S. MNEs, with a non-
refundable credit for foreign taxes paid, and liability to U.S. tax being deferred until dividends were
paid from the foreign subsidiary to the U.S. parent. The TCJA now excludes from U.S. taxation active
business income that is earned abroad, thus moving the system closer to those of other OECD
economies. It also includes three novel measures of considerable importance to the current reform
debate:1

 ‘Global Intangible Low Taxed Income’ (GILTI). As an important qualification of the move to
territoriality, the TCJA imposes a minimum tax on overseas income. (Despite the name, GILTI
income is not formally associated with intangible assets). This taxes at the 21 percent corporate
rate the aggregate of the income of CFCs earned abroad that exceeds 10 percent of qualified
business asset investment—but with a deduction for corporate recipients of 50 percent of that
income. Credit is given for 80 percent of the foreign tax paid on such income. There is, however,
no deferral of the tax and no link to repatriation of the income. This, in effect, imposes a
minimum rate on GILTI income of 10.5 percent (if no tax is paid abroad) with tax liability to the
U.S. wholly eliminated if the foreign tax on that income is at least 13.125 percent.

 ‘Foreign Derived Intangible Income’ (FDII). Domestic corporations receive a 37.5 percent
deduction from the corporate tax base for ‘FDII,’ which is calculated as the income of the
corporation in excess of 10 percent of qualified business asset investment multiplied by the ratio
of foreign-derived income to total income (all calculated on a consolidated group basis). This
effectively reduces the corporate tax rate from 21 to 13.125 percent for income arising from the
sale of goods or services that are produced in the U.S., but sold to non-U.S. parties, to the extent
that such income exceeds 10 percent of tangible assets.

 Base Erosion Anti-Abuse Tax (BEAT). This is a minimum tax in relation to inbound investment,
applied to MNEs with annual gross receipts over US$500 million in the preceding 3 years and
making cross-border payments from the U.S. to affiliates of more than 3 percent of their total
deductible expenses. The payments targeted are those (such as interest, royalties, and
management fees) commonly associated with profit shifting. The provision does not apply to
items characterized as cost of goods sold.2 Specifically, the BEAT imposes a tax liability that is
the larger of (i) 10 percent (5 percent for 2018; 12.5 percent after 2025) on a concept of
“modified” taxable income , which adds back into income those applicable deductions claimed
for cross-border payments to affiliates that are not part of the costs of goods sold, or (ii) the
regular tax liability (net of tax credits, with some exceptions) under the normal CIT base.

1 These descriptions are highly simplified: the proposed GILTI regulations for example, run to 400 pages.
2“Cost of goods sold” (COGS) generally includes: the cost of products or raw materials, including freight or shipping
charges; costs of storage; direct labor costs; factory overhead expenses; and depreciation. The advent of BEAT puts
more weight on whether certain costs are characterized as COGS for tax purposes.

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Appendix V. Profit Shifting: Evidence and Opportunities

1. The scale of profit shifting remains hard to assess.1 At the time of IMF (2014), there was
much anecdote but little hard evidence. More has been learnt since. Damgaard and Elkjaer (2017),
for example, estimate that around 40 percent of global FDI is routed through special purpose
entities, which are often set up for tax avoidance purposes—with 85 percent of that in eight
jurisdictions. There has also been much work on quantifying the revenue losses from profit shifting.2
Using differing methodologies, OECD (2015e) put the overall loss at an average 4-10 percent of CIT
revenues in 2013; IMF (2014) put it at an (unweighted) average of about 5 percent. Results relating
to G-7 countries are summarized in Table 1.

2. One robust conclusion is that profit shifting is especially important for developing
countries. This a central finding of IMF (2014) and Crivelli, de Mooij, and Keen (2016), which put the
revenue loss to developing countries from profit shifting at 1.3 percent of GDP, which is larger than
for OECD countries (Figure 1). Subsequent studies reach a similar conclusion.3

3. The BEPS project has brought progress in addressing central opportunities for tax
avoidance. ‘Treaty shopping’ is made harder by one of the BEPS minimum standards, supported by
provisions in the MLI. The strengthened transfer pricing guidelines, including some increased
emphasis on substance over form, and, perhaps most directly, the minimum standard on harmful tax
practices, will go some way to impeding profit shifting. CbC reporting may give tax administrations a
better understanding of the operations and structure of the MNEs with which they deal.

4. Nonetheless, considerable opportunities for profit shifting remain—and may in some

respects be growing.4 The BEPS project sought to fix the most egregious abuses within, while
preserving, the core international tax system. Not surprisingly, it has not fully resolved all the
tensions inherent in it. First, while revisions to the transfer pricing guidelines dampen, they far from
eliminate opportunities created by fundamental difficulties in applying the ALP to:5

 Allocation of risk within MNEs. Companies may arrange to have internal financing provided,
and risk apparently borne, by an entity located in a low tax jurisdiction. The essential problem
this creates is not a practical one of how to apply the ALP to properly identify where that risk is

1 Evidence on each of the principal channels of profit shifting is reviewed in Beer, de Mooij, and Liu (2018).
2 Some of the data and methodological issues are reviewed in Bradbury, Hannapi, and Moore (2018).
3 Cobham and Jansky (2018) update Crivelli, de Mooij, and Keen (2016). Fuest, Hebous, and Riedel (2011) find tax

effects on debt shifting twice as large in developing countries as in developed. Johannesen, Tørsløv, and Wier (2016)
find that less developed countries are relatively more exposed to profit shifting, and Tørsløv, Wier, and Zucman
(2018) that developing countries are the prime losers from global profit shifting, with reported revenue losses of
around 20 percent. Looking at profit shifting in oil and gas, Beer and Loeprick (2017) report larger effects for LICs.
4 For fuller discussion, see Avi-Yonah and Xu (2017) and Collier and Andrus (2017). Lane and Milesi-Ferretti (2017)
report that the significant growth in FDI since the Global Financial Crisis is due to routing through special purpose
vehicles and likely driven by tax considerations.
5 Wei (2018).

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located: it is a conceptual difficulty with the notion that it can meaningfully be allocated
anywhere within the MNE, when it is ultimately borne only by the final shareholders and external
creditors of the MNE itself. For many economists, attempts to use the ALP (or any other method)
to allocate risk within a MNE are inherently incoherent.

