International Capital

Taxation
Rachel Griffith
James Hines
Peter Birch Sorensen
Comments
Julian Alworth

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Overview

1. Importance of international considerations in

tax design
2. The UK Tax system
3. International Tax competition
4. Options for capital income tax reform

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1. Importance of international considerations
in tax design: distinctions

 Source
– Territoriality and Capital income neutrality
– DTR: exemption
– In a small economy a tax will raise borrowing costs and fall on investments
– Savings decisions are unaffected
 Residence
– Tax on income or wealth of domestic residents
– Capital export neutrality
– DTR: credit
– In a small economy, the tax will reduce after tax returns on lending and fall
on savers
– Investment allocation is unaffected

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1. Importance of international considerations
in tax design: distinctions

 Taxes on normal returns to capital

 Taxes on rents
– Firm-specific or mobile (brand, know-how etc.)
– Location-specific or immobile (natural resources,
agglomeration effects etc.)
 Scope for taxes on immobile rents
– Not discussed thoroughly in paper
 Fundamental theorem: a small open economy
should not levy sourced-based taxes because
the burden is shifted onto immobile factors

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1. Importance of international considerations
in tax design: scope for source-based
taxes
 Scope for source based (corporation) taxes is limited and
should be vanishing if governments behave optimally
 GHS: this does not appear to be the case: why?
– Location-specific rents can be exploited
– Capital may not be perfectly mobile
– If capital exporters impose residence based taxes and allow
crediting of host country taxes there is an incentive for source
based countries to raise their tax rates
– Corporate taxes on foreigners are a backstop for the personal tax
system in host countries to avoid round-tripping
– “Tax illusion”: voters are unaware source based-taxes are shifted
onto immobile factors
 GHS agnostic on weight of different reasons
 Passing comment: in most countries withholding taxes on interest have
been abolished (with one notable exception)

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1. Importance of international considerations
in tax design: empirical evidence

 Considerable volume of solid empirical evidence

that the allocation of investments is highly tax
sensitive (though the size of the effects is not
measured precisely)
 Much evidence of tax-avoiding profit shifting
 Global responsiveness to changes in tax rates of
other jurisdictions
 Tax rates (nominal and effective) have declined in
the past 30 years but corporate tax revenues have
remained stable or actually increased

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3. International Tax competition: case
against

 A jurisdiction that unilaterally lowers taxes will attract mobile

factors of production thereby reducing national income and tax
revenues in other jurisdictions.

=> Spill-over effect (fiscal externality)

 In a non-cooperative game framework with many jurisdictions
this will result in a “race to the bottom”

=> Under-provision of public goods

=> Strong case for tax co-ordination

Note: this analysis applies to all taxes on mobile factors of production (little
difference between labour and capital mobility)

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3. International Tax competition: case
for competition

 Gains from tax coordination presume a benevolent

government acting in the best interests of citizens
 “Starving the beast” through tax competition is a way to
reduce inefficiencies in government
– Rent seeking behaviour of bureaucrats and politicians
– Inefficiencies from redistributive policies
– Inability to pre-commit to an efficient intertemporal path of
taxation
 Other argument against coordination: common tax
policy is not responsive to requirements of individual
jurisdictions (national autonomy)

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3. International Tax competition

 GHS seem to suggest that tax competition/ coordination is an empirical

matter
 Results are reported of a GE model for OECD countries
– Cost of capital differs across countries, leading to wedges in
marginal productivities
– Coordination leads to a more efficient allocation of capital (raising
total income by 0.4%)
– However, welfare rises in aggregate by only 0.1% because of
induced increase in factor supplies but
– There are significant differences in distributional impact amng
various countries
– Other distortions persist limiting scope of benefits from
harmonisation (second-best argument)
 On balanced GHS are non-committal regarding the benefits from tax
harmonisation in the absence of compensation mechanisms

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3. International Tax competition:
Policy Response
 OECD: Harmful Tax Practices
 EU Code of Conduct on Preferential Tax Regime
 EU Savings Directive

 Authors view: these measures have not necessarily had

the intended consequences
– Tax havens may be beneficial
– The reduction of preferential tax regimes may lead to more explicit
tax rate competition
– Savings directive leaves large loopholes

 Common Consolidated Tax Base

 Role of European Court of Justice

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3. International Tax competition:
Common consolidated tax base

 Objective: multinational companies could opt to have

their business income taxed under a common set of
rules valid for all EU countries, base would be
apportioned according to formula, each country
would apply own tax rate
 No need to discuss with various tax authorities and
sharp reduction in transfer pricing

 Problems:
– Relation with non EU (formula apportionment with
separate accounting)
– Intangibles in formula (valuation)

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3. International Tax competition: ECJ

