Alternatives to Taxation of Corporate Profits? Presentation made at the ICTD Annual Centre Meeting Arusha, Tanzania December 8, 2014

1. Alternatives to Taxation of
Corporate Profits?
Michael C. Durst, ICTD and Bloomberg
BNA
Arusha, Tanzania
December 8, 2014

2. The Transaction Structures of Base
Erosion are Complex
• BEPS depends on the establishment by
multinational group of various kinds of hub
companies (finance companies, intellectual
property companies, supply chain management
companies, etc.) in zero- or low-tax countries
• The shifting of income to the zero- or low-tax
subsidiaries can take different forms, including
but not limited to payments for (i) interest, (ii)
royalties, and (iii) the marked-up cost of goods or
intra-group services routed for legal purposes
through the hub company.

3. OECD, IMF Intensively Studying BEPS
• Measures under consideration include –
– Global network of controlled foreign corporation
(CFC) rules, under which home countries of
multinationals would effectively prohibit them
from accumulating income in zero- or low-tax
jurisdictions
– Limitations on interest deductions
– Revised transfer pricing rules

4. Political Background of BEPS
• All the measures being considered could as a technical
matter eliminate or greatly curtail profit shifting under
the corporate income tax
• Politically, though, what are the likely reactions of
policymakers around the world to measures that would
greatly curtail BEPS and therefore drive up effective tax
rates on income from cross-border activities?
• Should the poorer developing countries, which depend
heavily on revenues from taxation of cross-border
activity, put all their eggs in the income-tax basket?

5. Some Possible Alternatives to Income
Taxation
• Revitalized withholding taxes on outbound
deductible payments, including royalties,
interest and service fees
• Substitution of excise for income taxes in
selected settings where income taxation poses
severe administrative and enforcement
difficulties
• Greater use of variable royalties instead of
income taxation in natural-resources sector

6. Withholding Taxes on Interest,
Royalties, Service Fees
• Have long history, but sometimes considered
archaic and excessively blunt fiscal
instruments
• Often limited or eliminated under treaties
• But generally acknowledged to be easier to
administer than other available means of
limiting base erosion
• Likely political responses to proposals to
reinvigorate withholding taxes?

7. Selective Use of Excise Taxes
• Telecoms services (including mobile and
Internet services)
– Companies often foreign-owned, typically play
major roles in developing economies
– Transfer pricing exceedingly hard to verify:
complex networks of cross-border charges for call
origination and completion, roaming
– Providers can be very highly leveraged
– Telecoms services already typically subject to
excise taxes

8. Telecoms Excise Taxes (cont’d)
• Hypothetical example (numbers not “real” but
for illustration only)
– Assume reasonable arm’s-length margin of
company is 8 percent
– Assume applicable corporate income tax rate of
30 percent
– Then, excise of 0.3 x 8 percent, or 2.4 percent,
would fund elimination of corporate income tax
on providers
– Likely political reactions to idea?

9. Other Industries for which Excise Taxes
Might be Especially Useful
• Insurance companies – virtually impossible to
verify transfer pricing for reinsurance;
precedents available for taxes on premiums in
lieu of income taxation
• Banks – Very large and complex networks of
intragroup transactions; significant body of
knowledge on transaction fees

10. Natural Resource Fiscal Regimes
• Relative merits often debated of sliding scale
royalties, which increase as product prices
increase, versus taxes based on net income
(corporate income or resource rent taxes)
• Income-based taxes said to pose fewer financial
risks for both investors and governments;
however, income-based taxation generally
perceived as more difficult to administer
• Income taxation also is vulnerable to leverage

11. Natural Resource Fiscal Regimes
(cont’d)
• One element to be considered: relative
vulnerability to mispricing of product.
Example:
– Assume extractor that mines $1 million worth of
product at fair market prices, and has properly
determined net income of $150,000
– Compare now royalty of 6% versus income tax of
40%. If product is priced correctly, both will raise
$60,000

12. Natural Resource Fiscal Regimes
(cont’d)
• Now, however, assume that taxpayer misprices
product value by 10%, claiming value of $900,000
• Amount of royalty goes down from $60,000 to
$54,000, a decline of 10%
• Amount of net income goes down from $150,000
to $50,000, so income tax goes down to $20,000,
a decline of 60%
• How important should the implications of this
example be to the design of fiscal instruments,
for natural resources?