 The valuation of intangibles (such as patents, brand names, goodwill) which are relatively easy
to relocate to, or create in, low tax jurisdictions. Valuation is commonly needed of both their
asset value (since any capital gain on their transfer will generally be payable) and of the
associated income (generating deduction where paid, and income where received). In this case,
it is the application of the ALP that is the difficulty. By their nature, valuable intangible assets
commonly have a uniqueness which means that there are unlikely to be closely comparable
transactions between independent parties by which they can be assessed, and when transfer
occurs there are likely to be considerable asymmetries of information as to potential value
between the company owning the intangible and the tax administration. 6

 Two-sided markets of the kind central to the digitalization debate.7

5. Difficulties also arise from:

 The ease of avoiding or limiting a presence creating a right to tax. The definition of a PE has
been tightened, but increased ability to do business remotely has made it easier to avoid a
taxable presence or to limit it to operations to which the ALP will allocate relatively little income.
Intra-group services also raise challenges for which the traditional PE concept has proven
insufficient. To protect source countries against such base eroding payments, the 2017 UN
Model Tax Convention includes a new technical service fee article—though it remains to be seen
whether developing countries will be successful in negotiating its inclusion in their DTAs.

Appendix Table 1 summarizes issues within the current architecture, how the BEPS measures address
some of them, and remaining vulnerabilities.8

6Value can be observed ex post, but inferring the ex-ante value requires also information on the probability of that
outcome occurring.
7 See Wei (2018).
8 The latter include, for example, two issues taken up in Appendix VII, related to offshore indirect transfers of interest

and service and management charges.

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 Appendix Table 1. BEPS Impact on International Concepts and Norms for International Tax Law Design
56

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International concept and norm /1 Gap or mismatch being BEPS focus Remaining deficiencies and weaknesses
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exploited after BEPS

Residents are taxed on worldwide income Ability to strip and shift profits out BEPS (e.g. Actions 2, 4 and Other base eroding payments (e.g. cross-
(residence principle) and non-residents are of high tax (residence or source) 8-10) directed at: limiting base border service or management fees) are
taxed on domestic source income (source countries (e.g. through base erosion through interest and unaddressed, and intangible and risk related
principle). 1 eroding payments such as interest other deductions; neutralizing returns are still capable of being shifting to
deductions or profit shifting by the (deduction) effects of low tax jurisdictions using ALP (see below).
minimizing assets/risks in those hybrid mismatch arrangements;
high tax countries). and seeking to align transfer
pricing outcomes with value
creation.
The source country has the primary right to Weakness of existing nexus BEPS (e.g. Action 7) directed No fundamental change to nexus test, which
tax active income, subject to finding a requirement exacerbated by only at preventing the artificial has focused attention on the fairness of
sufficient economic presence (nexus), digitalization because a PE does avoidance of (physical) PE. existing allocation of taxing rights, particularly
defined by reference to a permanent not arise when businesses sell in the context of digitalization.
establishment (PE) in its jurisdiction. remotely from abroad, even
though there is a significant
internet and economic presence in
a local market.
The residence country has the primary right Engaging in treaty shopping or BEPS (e.g. Action 6) directed at Reduced source country taxation under DTA
to tax passive income (other than from arbitrage of domestic tax rules to preventing the granting of not otherwise dependent on being subject to
immovable property in source country), with achieve low or no withholding tax treaty benefits in inappropriate a minimum level of taxation.
the source country typically accepting rate on payments made from source circumstances.
limits on locally sourced passive income country.
(e.g. by entering into DTAs).
Residence country taxation of foreign Ability to achieve inappropriate tax BEPS (e.g. Action 3) directed at Residual profit still capable of being shifted to
income is deferred until repatriation, unless deferral by exploiting the absence designing effective CFC rules. low tax jurisdictions using arm’s length
controlled CFC rules apply to combat of (effective) CFC rules. principle, and often left untaxed by CFC rules.
inappropriate deferral.
The residence country provides relief from Trend towards territorial system of Not specifically dealt with by Tax competition not fundamentally addressed
international double taxation, either through taxation in residence countries BEPS and often left untaxed by (e.g. no or nominal tax jurisdictions), with ALP
domestic law or DTAs, typically by way of a enables residual profit shifted to CFC rules. still enabling substance (assets/risks) to be
credit or exemption method. low tax jurisdictions to remain shifted to justify the location of large residual
untaxed. profits in low-tax jurisdictions.
Income is allocated between jurisdictions Ability to produce transfer pricing BEPS (e.g. Actions 8-10) Intangible and risk related returns still capable
based on the ALP. outcomes that do not align with seeking to align transfer pricing of being shifted to low or nominal tax
value creation. outcomes with value creation. jurisdictions, exacerbated by unconstrained
tax competition.
Source: IMF staff compilation.
Note: 1/ Some countries have pure territorial systems: that is, time tax only on a source basis.
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Appendix VI. Tax Competition

1. Revenue is eroded by tax competition between countries, whether intended to attract
real activities or paper profits. Such competition is manifested most obviously by a decline in
statutory CIT rates (Figure 2), but other devices—such as the provision of favorable tax treatment for
highly mobile income related to payment for the use of patents—have also been prominent. Many
avoidance devices can be seen as having been created to attract tax base. Some have argued that
such tax competition may be beneficial, by constraining governments otherwise inclined to waste
resources.1 That argument is now less common, perhaps reflecting both an enhanced focus on
revenue-raising since the Global Financial Crisis and a recognition that fiscal rules offer the
possibility of constraining public spending without imposing potentially inefficient or inequitable tax
policies. A somewhat more telling (if politically awkward) argument in favor of the existence of low
tax jurisdictions that tax competition tends to produce is that they provide a way by which firms
most subject to distortion from heavy taxation can reduce the excess burden they suffer.2

2. Making avoidance harder could result in tax competition becoming more intense and
damaging—particularly for real investments. Closing only some avenues for avoidance can lead
to more intense use of others.3 If all avoidance possibilities were closed and tax effectively levied
only ‘where value is created’, and the location of that value creation is mobile, then the result can be
expected to be tax competition aimed at attracting those value-creating activities.4

3. Such collective efforts as there have been to address tax competition have focused on
identifying and removing specific practices regarded as having harmful spillover effects.
Common minimum rates have sometimes been proposed for regional groupings, but rarely
implemented:5 WAEMU and CEMAC appear to be the only examples of international agreements on
a minimum CIT rate (at 25 percent).6 Collective approaches to easing tax competition—beginning
with OECD (1998) and the establishment of the Code of Conduct group on Business Taxation in the
EU (1997)—have focused not on general levels of corporate taxation but on precluding certain
practices identified as harmful (the same is true, implicitly, of the EU state aid rules). Low or no
effective taxation has thus been seen not as inherently harmful in itself.

1 Notably Brennan and Buchanan (1980).

2 The possible benefits of this are developed by Hong and Smart (2010); and its empirical relevance shown by the

finding of de Mooij and Liu (2018) that effective anti-avoidance measures can lead to lower levels of real investment.
3 Saunders-Scott (2015).
4 Becker and Fuest (2012) show how more restrictive transfer pricing rules can lead to more aggressive tax

competition; more generally, see Keen (2018).

5 An early example was the proposal of the Ruding Committee (Commission of the European Communities, 1992) for

a minimum CIT rate in the EU of 30 percent.

