Selected Issues

Abstract

Selected Issues

Capital Income Tax Reform Options in Denmark1

Like other countries, Denmark faces pressures from international tax developments, such as tax competition and profit shifting, and increasingly digitalization. The international tax provisions of Denmark are comparatively strong and require only minor technical adjustments for full alignment with international initiatives such as the EU Anti-Tax Avoidance Directive. Domestically, the Danish tax system could be made more favorable toward investment, especially for small and high-technology firms, for example by reducing dividend taxation, relaxing rules on loss utilization, and making the R&D tax treatment more generous. Moreover, starting from a relatively efficient tax system, Denmark is in a position to consider fundamental reforms that would address the debt bias and disincentives to investment at the margin, for example through the introduction of an allowance for corporate equity. Addressing the fundamental problems of international corporate income taxation, such as those exacerbated by digitalization, would benefit from multilateral rather than unilateral actions.

A. Introduction

1. Corporate income tax (CIT) systems around the world are under increasing pressure from international profit shifting and the mobility of capital. Tax competition over reported profits2 and investment has put downward pressures on CIT rates, which have been on a downward trend for the least three decades. Denmark, like any small open economy, is affected strongly by these developments.

2. Recently various international initiatives have been taken to curb profit-shifting opportunities of multinational enterprises. These include the OECD/G20 initiative to curb Base Erosion and Profit Shifting (BEPS) and the EU’s Anti-Tax Avoidance Directive (ATAD). For Denmark, these initiatives provide opportunities, in that they may help reduce profit-shifting and they bring other countries closer to the relatively tight rules already existing in Denmark. They also affect Denmark in requiring some adjustments, where Danish rules are not fully in line with agreed standards.

3. Digitalization intensifies many of the existing difficulties in the international tax system. Digital companies—or more generally any companies becoming more digitalized—are often marked by high profitability and intensive use of intangible assets. Neither issue is new, for example they are also prevalent in the pharmaceutical industry, but they are increasing in importance. One feature of the so-called “digital economy” is sales without a physical presence. This is also not entirely new, but is much more prevalent now than during times of catalogue shopping. Under the current tax system, market jurisdictions (i.e., where consumers are located) cannot tax the profits of companies selling into their economy from abroad, because, in the generally agreed architecture, a nexus in the form of a physical presence (or “permanent establishment (PE)”) is a precondition. Moreover, some firms make use of user-generated value, from data that users provide in return for access to a service. This is a relatively newer issue, and there is no consensus on whether and how this should affect international tax design issues.

4. The challenges of the digitalization of the economy are also reflected in international efforts, like those on BEPS generally, but unlike on those issues, no consensus has yet been achieved at all. Digitalization was a specific focus of the BEPS Action Plan leading to the 2015 BEPS Action 1 Report. Although the BEPS project addressed some of the BEPS challenges exacerbated by digitalization, no consensus was reached in 2015 on either an interim or longer-term solution. It was further acknowledged that it would be difficult—if not impossible—to ‘ring-fence’ the digital economy from the rest of the economy. The OECD Interim Report—Tax Challenges Arising from Digitalization—mandated in 2017 by the G20 and published on March 16, 2018 (Interim Report) did not contain concrete proposals for international tax reform. However, the Interim Report did recognize the need to continue to work toward a consensus-based solution over the longer term—noting that at present—there are divergent views on how the issue should be approached, with also no agreement on the need for interim measures. In contrast, on March 21, 2018, the European Commission (EC) published a concrete proposal for a two-fold strategy to reform the taxation of digital companies and business models. The EC put forward a “comprehensive solution” over the longer term, together with a more “targeted solution” in the interim in the form of a digital services tax at a rate of 3 percent on the turnover of certain large digital companies. The OECD will also undertake further work in this area with the intermediate step of updating the G20 on its progress in 2019 and with the ultimate aim of continuing to work toward a consensus-based solution by 2020. Table 1 provides a comparison of key aspects of the OECD Interim Report and EC proposal. Denmark, as both a user and producer of digital services, will clearly be affected by these initiatives.

Table 1.

Comparison of Key Aspects of the OECD Interim Report and EC Proposal

article image
Source: IMF staff assessment.

B. Assessment of Business Taxes

Main Features

5. The CIT rate of 22 percent is close to the EU and OECD averages. As shown in Figure 1, when local taxes and surtaxes are included (which can be sizable in some countries, such as Germany, Switzerland, or the United States), the Danish rate is at the EU, and slightly below the OECD, average. The recent U.S. reform brought the federal U.S. rate down to 21 percent. However, as the average combined rate including state taxes stands at around 25.75, the Danish rate remains lower.