 Internal Market (1992): “freedom of

movement of goods services capital and
persons”
 ECJ is striking down rules that appear to
disciminate on grounds of nationality or limit
four freedoms
 Authors: describe the various areas affected but
no judgement

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4. Options for capital income tax
reform

 Alternative concepts of tax neutrality (can we think

of territoriality and residence in other terms)
– GHS recognize a trend towards exemption
– Justification
 Most international investments occur through acquisition
 If all companies are to be treated on a par in a bidding
the valuation of assets should be unaffected by tax
(ownership neutrality)
 Holding company regimes (participation exemption)
 Spanish shopping spree
 Countries are trying to place their multinationals at a
competitive advantage in a bidding environment

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4. Options for capital income tax
reform

 Should UK move to territoriality?

– What do we think of the current system?
– If one believes that deferral entails that the current credit
system operates like an exemption system then the
behavioural response to moving towards an exemption
system should be small
– GHS argue that such a move would probably result in a
small net loss of revenue
– GHS however suggest design of new system would be
critical (without going into details)
 The UK does not have an active/passive distinction
 UK does not have complex interest and expense allocation
rules

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4. Options for capital income tax
reform

 Common Consolidated Tax Base (CCCTB) vs. Home state taxation

(HST)
– EU: 27 national corporate tax regimes
– High compliance and costs for multinationals and significant costs of
administration
 CCCTB
– Option would be to define a common base
 Home state taxation (Gammie & Lodin)
– MNCs calculate EU wide tax on a consolidated basis according to the rules
of the country of residence of parent company
– Tax base would be allocated according to formula apportionment and
revenues would be allocated on the basis of tax rates in individual
countries
– Pros: flexibility no need for a common base and optional for companies
– Cons: competition for headquarters may narrow tax base (though mutual
recognition of tax bases would limit problem) and potentially lower
revenues if companies opt for system with lower revenues.
– GHS do not appear to favour HST

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4. Options for capital income tax
reform

 ACE
 CBIT
 Dual Income Tax

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Conclusions

 Source based taxation is under pressure but

there is continued for taxation in foreseeable
future
 The benefits for tax co-ordination are small
 Current reform proposals appear to solve
certain issues but have some flaws

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Comments

 General Aspects
 Specific theoretical and policy questions

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General Aspects
 Insufficient description of UK tax system and
comparison with US, Canada and main EU
countries
– How much revenue does the UK raise from foreign
source income?
– CFC regime, working of DTR in UK versus other
countries, active/passive income, transfer pricing
– What are perceived to be the main areas needing
adjustment?
– Major changes in recent years

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Elements not considered in this version

 Editorial: International aspects of the taxation of

labour, wealth and consumption (including
transaction taxes)
 Several current issues treated only in a cursory
fashion (example: active/passive distinction,
corporate personal tax integration in an open
economy, transfer pricing)
 => Prime focus on certain aspects of corporate tax
(individual income tax discussed only in passing)

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General Aspects
 Macro-background
– Trends in the economy (de-materialisation, services, finance etc.
– Do these trends pose permanent or passing issues for tax policy?
 Political framework
– Internal market
– Constraints on sovereignty
– Which audience for the policy recommendations ? Domestic or
European?
 Evaluation
– Will the EU go ahead? What solution is desirable at the EU level? If
coordinated solutions are not found what is a reasonable standalone
policy?

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Specific issues

 The attractions and limits of exemption

 Rents and source based taxes
 Financing complications
 Collective investment vehicles

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Attractions and limits of exemption

 Attractions: Simplicity and EU compatibility

as applied on the continent
– Participation exemption (parent-subsidiary
directive – non black-listed countries)
– Black listed countries (CFC)
 Back-stop provisions
– Active-passive
 Losses, triangulations

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Rents and sourced based taxes
 Do rents represent a solid basis for believing in a
source based tax system?
 Are foreigners being truly taxed? Who
incorporates agglomeration and other location
specific rents?
 Timing issues are important
 If assets tradeable, capitalisation effects are
important and rents are taxed upfront
 Capital gains tax crucial

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Financing complications
 Debt-equity distinction is a major issue at the
international level
 Financing arrangements are important in the
way exemption and residence operate
 Example: authors suggest that exemption is
equivalent to ownership neutrality
 Yes only if financing is loaded unto acquired
company

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Collective investment vehicles
 Collective investment vehicles have proliferated in
recent year
– create greater liquidity from previously untradeable assets
– Diversification
 Corporate form desirable but not corporate tax
– Pass-through treatment desirable for investors: If you
previously owned a building directly you still wish to be
taxed in the same fashion
– Limited liability and transferability
 Reliance on Residence of final investors
 Source-based taxes have not worked

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