6 Combined with a maximum of 30 percent in WAEMU and 40 percent in CEMAC.

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4. This approach has come to center on precluding preferential regimes with little
requirement of substantial activity. BEPS and the EU Code of Conduct7 identify measures as
harmful if, broadly, they provide preferential tax treatment without requiring a significant real
presence (‘nexus’) in the jurisdiction.8 Refraining from such regimes is a BEPS minimum standard; the
EU applies the test to real as well as financial activities and to non-members by listing of non-
cooperative jurisdictions.

5. The theoretical case for identifying preferential regimes as inherently harmful is

uneasy, and substance requirements can be problematic. Requiring countries to tax all activities,
however mobile, in the same way can make tax competition even more harmful. This is because
countries may choose, if prevented from setting differential rates, to switch from charging a high
rate on less mobile activities and a low rate on more mobile ones to charging some intermediate
rate on all activities—and the spillover from the rate cut element of that may damage other
countries more than the rate increase element benefits them.9 The circumstances in which this will
be the dominant effect have yet to be fully understood.10 Nonetheless, the BEPS minimum standard
is consistent with this thinking in implicitly recognizing that differential treatment is not intrinsically
harmful. One difficulty is the risk that the substance can be created artificially by inefficient
allocation of production factors. Recently, OECD have sought to overcome the potentially perverse
that a higher rate attached to a scheme which does not pass the nexus test would be harmful while
a uniform very low CIT rate is not.

6. Whether low or zero tax rates should be regarded as per se harmful is increasingly
coming to the fore. There would be some logic in doing so—so long as source-based taxes
substantially determine overall liability—but also considerable conceptual, practical, and political
obstacles. Conceptually, any spillover effects from CIT choices need to be weighed against domestic
considerations, which for some countries (such as those rich in natural resources) may reasonably
point to low/zero general tax rates. Practically, agreement would also be needed on tax bases to
prevent low or zero effective tax rates being achieved by base narrowing.11 Politically, the choice of
national CIT rates continues to be seen as a core aspect of national sovereignty.

7 As set out in respectively OECD (2015mm) and European Council (1998).

8 This was largely in reaction to ‘IP’ or ‘patent’ box regimes providing favorable treatment of related income even if
the development had occurred elsewhere. But the principle is now applied more generally: BEPS Action 5 requires
“...an adequate number of full-time employees with necessary qualifications and incurring an adequate amount of
operating expenditure to undertake such activities.”
9 The classic example is that of Ireland, which, under pressure from the EU, moved between 1999 and 2005 from the

combination of a general CIT rate of 32 percent and a preferential rate of 10 percent to a single rate of 12.5 percent.
10 On this, see Keen and Konrad (2013). Domestically, differential treatment does, however, bring its own distortions,
can create problems of profit shifting between wholly domestic enterprises and can raise significant governance
issues: see IMF, OECD, World Bank and UN (2015).
11The relevant WAEMU and CEMAC directives, for example, include restrictions on the CIT base—but even that may
not be enough: tax competition in WAEMU, for instance, has flourished outside the areas of agreement (Mansour
and Rota-Graziosi, 2013).

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Appendix VII. Some Developments Concerning Developing

Countries
There has been some progress in each of the four areas that IMF (2014) identified as
especially important to developing countries:

 Double tax agreements (DTAs) continue to impose revenue risks for developing countries.
They generally limit some source taxing rights in the hope of attracting FDI. IMF (2014) reported
mixed evidence on FDI effects. More recent studies confirm this ambiguity 1 and suggest that the
effect depends on countries’ overall treaty networks and specific provisions in the DTAs. On the
revenue impact, however, the evidence has grown still stronger that the losses for developing
countries can be significant: Beer and Loeprick (2018) estimate that the ability of MNEs to
reroute their intra-group payments to exploit favorable treaty arrangements with ‘investment
hubs has reduced CIT revenues in Sub Saharan African countries by around 15 percent.

Countries are now increasingly seeking to adopt treaty anti-abuse provisions to counter treaty
shopping. The MLI offers a potentially efficient way to modify existing treaties so as to do this,
consistent with the BEPS minimum standard, by adopting safeguard provisions in the form of a
principle purposes test (PPT) and/or limitation of benefits (LOB) provision.2 As with all provisions
under the MLI, however, the effectiveness of this depends on agreement with treaty partners: if
the treaty partner makes a reservation in the MLI to a certain provision that a country wishes to
change, there is no modification to that aspect of the treaty. And preferred approaches differ.3

More generally, other problematic areas in developing countries’ DTAs, such as maximum
withholding tax rates, key elements of the PE definition and service fees require a separate
process of renegotiation as they are not covered by the MLI.

 Taxation of capital gains on offshore indirect transfers of interest in assets (OITs). The
issue, which arises in relation to immovable property and potentially more broadly to telecoms,
mineral and other licenses, is the potential for companies to avoid liability to tax on a capital
gain associated with some underlying asset where that asset is located by realizing that gain
through the sale in a low tax jurisdiction of a company holding that asset indirectly. This has
emerged in IMF TA as a macro-relevant concern in many low-income countries, particularly

1Three recent studies find no effect of treaties on FDI (Baker, 2014; Daniels, O’Brien, and von der Ruhr, 2015; Beer
and Loeprick, 2018); three find a positive effect (Marques and Pinho, 2014; Van ‘t Riet and Lejour, 2017; Hong 2018).
2 Under a PPT, broadly speaking, treaty benefit is denied if one of the main purposes of an arrangement is to obtain
those benefits; an LOB seeks to limit tax treaty benefits to genuine residents of the other contracting state.
3Advanced economies seem to opt for the (more complex to enforce) PPT, rather than the LOB, far more often than
emerging economies.

INTERNATIONAL MONETARY FUND 59

INTERNATIONAL CORPORATE TAXATION

those with natural resources. Domestic laws and treaties of many developing countries need
strengthening if they are to tax gains on OITs.

Since 2014, the PCT has developed guidance on how source countries can secure taxing rights
on such transfers.4 Importantly, the MLI allows for adoption of a key treaty provision to secure
taxing rights of OIT in the source country (Article 13.4). As of December 2018, however, of the 85
MLI signatories, it appears that 44 (mainly advanced) countries have reserved on this provision.

 Interest deduction limitations can usefully curb base erosion through debt shifting and are a
standard recommendation in IMF TA. By 2014, 28 developing countries had thin capitalization
rules in place (IMF 2016); since then, at least six more have adopted such rules. A common
approach is to use a debt/equity ratio to determine the proportion of interest that will be denied
for deduction. BEPS Action 4 endorses a new approach based on an interest/earnings ratio.5 All
thin cap rules, however, have an element of arbitrariness, potentially deterring investment
through their impact on non-abusive arrangements. The interest stripping rule, for instance, can
unduly pressure firms with temporarily low earnings (with adverse cyclical effects) or with firm-
specific characteristics enabling them to bear more debt. Action 4 therefore allows
complementary provisions, such as a group escape (which undoes the deduction limitation if the
company’s ratio remains below that of consolidated group) and a carry forward provision for
unused interest. These complementary measures may, however, be hard for LICs to implement.
More fundamentally, the problems of artificial debt shifting and perhaps debt bias linger.