Figure 1.
Figure 1.

The Danish Corporate Income Tax Rate in International Comparison

Citation: IMF Staff Country Reports 2018, 178; 10.5089/9781484362556.002.A003

Source: FAD TP Rates Database.

6. The tax base is marked by relatively generous depreciation, but restrictive loss offsets. Most plant and machinery is depreciated using the pooled3 declining-balance method under a 25 percent rate. Business buildings are depreciated individually at 4 percent straight line. An interesting feature of Danish depreciation rules is that they are only maximum amounts, and companies can choose lower—even zero— depreciation if they prefer. Losses may be carried forward but cannot offset more than 60 percent of future profits above DKK 8.2 million (2018).4

7. A limited number of business tax incentives are offered, most importantly for Research and Development (R&D). As a general investment incentive additional depreciation was used in the past (e.g., between May 30, 2012 and December 31, 2013). Shipping companies benefit from a tonnage tax regime (with European Commission approval). R&D costs can be expensed—as in most countries; moreover, the tax benefit of R&D expensing of up to DKK 25 million per year is refundable for loss-making taxpayers. Nonetheless, the implied tax subsidy rate is far below the OECD median (OECD, 2017). The government announced (February 2, 2018) an R&D super-deduction of 110 percent of R&D spending by 2026, phased in from 2018 at initially 101.5 percent. Unlike the standard deduction, the tax value of the part that exceeds 100 percent is not refundable.

International Initiatives

8. Denmark is an early adopter of strong anti-avoidance rules. Denmark’s rules cover transfer pricing, controlled-foreign companies (CFC), limitation on interest deductibility, and other more general anti-abuse provisions. These are largely in line with the G20/OECD BEPS Project and the July-2016 ATAD (Box 1). However, some further strengthening of existing anti-avoidance rules is expected.

Denmark’s International Obligations and Commitments Regarding the CIT

Denmark is committed to implementing the four Minimum Standards of the G20/OECD BEPS Project. These are: countering harmful tax practices, preventing tax treaty abuse, transfer pricing documentation, country-by-country (CbC) reporting, and improving tax treaty dispute resolutions. Denmark has already largely implemented all 15 BEPS Actions. For example, Denmark has implemented CbC reporting under which multinational groups with a consolidated turnover of at least DKK 5.6 billion must prepare and submit a CbC report to the Danish tax administration. In addition, Denmark has several obligations and commitments under EU law. Notable obligations include the implementation of the ATAD, adopted on July 12, 2016. ATAD requires all Member States to implement five anti-tax abuse measures. The ATAD goes further than the four minimum standards under BEPS. Table 2 provides a summary.

Table 2.

Denmark: ATAD Implementation in Denmark

article image

Denmark has until January 1, 2024 to conform to the ATAD where its targeted rules are equally effective as the prescribed interest limitation rule.

Source: IMF staff assessment

9. Being an early adopter, Denmark imposed relatively higher compliance costs on firms and, because of frequent changes in the past, had a reputation of lack of tax certainty among taxpayers. Denmark therefore stands to gain from the international initiatives, which will lead to the adoption of similar rules in other countries through more significant reforms, and which will only—in comparison—require minimal changes in Denmark. Tax certainty is increasingly recognized as an important factor in encouraging investment (Box 2). Further, a stable, competitive and predictable tax system is also important from the perspective of businesses as well as governments. Complexity of tax legislation and frequency of tax law changes are commonly cited sources of tax uncertainty for both taxpayers and tax administrations. Denmark should also take into account the impact of implementing more extensive measures than are required under the international initiatives, with particular regard to what is being adopted by other relevant countries. For example, Denmark’s interest limitation rules are generally more extensive than ATAD.

Tax Certainty

Tax uncertainty is a concern among the business community—as in many other countries. It has been subject to a longstanding debate in Denmark, given that Denmark has historically been an early adopter of strong anti-avoidance rules. The importance of improving stability and certainty in tax matters has also received attention internationally in the context of the G20 tax agenda (IMF/OECD, 2017). An update on tax certainty is expected to be delivered to the G20 in July 2018.

Theoretically, the impact of uncertainty on investment is unclear, but empirical studies, while limited, suggest that tax uncertainty can adversely impact investment and trade. This is supported by the business and tax administration surveys included in the IMF/OECD (2017) G20 report on tax certainty, according to which uncertainty in the CIT (and VAT) systems has an important impact on investment and location decisions of businesses.

