In my previous bog about NGO policy I referred to a review of the advantages of unitary taxation and the work of the ICC (under Theo Keijzer).
I spent some time as part of the Business Europe advisory group working with the EC on the CCCBT project and I have had extensive experience of how unitary tax works (or more accurately doesn’t work) in the US. The CCCBT project was a very good piece of work and produced a comprehensive system within the scope that existed. But I think its useful to focus on the problems that a unitary system poses before getting carried away that it is the solution of all the problems of international tax.
1. What is the tax base? Unitary focuses on three factors which divide the taxing rights between tax authorities: assets, sales and workforce. Unitary tax as a concept has its origins in an economy that was more tangible than intangible. Todays economy has a significant element of the intangible (which is why the OECD is grappling with the subject of intangibles) and the taxable base for an unitary tax system will contain profits derived from intangibles.
2. Allocation issues. Allocation is the elephant in the room in Unitary. We know how the current arms length system allocates profits between fiscs – people may not like the result but we know how it works – but unitary allocation will change that allocation with some fiscs being winners and others losers. Forecasting the difference between the current system and unitary is difficult, but neither fiscs nor politicians like the uncertainty and allocation has been one of the most divisive issues in CCCBT so far. So the key allocation issue is can you get all the fiscs to agree the same allocation keys, if you can’t double taxation or double non taxation will result.
3. Which assets? I referred to the origin of unitary in a more tangible economy. So which assets does one use to allocate tax base? In the CCCBT proposal only tangible assets are used and intangibles are ignored – despite the profits being allocated being in part derived from intangibles. If you do include intangibles, how do you value them? Don’t you just exchange one set of problems under the arms length principle in valuing the income from intangibles for another set of problems in valuing the intangible assets themselves? What is the value of a trademark compared to the tangible assets used with it? A further twist is what do you do to assets which are rented or leased or subject to mechanisms such as a sale and leaseback?
4. Sales seems a simple issue because like VAT on the destination principle it relates to the final sale to a third party customer. But this changes the allocation of profits as two examples will explain.
Take a Swedish high tech company with most of its sales outside Sweden. If the IP is held in Sweden, most of its taxable profits will arise in Sweden under the arms length principle despite most of the sales being outside Sweden. Under Unitary, as most of its sales are outside Sweden they will be allocated to the. countries where it markets. If we assume most of its workforce is in Sweden this factor will mainly be allocated to Sweden. If intangibles are included in assets then most of its assets will be in Sweden, if they are not more assets will arise outside Sweden. So under the arms length principle most of the profits arise in Sweden ( say 90%) under unitary, particularly due to sales, closer to 60% will arise in Sweden. Because of the 1/3, 1/3, 1/3 split, market location moves taxing rights to the biggest markets with a reduction in taxable profits for small developed markets and developing country markets (unless they are very large) where sales are likely to be proportionately smaller.
The second example is a mine in France. All its production facilities are in France, but most of its sales are outside France. Under arms length principles more than 90% of the taxable profits arise in France with the balance relating to sales and marketing. Under unitary, the taxable profits in France fall to roughly 70% due to the sales allocation factors.
5. Workforce. The problem with workforce is the difference in wage levels between economies. If you use wages then higher wage countries attract more of the allocation than lower wage countries – so developing countries lose out in the allocation. If you adjust to headcount, then this allocation key is more susceptible to planning. In addition, what do you do when jobs are outsourced – what is an employee for allocation purposes?
I don’t have an intrinsic opposition to unitary as a system per se. I think it poses as many issues as corporate income tax based on the arms length principle – it certainly doesn’t provide an easy fix. It allocates more taxable profits to markets, it has similar problems with intangibles as the arms length principle and it won’t stop tax planning even if all countries can agree on a common base and allocation system. And finally, it is likely that developing countries could see a reduction in taxable profits.