 Transfer pricing rules aim to limit profit shifting through transfer mispricing by, among others,
prescribing agreed methods and reporting requirements. In 2012, 34 developing countries had
transfer pricing rules in place;6 Over the last 5 years, 17 African countries adopted such rules.7
But transfer pricing practice can be extraordinarily complex, and is not made less so by BEPS.
The guidance provided by the PCT (2017) on the application of ALP in circumstances of the kind
likely faced by developing countries, for instance—supplementing the BEPS material itself—runs
to 237 pages. Developing countries continue to face significant difficulty in enforcing transfer
pricing regulations and, for example, challenging the transfer prices used by MNEs.

Country-by-country (CbC) reporting—a BEPS minimum standard—could help LIC tax authorities
in their transfer-pricing risk assessments (although a transfer pricing adjustment cannot be
based on a CbC report alone). Further information will still be needed (on, for instance, profit
drivers, functional analysis, ownership structures, and intangibles), however, to apply ALP; and
the skills to perform the corresponding audits are demanding. LICs may, moreover, have
difficulty meeting the required standards for data protection and other conditions for the
exchange of CbC information needed if they are to be able to access CbC reports.

4 Platform for Collaboration on Tax (2019).

5 This is not, however, a minimum standard.
6 De Mooij and Liu (2018).
7 Piccioto (2018).

60 INTERNATIONAL MONETARY FUND

 Appendix VIII. Digital Service Taxes, Enacted and Proposed
European France /1 Italy U.K. Chile India Uruguay
Commission

Date of Proposal issued Jan 1, 2018 Jan 1, 2019 Apr 6, 2020 Proposal issued Jan 1, 2016 Jan 1, 2018
introduction in March 2018; (Decree No. 2017-1364; (Budget Law (Finance Bill Aug 23, 2018 (Finance Act (Law 19.535;
modified Sep 20, 2017) 2018, Law 205) 2019/20) 2016, Chapter Resolution
November 2018. VIII) 6,409/2018)
Tax Rate 3 percent 2 percent; (10 percent 3 percent 2 percent 10 percent 6 percent 12 percent /2
for certain content)
Thresholds/ Annual Tax free allowance of Tax payable by Annual Not specified. Aggregate In the case of
Exemptions worldwide EUR 100,000 for businesses worldwide in- payments to intermediation
for in-scope revenues > EUR provider of free online with more scope revenues non-resident > services, the
businesses 750 million; and access to Audiovisual than 3,000 > GBP 500 INR 100,000 tax base will
Annual EU-wide (AV) content, 4 percent digital million; and (approx. US$ be 50 percent
taxable revenues allowance for transactions Annual U.K. in- 1500) in a of the
> EUR 50 million. advertising revenues, annually. scope revenue financial year. transaction if
66 percent allowance > GBP 25 only one of
for EU platforms million the parties is
sharing content created Safe harbor based in
by private users, and provisions for Uruguay.
exemption for sites loss-makers and
where AV content is businesses with

INTERNATIONAL CORPORATE TAXATION

INTERNATIONAL MONETARY FUND 61

not primary business. low margins.

Annual GBP 25
million tax-free
threshold.
 Taxable All companies. All companies. Non-resident All companies. Non-resident Non-resident Non-resident.
62

INTERNATIONAL CORPORATE TAXATION

person(s) companies. companies. companies.
INTERNATIONAL MONETARY FUND

Withheld by Withheld by Withheld by

payer. payment payer.
intermediaries.
In-scope Online Sales and rentals of Digital services Search engines, Digital Online AV services
activities advertising, video storage media, supplied via social media brokering, advertising and digital
digital videos on demand, and the internet or platforms and advertising, purchased by mediation or
intermediation advertising and other online entertainment, Indian buyers. intermediation
services, sale of sponsorship revenues networks. marketplaces. intermediation, services.
data generated derived by paid-for or and storage
by users. free online video sites. services.
Taxable Portion of annual Revenues received from Revenues Portion of Revenues Revenues Revenues
revenues worldwide French residents. received from annual received from received from received from
revenues Italian worldwide Chilean Indian Uruguayan
attributable to EU residents or revenues consumers residents or residents
users. /3 Italian PEs of attributable to (B2C). Indian PEs of (Uruguay-
non-residents U.K. users. /4 non-residents. based IP
(B2B). address or
user billing
address).
Notes: 1/Germany has a similar tax with proceeds earmarked for the promotion of national cinema.
2/ Constitutes an expanded scope of the existing non-resident income tax on Uruguayan-sourced income. Similar rules apply to the extended scope of the VAT.
3/ Revenue allocation in proportion to (i) the number of times an advertisement has appeared on EU users' devices; (ii) the number of EU users having
concluded underlying transactions on a digital interface, with user location to be determined based on Internet Protocol (IP) addresses.
4/ Revenue allocation in proportion to (i) for social media platforms, revenues from targeting adverts at U.K. users, (ii) for search engines, revenues from
displaying advertising against the result of key search terms inputted by UK users; (iii) for online marketplaces, commissions generated by facilitating a
transaction between U.K. users.
 INTERNATIONAL CORPORATE TAXATION

Appendix IX. Revenue Implications of Formula

Apportionment
1. This appendix explores the impact of various FA schemes on national corporate tax
bases, using two datasets. It first uses aggregate data on the major affiliates of U.S. MNEs in 52
countries from the Bureau of Economic Analysis (BEA).1 It then uses firm-level data from ORBIS,
covering 7,772 global MNE groups with 58,345 subsidiaries; this also enables estimation of the
change in the MNE tax base due to cross-border loss consolidation. In both datasets, the countries
covered are high-income and middle-income economies; only two low-income countries are
covered in the BEA data (Honduras and Nigeria) and only one has sufficient data in ORBIS (Kyrgyz
Republic).

Aggregate U.S. MNE Data

2. Data for U.S. MNEs is first used to compare the current tax base with that under FA.
The BEA publishes annual data on the aggregate finances and operations of U.S. based MNEs,
separately reporting statistics for U.S. parent companies and their foreign affiliates in a large set of
countries. The variable ‘economic profit’ is used as a proxy for the corporate tax base of U.S. MNEs:
it measures operating income, excluding capital gains and losses and income from equity
investments (which are usually exempt, to avoid double taxation). The unitary tax base under FA is
calculated as the sum of economic profits in the U.S. and all countries in which U.S. MNEs operate.
Denoting economic profit of affiliates in country by , aggregate consolidated profits earned by
all U.S. MNEs is thus:

3. The aggregate unitary tax base is allocated using alternative apportionment

formulas. For this purpose, data are used for the share of each country’s affiliate sales (on a
destination basis),2 value added, fixed assets (defined as gross property, plant and equipment),
payroll, or employment, with the share of the latter, for instance, defined as:

, .
∑

1 This exercise differs from that in IMF (2014) in: (i) using more recent data for 2015, which expands the number of

countries from 29 to 52; (ii) using a different indicator for economic profit, which excludes foreign earned income
from the tax base (as this income is generally exempt from tax); (iii) exploring more weighting schemes, including
sales by destination (instead of origin), value added, a Cobb-Douglas formula and the CCCTB formula.
2This means sales to unaffiliated persons that can be attributed to the country of the purchaser. For about 10
percent of offshore sales to unaffiliated persons, the destination country is not specified in the BEA data. For those
sales, we assume they are proportionally attributed to the known distribution of sales to non-US countries.