Various tax integrity or anti-avoidance rules are very important in order to effectively counter tax avoidance practices and protect the integrity of the tax system. This is because even the best-designed and drafted tax laws are not capable of anticipating every taxpayer transaction and aggressive tax-planning structure. Anti-avoidance provisions can take different forms and their effect on tax certainty needs to be carefully managed. For instance, the success of a GAAR is often dependent on it being applied by the tax administration in a measured, even handed and predictable way, particularly given that a GAAR is necessarily less rules-based and more discretionary in its application (Waerzeggers and Hillier, 2016).

Unacceptable tax avoidance practices may also be dealt with through other legal instruments or doctrines, each of which can also affect tax certainty. These include a more specific legal provision of targeted application in domestic law (for instance, a specific anti-avoidance rule or SAAR), equivalent provisions to that of a GAAR or SAAR in tax treaties, and/or judicial anti-abuse doctrines. All of these instruments and doctrines are already features of the Danish tax system. Anecdotal evidence suggests that this has made the Danish tax system relatively more complex and uncertain for businesses when compared to other countries who have deferred adoption of new or tighter tax anti-avoidance rules, despite many of those rules being considered necessary to protect the local CIT base.

Many of the stronger and more complex tax anti-avoidance rules that have been adopted early by Denmark now form part of the BEPS and ATAD measures. Therefore, the Danish tax system could now benefit from relatively greater stability and predictability (and therefore reduced taxpayer compliance costs) when compared to other countries which need to implement more significant tax law reforms in order to comply with those measures.

Important efforts have also been made to improve legal certainty for taxpayers in Denmark, in particular through the advance tax rulings system. Advance tax rulings are widely recognized as an important tool for improving taxpayer certainty (IMF/OECD, 2017, pp. 45–46), and as a way to promote clarity and consistency in the application of the tax law for both taxpayers and the tax administration (Waerzeggers and Hillier, 2016). To fully achieve these objectives, however, taxpayers should be able to obtain a swift response from the tax administration on the widest range of material issues, including international tax issues. Other tools—such as an increased Advance Pricing Agreements (“APAs”) program— can also improve certainty for businesses and tax administrations (IMF/OECD, 2017, pp. 52–54).

10. Denmark’s tax policy is also constrained by obligations and commitments under the EU, notably the Code of Conduct for Business Taxation and the State Aid Rules. The Code of Conduct for Business is a political commitment by Member States to refrain from engaging in “harmful tax competition,” which covers many preferential tax regimes, including those targeted at attracting reported profits. EU state aid rules prohibit Member States from offering government support, including through the tax system, that gives a company an advantage over its competitors in the EU. Cases can be simultaneously within the ambit of the Code of Conduct and state aid rules. Currently, no major Danish rule is known to be in violation of these obligations. The preferential shipping regime has EU approval.

11. Despite tight tax anti-avoidance rules in Denmark, the observed bilateral FDI pattern suggests that international profit shifting remains a risk to CIT revenue. Cristea and Nguyen (2016) estimate that Danish multinationals reduced their tax liabilities by 3.2 percent during the period 1999–2006. Comparing data from bilateral FDI stocks to data that are adjusted for the country of ultimate ownership, reveals that inbound FDI often comes through indirect routes (Table 3). While this may have many reasons, it is very likely that it also reflects tax-driven conduit and other complex structures of multinationals. One factor may be special tax provisions offered in some countries.5 Another important factor that may drive bilateral Danish FDI is seeking to benefit from double tax treaties between a conduit country and a non-EU member (“treaty shopping”)—which can be especially important for non-Danish multinationals. This pattern occurs despite Denmark’s strong anti-abuse rules to combat treaty shopping, including a domestic law general anti-abuse rule (GAAR) that applies to deny tax treaty benefits where the most significant purpose of an arrangement or transaction is to obtain treaty benefits which are not in accordance with the content and purpose of the particular tax treaty. Denmark also signed the Multilateral Convention (MLI) on June 7, 2017 which will see Denmark’s covered tax treaty network adopt the principal purpose test (PPT) to address situations of treaty abuse.

Table 3.

Denmark: Top Danish FDI Partners

article image

Inward FDI figures for 2015 are extremely similar.

Sources: unadjusted: IMF Coordinated Direct Investment Survey (CDIS), adjusted: Danmarks Nationalbank (2017).