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Apart from weighting schemes with only one factor, we also explore two multiple-factor formulas.
The first, ‘Cobb-Douglas’ (CD) formula, combines asset and payroll shares—to roughly reflect the
shares of capital income and labor income in aggregate value added:
1 2
, , , .
3 3
The second multiple-factor formula is that used in the CCCTB proposal for the EU:

1 1 1 1 1
, ⋅ .
3 3 3 2 2

4. The change in the tax base is measured as the difference between the simulated
economic profit under FA, and the reported economic profit in the BEA data. This is done for each
of the seven weighting schemes ( ) above:

∆ , , ⋅ .

Since ∑ and ∑ , 1, ∑ ∆ , 0: the change in the aggregate global tax base of U.S.
MNEs is zero: FA only redistributes that base across countries. This ignores the impact of cross-
border loss consolidation, which is analyzed further below with the firm-level data.

5. For many countries, the tax base under FA is markedly different from the current. The
estimated base changes (in percent of GDP) from FA for individual economies under each of the
seven formulas are shown in Appendix Figures 1 and 2. Appendix Figure 1 ranks economies
according to the base effect under the value-added formula (red dots), ranging from the largest
base expansion at the top to the largest base reduction at the bottom. Beyond the general
observations made in the text, it is worth noting that the effects under different weighting schemes
are generally broadly similar. For instance, several countries find an expansion of their tax base,
regardless of the apportionment factor. The effects of apportioning by employment differ across
countries quite widely: some middle-income and low-income countries gain considerable base while
some high-income countries lose. Using destination-based sales as the single formula factor
benefits several middle-income countries.

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Appendix Figure 1. Base Change of FA for U.S. MNE Income

(percent of GDP)
Australia
United Kingdom
United States
Brazil
Canada
France
Germany
Colombia
Poland
Philippines
Honduras
Italy
Venezuela
Denmark
Portugal
South Africa
Turkey
Russia
Ecuador
Spain
Argentina
New Zealand
Sweden
Czech Republic
India
Saudi Arabia
Belgium
Israel
Indonesia
Peru
Costa Rica
China
Korea
Malaysia
Nigeria
Taiwan Province of China
Japan
Mexico
Dominican Republic
Norway
Egypt
Thailand
Chile
United Arab Emirates

-2.00 -1.00 0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00

Value Added Sales Employment Assets Payroll CCCTB CD

Source: IMF staff estimates.

6. Investment hubs stand to lose from FA. Appendix Figure 2 shows the effects for eight
economies with comparatively high ratios of FDI to GDP due to their relatively attractive tax regimes:
‘investment hubs’ (Dalgaard and Elkjaer 2017). These economies find their tax base significantly
reduced under FA, whatever the formula used: the erosion of the tax base can even exceed 100
percent of GDP under some formulas. These results illustrate the large difference between the
currently reported profits by U.S. MNEs in these economies and reported factor share used in the FA
calculation to apportion global profits of these MNEs.

Appendix Figure 2. Base Change under FA for U.S. MNEs—Effects on

‘Investment Hubs’
(percent of GDP)
20

-20

-40

-60

-80

-100

-120

-140

CD CCCTB Payroll Assets Employment Sales Value Added

Source: IMF staff estimates.

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7. At unchanged tax rates, global CIT revenue will rise under FA due to a reallocation of tax
bases from low to high tax countries. The revenue impact of these tax base changes is found by
multiplying the change in the tax base in each country by the prevailing statutory CIT rate:

∆ , , ⋅∆ ,

Unlike the base effects, the aggregate revenue impact is likely to be non-zero, since corporate tax
rates differ across countries. This is illustrated in Appendix Figure 3 for the case of FA with a value-
added formula. The figure ranks economies from left to right according to their base change. On
average, countries that experience an expansion of their CIT base have a higher CIT rate than those
suffering a reduction.3 The implication is that, at unchanged rates, global CIT revenue would—in
relation to U.S. MNEs—be increased by common adoption of FA, reflecting a shift in tax base from
low-tax to high-tax countries. The estimated increase ranges between 5.7 percent for the
employment formula and 12.1 percent for the payroll formula.4

Appendix Figure 3. Base Changes for U.S. MNEs Apportioning by Value Added

Source: IMF staff estimates.

Analysis Based on Firm-level Data

The micro data extends the analysis beyond U.S. MNEs and enables estimating the impact of
loss consolidation. The same analysis as above is performed using firm-level data from ORBIS,
provided by Bureau van Dijk. This exercise follows Cobham and Loretz (2014), with some

3 Differences in not only statutory tax rates but in tax incentives may affect the ultimate revenue effects of FA.
4For other weighting schemes, the increase is: assets 10 percent, value added 7.7 percent, sales 7.4 percent, CD 11.4
percent and CCCTB 8.8 percent.

66 INTERNATIONAL MONETARY FUND

 INTERNATIONAL CORPORATE TAXATION

modifications and using more recent data. The sample consists of unconsolidated company financial
statements for affiliates that are part of an MNE group.5 In selecting MNE groups, the
unconsolidated statements are matched with the sample of consolidated accounts for which
information on the balance sheet of the parent company is available.6 The sample is restricted to
subsidiaries for which the sum of employment in the unconsolidated account represents at least 70
percent of employment reported in the consolidated financial statement, to ensure that the data are
representative for the MNE affiliates.7 The final sample comprises 58,345 unique affiliates operating
in 7,772 MNE groups during 2009-2016. It consists of subsidiaries of European-based MNEs (80
percent), but with extensive information on their activities in the rest of the world, including in 20
middle-income countries and one low-income country (Kyrgyz Republic).

8. Cross-border loss consolidation under FA modestly reduces global CIT revenue. To

explore the effect of unitary taxation on the global tax base of MNEs, profits and losses before
taxation of all subsidiaries in an MNE group for a given year are added up. If this sum is negative,
the loss is carried forward at the group level, while recording a zero-taxable profit in the current
year. Summing up these MNE corporate tax bases produces a measure for the aggregate tax base
under unitary taxation. This is then compared to the tax base under separate accounting (SA), which
assumes a carry-forward of losses at the affiliate level but no group relief.8 For 2016, the overall tax
base under unitary taxation is 3.7 percent smaller than that under separate accounting.

9. Tax base effects from FA are again significant. Only two single-factor formulas are
considered with the firm-level data: the number of employees and value-added (calculated as gross
sales minus the costs of goods sold); this is because the destination of sales is not available from
ORBIS and information about payroll is missing for many emerging market economies. After
computing the profit allocation for each individual subsidiary, the FA tax bases are aggregated by
country of operation. The country-specific results—the excess of the FA tax base over the SA tax
base in percent of the latter—are shown in Appendix Figure 4. As for the analysis with BEA data,
several countries regarded as ‘investment hubs’ experience a significant reduction in their tax base
under both FA factors. Moreover, middle-income countries are more likely to gain under the
employment factor than under the value-added factor. For some countries, the difference between
the two FA factors is very large, sometimes even larger than that between FA and SA.

5An MNE group is defined as one in which at least one subsidiary is in a different country from the parent.
Subsidiaries are part of an MNE group if they are majority owned by the ultimate parent (directly or indirectly).
6 The matching process combines the parent companies with the corresponding subsidiaries where the identification

of the parent company is available.

7 While this selection restricts the sample size, it overcomes the caveat that the coverage of subsidiaries comprising

an MNE group in ORBIS is limited and may not provide a representative picture of the worldwide activities for such
an MNE.
8 This is an upper bound on the tax base under SA, as some countries allow for domestic relief/loss consolidation.

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10. The net revenue effect of shifts in the tax base to high-tax countries and cross-border
loss consolidation is small. As in the previous analysis, the aggregate revenue effects of FA are
computed, which is now the result of two offsetting effects. On the one hand, the smaller global tax
base as a result of loss consolidation reduces global CIT revenue. On the other hand, the
reallocation of the tax base from low-tax countries to high-tax countries increases it. On balance,
global CIT revenue declines by 0.5 percent if the employment weight is used, and increases by
0.8 percent if the value-added weight is used.

Appendix Figure 4. Bases Change under FA Using Firm-Level Data

(percentage change)
Philippines
Bulgaria
Bosnia and Herzegovina
Montenegro
Hungary
Belgium
Serbia
Slovenia
Estonia
Slovak Republic
Norway
Romania
Italy
Czech Republic
Mexico
China
Croatia
Poland
Australia
Ireland
France
Peru
India
Finland
Portugal
Kyrgyz Republic
Turkey
Macedonia, FYR
Germany
Lithuania
Japan
Spain
Austria
Colombia
Kazakhstan
Ukraine
Korea
Greece
Latvia
Pakistan
Russia
Brazil
Denmark
United Kingdom
Iceland
Sweden
Luxembourg
Malta
Netherlands
-200.00 -100.00 0.00 100.00 200.00 300.00 400.00 500.00

Value Added Employment

Source: IMF staff estimates.

 

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Appendix X. The Scale and Allocation of Routine and Residual

Profits
1. This appendix combines micro- and macro data to provide empirical evidence on the
scale and cross-country distribution of routine and residual returns. The first section quantifies
the overall size of residual returns, including relative to routine returns, using consolidated financial
statements of the world’s largest 10,000 companies. Exploiting macroeconomic data for 51
countries, it also examines the allocation of routine returns across countries. The second section
employs a simple theoretical model in combination with micro- and macro data to derive the
revenue effects from implementing a destination-based RPA mechanism.

Micro Analysis of Routine and Residual Profit

2. Residual returns are defined at the consolidated multinational group level. The
consolidated profit of any MNE i, denoted , can be expressed as:

. 1

where, denotes its routine profit (which broadly corresponds to a normal return on the
underlying real activities of MNEs, and can be calculated by applying some notional return to the
assets of MNEs or as a markup to the costs of these activities) and its residual profit.

3. Financial statements for the largest 10,000 companies in the S&P Capital IQ database
allow inferring the size of routine and residual returns. After basic data cleaning, the baseline
sample comprises 7,641 MNEs. In 2017, these companies jointly own total assets of US$658 trillion,
total net fixed assets (including property, plant, and equipment) of US$30 trillion, and report US$5.5
trillion of taxable profits. Appendix Table 1 lists the number of companies, as well as their respective
shares of fixed assets and earnings before tax (EBT) in three different country groups: Advanced
Economies (AEs), Emerging Economies (EMEs), and Low-Income Countries (LICs) (based on the
country of the headquarters). Appendix Table 2 provides the same information across industries and
reports the actual rate of return on fixed assets (that is, reported EBT relative to fixed assets) in
Column 4 and the actual mark-up ratio over the costs of goods sold (defined as EBT over costs of
goods sold).1 These two ratios show at which rate the normal returns would equate the EBT for the
average MNE in the particular industry. For example, on average MNEs in manufacturing would
require a 14 percent return on their fixed assets to declare all their EBT as normal profits. The
weighted average ratio of EBT over fixed assets is 12 percent, while the average mark-up is 13
percent.

1 Costs of goods sold include all intermediate purchases from third parties and direct labor costs, and hence is a

lower bound of total costs of production by excluding indirect costs.

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Appendix Table 1. Descriptives by HQ Location

Number of Share of Fixed Share of
Headquartered in Companies Assets (%) EBT (%)
Advanced Economies 5,476 64.5 74.2
Emerging Markets 2,065 35.2 25.4
Low-Income Developing Countries 24 0.1 0.1
HQ Unknown 18 0.22 0.30
Source: IMF staff calculation based on S&P Capital IQ database.

Appendix Table 2. Profitability by Industry

Number of Share of Share of RoR (%) Mark-
Companies Fixed EBT (%) up (%)
Assets (%)
Industry Sector (1) (2) (3) (4) (5)
Agriculture, Forestry and Fishing 26 0.1 0.1 12 8
Construction 296 2.4 2.2 14 7
Finance, Insurance and Real Estate 1,057 8.8 19.8 32 15
Manufacturing 2,689 29.1 38.9 14 13
Mining 222 9.0 5.3 6 17
Retail Trade 612 4.4 5.0 13 6
Services 726 4.9 8.8 22 18
Transportation, Communication, Utilities 1,161 38.1 16.4 5 15
Wholesale Trade 699 2.2 3.5 20 4
Average, unweighted 15 12
Average, weighted 12 13

Source: IMF staff calculation based on S&P Capital IQ database.

Notes: Average profitability is weighted by the share of fixed assets in each industry in column (4), and by
the share of costs in each industry in column (5).