C. Integration with Personal Income Taxes

12. Personal income is taxed at progressive rates, which differ by the type of income.

  • Labor income faces a top tax rate of 55.9 percent. This rate includes the labor market contribution of 8 percent, which applies without allowance to all labor income and is deductible for other taxes. The other taxes, which include the national income tax, the municipal income tax, and health contributions add up to at most 52.02 percent (the national tax is reduced below its 15 percent top value in case the total of all three taxes exceeds 52.02 percent). Moreover, labor income is additionally subject to a fixed monthly supplement payment of DKK 94.65.

  • Income from capital other than shares is taxed at a top rate of 42.7 percent. The rate is thus lower than for labor income, and moreover capital income benefits from additional allowances. Capital gains are taxable at the same rate, and capital losses are deductible within this income category. Both are recognized only on realization.

  • Income from shares is taxed at rates of up to 42 percent. Below DKK 51,700 a rate of 27 applies, which is collected through withholding. As for other capital income, capital gains are taxed on realization at the same rate, and losses are deductible against other income from shares. The combined rate on dividends, including the CIT paid before distribution, reaches 54.8 percent, which is very close to the top rate on labor income. The combined rate is also very high by international comparison (Figure 2).

Figure 2.
Figure 2.

Combined CIT and Dividend Tax Rate on Distributed Profits

(Percent)

Citation: IMF Staff Country Reports 2018, 178; 10.5089/9781484362556.002.A003

13. Capital invested through certain vehicles, most notably pension funds, benefits from preferential tax rates.

  • Pensions contributions are made out of pre-tax earnings, returns are taxed, and final pensions are also taxed (ETT). This is less generous than in most other countries that either tax contributions (TEE) or pensions (EET). However, it is still an advantage compared to saving outside of pension funds, because the tax on return is reduced to 15.3 percent.6 Even though this tax applies to accrued capital gains, rather than realized ones as for direct share holdings, the much lower rate will in most cases provide a reduction. Any capital losses can be used only against pension account income. Contribution levels are usually set in labor contracts (typically 12 percent of salary, 2/3 of which is paid by the employer), but individuals can also set up individual pension accounts to which they may contribute up to DKK 54,000 per year.

  • Authorities are planning to introduce a Share Savings Account as a vehicle for saving in listed shares. This will benefit from a preferential rate of 17 percent (including on accrued capital gains, as in the case of pensions), and would be limited to DKK 50,000 or DKK 200,000 (discussions are ongoing) per person. Once the limit is reached individuals will not be allowed to add further new funds into these accounts, but any returns on existing shares may be kept in the account without limit.

14. Overall, the Danish tax system can be described as a dual income tax, although it is relatively close to comprehensive income taxation. Compared to theoretical tax systems ranging from consumption to comprehensive income taxation, the Danish system is closer to the latter. Capital income, except for income from shares, does face a slightly lower rate and various savings vehicles ensure preferential treatment of savings, but only within limits. Investment in owner- occupied housing, as in many other countries, has tax advantages through the nontaxation of imputed rents, while mortgage interest is partly deductible.

D. Reform Options

15. Overall, the Danish CIT system is in good shape with no urgent need for major adjustments. Still, some relatively small adjustments need to be taken to fully align the system with international requirements, and some reforms could be considered to improve investment incentives, especially of small and high-technology firms. Moreover, fundamental tax reforms could be considered to go beyond international standards and make the system neutral with respect to debt and investment.

Reforms within the Current System

16. In response to recent international initiatives aimed at reducing profit shifting, Denmark will require minor technical changes only. Specifically, one of the Danish interest deduction limitation rules will need to be changed from EBIT to EBITDA to be aligned with the requirements. The practical implication is likely to be limited, as for most firms the more binding limitation is the restriction in terms of assets, which is not affected. In general, there is little need for further tightening of anti-avoidance rules, which are already stronger than in most countries. However, as new avoidance strategies keep being developed, vigilance in this area is always warranted.