4. For a considerable proportion of firms in the sample, the computed routine return
exceeds the corporations’ reported earnings before taxes, thus implying a negative residual.
In the notation of equation (1), returns before taxes (EBT) are used to measure an MNE’s
consolidated profits, , and two methods then used an approximate routine component, : (i) A
cost mark-up approach, presuming that routine profit is 7.5 percent of the firm’s total costs of
goods sold (as in Avi-Yonah and others, 2009); and (ii) A notional return approach, which presumes
tangible fixed assets provide a 10 percent routine return (in the spirit of GILTI). Residual profit is
defined as the difference between EBT and the routine profit. The routine returns are somewhat
lower than the average returns reported in Appendix Table 2, so that firms will on average report
positive residual profits. However, this does not hold for all firms. The share of companies with a
negative residual profit is 44 percent when using the mark-up ratio and 32 percent under the
notional return approach. These shares decrease slightly when using earnings before interest, taxes,
depreciation, and amortization (EBITDA) as the profit measure. They are also smaller when assuming

70 INTERNATIONAL MONETARY FUND

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lower routine returns: using a mark-up ratio of 4 percent, for instance, (the lowest industry-level
average in Appendix Table 3), reduces the share of companies with a negative residual to 25
percent; with a notional RoR of 5 percent, the share of companies with a negative residual is 16
percent.

5. Positive residual returns are highly concentrated among a few firms. The 100
companies with the largest residual, roughly one percent of the sample, account for one third of
total residual returns. Among these firms, the ratio of residual return to profit is 85 percent. In
comparison, the ratio of residual return to profit is 58 percent for all firms with a positive residual
and the average ratio is -147 percent for the full sample. Since the major share of the aggregate
residual return is earned by a few MNEs, the major share of the aggregate residual return is earned
by a few MNEs that are headquartered in a small number of countries. Table 3 lists the 10
economies with the largest amount of residual returns, for varying rates of cost mark-up and return
to fixed assets, and the proportion of all residual profit which they account.

Appendix Table 3. Residual Profit by Country of Headquarters

Allocation method:  Cost Mark‐Up  Notional Return to Assets 
Rate:  7.5% 10% 7.5% 10%
Share of 
Share of  Mean  Share of  Mean  Mean  Share of  Mean 
Global 
Global RP RP/EBT Global RP RP/EBT RP/EBT Global RP RP/EBT
RP
United States 37% 53% United States 53% 37% United States 34% 44% United States 49% 25%
United Kingdom 7% 43% United Kingdom 8% 24% Japan 17% 71% Japan 38% 62%
China 6% 15% Hong Kong 6% 61% United Kingdom 10% 51% United Kingdom 17% 35%
Hong Kong SAR 4% 71% Russia 6% 61% Germany 5% 37% Hong Kong SAR 9% 60%
Japan 4% 17% Spain 5% 50% Hong Kong SAR 4% 70% Switzerland 6% 44%
Russia 4% 71% Australia 4% 55% France 4% 34% Germany 6% 16%
Germany 3% 26% Canada 4% 36% South Korea 3% 36% Ireland 4% 72%
South Korea 3% 38% South Korea 3% 18% Switzerland 3% 58% France 4% 13%
Spain 3% 63% Venezuela 3% 99% Spain 2% 40% South Korea 4% 14%
France 3% 27% Switzerland 2% 23% India 2% 48% Venezuela 3% 92%
Rest of the World 27% ROW 5% ROW 16% ROW ‐39%
Source: IMF staff estimates.

6. National accounts and additional macro-data allow approximating the current

distribution of routine and residual returns across countries. Specifically, aggregate information
on non-financial fixed capital formation is combined with a presumed depreciation rate to
approximate country-specific capital stocks for a sample of 51 countries. Routine returns, of both
domestic and multinational companies, then follow from multiplying these stocks with a presumed
rate of return.

7. The taxation of routine returns would likely foster government revenue in developing
countries. Assuming a notional rate of return of 10 percent, Appendix Figure 1 reports estimated
routine returns by country, and Appendix Figure 2 the excess of the current tax base over routine
returns (under two different assumed rates of return on tangibles). Magnitudes are expressed as a
share of GDP and thus do not add up to some hypothetical aggregate residual. A significant share of
routine returns is currently located in low tax jurisdictions. A sensitivity analysis shows that assuming
a lower depreciation rate increases the estimated revenues from routine returns whereas assuming a
lower return to fixed assets decreases estimated revenues from routine returns (results are not
reported). Figure 2 depicts the difference between current CIT revenues and revenues from taxing

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routine returns (would be taxed at the current statutory CIT rates). The unweighted average increase
in CIT revenue of ‘winner countries’ is 1.53 percent of GDP. The unweighted average decrease in CIT
revenue for the other countries is 1.47 percent of GDP.

Appendix Figure 1. Routine Returns by Country

(10 percent return on tangible assets)
50

45

40

35

30

25

20

15

10

0
Canada

Poland

Saudi Arabia

Mongolia
United States

Japan

Sweden

Kazakhstan
Switzerland

Slovak Republic

Luxembourg

Serbia
Croatia

Austria

Kyrgyz Republic
Belgium

Azerbaijan
Malta

Czech Republic

Australia

Bulgaria

Estonia
Iceland
Mexico
Germany

Portugal

Egypt
Denmark

Norway
Slovenia

Lithuania
Chile

Ukraine
Italy

New Zealand

Romania
Armenia
Cyprus

Finland

Kuwait

Hungary

Spain
Greece

Ireland

Korea
Netherlands

France

South Africa

Latvia
United Kingdom

Honduras
Source: IMF staff estimates.
Note: Numbers are for 2017 or latest available year if 2017 is unavailable.

Appendix Figure 2. Differences Between Revenues from Taxing Routine Returns and CIT
Revenues
Ten percent notional rate of return Five percent notional rate of return
8

6
2
Delta Revenue, percent of GDP

1
4
Delta Revenue, percent of GDP

2
-1

-2
0
-3

-2 -4

-5

-4
-6

Jkuwait
Malta

Switzerland

Ireland

Sweden

Germany
Cyprus

Portugal

Lithuania
Estonia
United States

Honduras
Egypt

Greece

Denmark

France

Kuwait
South Africa

Norway

Finland

Bulgaria

Italy

Poland

Spain
Serbia

Hungary
Netherlands
Chile

United Kingdom

Ukraine
Luxembourg
New Zealand

Slovak Republic
Japan

Canada

Australia

Korea

Iceland

Czech Republic

Austria

Slovenia
Latvia
Croatia
Azerbaijan

Saudi Arabia
Belgium

Kazakhstan

Kyrgyz Republic
Mexico

Armenia

Mongolia
-6
Sweden
Malta

Portugal

Germany

Lithuania
Estonia

Jkuwait
Cyprus

Denmark

United States

France

Honduras
Switzerland

Ireland

Finland

Poland
South Africa

Norway

Egypt

Bulgaria

Serbia

Hungary

Kuwait
Netherlands

Greece

United Kingdom

Ukraine
Luxembourg
New Zealand

Japan

Iceland

Azerbaijan

Spain
Slovak Republic

Canada

Australia

Korea

Italy
Czech Republic

Austria

Slovenia
Latvia
Croatia

Saudi Arabia
Chile

Kazakhstan

Mexico

Armenia
Kyrgyz Republic

Mongolia
Belgium

Source: IMF staff estimates.

Note: Δ Revenue = Revenue from routine profits minus CIT revenue. Numbers are for 2017 or latest available year if
2017 is unavailable.

Revenue Implications of Moving to an RPA Mechanism

8. This section combines micro- and macro data with a simple theoretical model to
gauge total revenue effects of implementing an RPA mechanism. For simplicity, the section
assumes that profit shifting is restricted to residual returns. The total revenue effect of implementing
an RPA mechanism thus depends on the current and on the future allocation of residual returns,
both of which are derived using a simple theoretical model.

72 INTERNATIONAL MONETARY FUND

 INTERNATIONAL CORPORATE TAXATION

9. The model considers an MNE using intra-group transactions to maximize its global
after-tax profit under the current tax system. Specifically, the MNE uses intra-group transaction
to reallocate its consolidated residual returns R across countries c=1,…N. However, any excess of
reported taxable earnings over routine returns, denoted by , triggers cost c( ) in this location.
Accounting for the constraint that all residual returns are reported in some location, the MNE’s
optimization problem is summarized by:

max 1 , (2)

where is the statutory tax rate in country i and is the Lagrangian multiplier associated with the
equality constraint that all residual returns need to be reported.2

The marginal costs of profit-shifting are assumed to be inversely proportional to i) the country-
specific tangible capital stock, ; and, ii) the ratio of the MNE’s residual profit to its aggregate
capital stock, K:
1 (3)
′ ,

where 0 i determines the overall cost of profit-shifting. This specification implies that profit
shifting is only possible with positive residual returns and is less costly with economic substance.

10. The first-order conditions of the MNE’s optimization problem imply that the excess of
reported taxable earnings in country c is given by:

1 ∆ (4)

where is the share of total fixed assets employed in location I and

is an asset

weighted tax rate differential between country c and the rest of the corporate group. This equation
reflects the assumption that residual returns are essential for profit-shifting: reported and real profit
coincide under the current international tax architecture only in the absence of residual returns.
Otherwise, reported and real returns differ, and more residual returns are reported where tax rates
are lower (as suggested by the negative sign on ∆ ).

11. Under the current international tax framework, country-specific tax bases may exceed
or fall short of aggregate routine returns located in this country. Using equation (4) and

2 Note that this formulation ignores the MNE’s tax liability and return associated with location-specific capital stocks,

which are unaffected by the optimal allocation of residual returns. For simplicity, the formulation also ignores the
usual asymmetry in the treatment of profit and losses.

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INTERNATIONAL CORPORATE TAXATION

accounting for the routine returns in this location shows that the tax base in country c can be
expressed, summing over MNEs indexed by i, as:

∑ 1 ∆ , (5)

Because of tax minimization schemes, excess taxable returns (depicted in equation 4) tend to be
positive in low-tax countries and negative in high-tax countries, suggesting that reported tax bases
in high-tax countries falls short of routine returns and tend to exceed them in low-tax countries.

12. Under an RPA mechanism, all countries would be entitled to fully tax routine returns.
The RPA proposal starts from MNEs’ consolidated residual returns and allocates this residual
based on some allocation factor. Denoting country c’s allocation share by , country-specific tax
bases under the new regime are:

∗
∗
0. (6)

since aggregate residual returns are assumed to be non-negative, equation (6) implies that countries
would be entitled to fully tax routine returns. Note that this conclusion rests on the assumption that
residual returns at the consolidated group level are a prerequisite for profit shifting.

13. The total effect of implementing an RPA method depends on the current and future
distribution of the total residual. This can easily be seen by subtracting equation (5) from (6),
giving:

∆ (7)

where ∑ is the aggregate residual, is the share of total fixed assets located in country c,
∆ is an assets-weighted tax differential between country c and other locations, and is a
hypothetical cost of profit shifting parameter.3 The equation formalizes the above result: countries
with large ’s relative to the country’s tangible asset stock will benefit from adopting the RPA
mechanism (indicated by , as will countries that currently impose a relatively high tax
burden on corporations (indicated by ∆ .

14. For instance, using destination-based sales as an allocation key, the implementation of
an RPA mechanism would benefit economies with large consumption bases and large CIT
rates. The main difference between a country’s GDP and domestic sales are its net exports. Partly,
destination-based sales may also show up as an intermediate input in the national accounts.
Countries with negative trade balances would thus likely benefit from implementation of an RPA
mechanism with destination-based sales as an allocation factor, as would countries with high

3 In contrast, if the location of fixed capital is irrelevant for the allocation of reported profit, equation (5) would

change to ∆ , where ∆ is now an unweighted average tax differential.

74 INTERNATIONAL MONETARY FUND

 INTERNATIONAL CORPORATE TAXATION

statutory tax rates since these countries’ tax bases are eroded due to profit shifting under current
rules.

15. To simulate the revenue effect of implementing an RPA mechanism using destination-
based sales, equation (7) is combined with various data sources. Specifically, equation (7) expresses
total effects from moving to an RPA mechanism as a function of five components: (i) destination-
based sales, (ii) relative capital stocks, (iii) tax-rate differentials, (iv) a parameter reflecting the cost of
profit shifting, and (v) the aggregate residual which is to be reallocated. None of these measures is
directly observed. The annex combines national consumption (private plus public) with gross fixed
capital formation to proxy for destination-based sales;4 it relies on country-specific CIT rates in
combination with estimated capital stocks to compute tax-rate differentials; presumes a hypothetical
profit shifting parameter of 1.5;5 and draws on the micro-data to quantify the aggregate residual.

16. Figure 8 in the text combines these, sometimes opposing effects, in illustrating the
redistribution of the tax base. The results build on a simple model, using various data sources, and
thus need to be interpreted with caution.6 Light-blue bars indicate tax base effects stemming from
country-specific differences in their consumption vs. capital intensity (the first term in (7)); dark-blue
bars illustrate tax base reallocation stemming from tax-rate differentials (the second).

Appendix Figure 3. Reallocation of Residual Returns Under Sales-based RPA

Source: IMF staff estimates.

Note: Black dots indicate overall effect of moving to RPA on residual returns. Depicted
numbers are shares of the global residual profit.

4Intermediate inputs, which are not captured by the difference between GDP and net exports, are disregarded in this
annex. The implicit assumption is that all intermediate inputs are purchased from related parties.
5 Following prior work by Beer and others (2018), a cost parameter of 1.5 is assumed in equation (7).
6The results are point estimates. The multiplicity of employed proxy-variables (such as destination-based sales) with
unknown probability distributions inhibits straight-forward sensitivity analyses or the computation of confidence
bands.

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INTERNATIONAL CORPORATE TAXATION

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