17. Various measures could be taken to decrease disincentives for investment by small and high-technology companies. New companies naturally face cash constraints and obstacles in access to finance, given their lack of history. High-technology companies also face difficulties in obtaining loans, because of a greater share of intangible assets, which cannot be used as collateral. Moreover, both startups and high-tech companies are prone to have many years of loss-making, followed by very high profits in case of success. Given the importance of such firms for technological progress, the tax system should at least not create additional difficulties for such firms. The rate of net new business creation in Denmark is relatively low compared to other European countries (Figure. 3), although this certainly is not only driven by the tax system. Various aspects of the Danish tax system discourage such businesses and could be reformed. In order of priority:

  • The tax rate on dividends could be reduced.7 The high taxation of dividends discourages equity investments in startups by individuals. Listed firms are less affected, as their marginal shareholders are likely to be pension funds or foreign investors. For small investors with little collateral, there is no alternative to equity funding, which implies a very high cost of capital for them.

  • The limitations on the use of losses carried forward could be relaxed. The limitation poses a challenge for cash-constrained startups. When they finally become profitable, this slows down the rate at which they can use up past losses. For some business activities, such as the development of patents, which are sold in case of success, loss recovery may never happen, as a successful year is followed by loss-making years during which the next patent is developed.

  • Alternatively, rules restricting the deductibility of costs for business establishment, expansion or development could be relaxed. As a result of the current rules, existing businesses with free cash flow that could instead undertake new investments are also disincentivized by the tax system.

  • The treatment of R&D deductions could be made more generous. The refundable part of the R&D deduction counteracts some of the problems of cash-constrained firms in a loss-making position. However, to fully reap the benefit of the super-deduction, this could also be made refundable.

Figure 3.
Figure 3.

Net Business Population Growth, 2014

(Percent)

Citation: IMF Staff Country Reports 2018, 178; 10.5089/9781484362556.002.A003

Source: Eurostat.

18. Reducing the rate of taxation on dividends would require accompanying regulations, but international experience suggests that these would be manageable. The advantage of the current system is that owner-run businesses have little incentive to categorize income as dividends rather than labor, as top tax rates are very similar. If the tax rate on capital income is materially lower than the tax rate on labor income, then owners face strong incentives to withdraw most of their income in the form of capital income (dividends and capital gains). A number of rules-based approaches have been developed in other countries to allocate income between labor and capital income in these circumstances (Table 4).8 These approaches are generally preferred over a more case-by-case rule using taxpayer specific facts and circumstances to determine reasonable compensation amounts. Denmark already has some similar rules, so as to prevent excessive savings inside such firms. Ensuring the effectiveness of the chosen rules will require striking an appropriate balance with respect to the inherent trade-off between certainty and simplicity. In this regard, the ultimate set of rules must be effective in achieving their policy objective of combating income shifting towards low taxed capital income and preventing abuse,9 but not become so complex that they are difficult to: (i) apply by taxpayers; and (ii) administer by the tax administration. It is considered important that the Danish authorities conduct a comprehensive study of costs and benefits and the effects on revenue and distribution before implementing such rules.

Table 4.

International Approaches to Splitting Wages and Profits of Owner-Run Businesses

article image
Source: IMF Staff compilation

19. A reduction in dividend taxes would not only benefit small and high-tech firms, but also have other long-term benefits. The authorities are currently considering an alternative measure to support the growth of small equity-financed businesses by allowing a special tax deduction worth 15 percent for individuals investing up to DKK 1.05 million equity in unlisted firms. This would also help some firms, but it would also make the tax system more complicated and may run into difficulties in practice. Private sector representatives expressed concerns about the practicality, given that one condition appears to be that investor must not personally know the owner (and it certainly does not help owners investing their own funds). Lower dividend taxes, however, would reduce the debt preference of the tax system (if the combined CIT and dividend tax comes closer to the tax on interest). The lower cost of capital for new equity would increase investment for all firms whose marginal cost of funds is equity. Finally, with continued downward trends in CIT rates, it is possible that Denmark, too, will wish at some point to reduce the CIT rate further. That would then in any case require rules for splitting profits of owner-run businesses, unless the dividend tax rate is increased even further, which would exacerbate the trapped equity problem.

20. It will be important to minimize the distortions that could arise from the Digital Services Tax (DST) which is proposed to be introduced uniformly in all EU Member States, including Denmark. There is a risk that the DST could create distortions because the tax applies irrespective of the level of profit; can lead to international double taxation; and might not achieve its goal of taxing profits, as the tax may ultimately be shifted onto local consumers. Further, interim or temporary measures often become permanent, thus prolonging these risks, and can be counterproductive if they reduce the likelihood of a global consensus. The comprehensive solution proposed by the EC also raises concerns associated with ring fencing, and should be become part of a wider debate at the global level. Addressing the challenges posed by digitalization coherently requires a vision of the longer-term design of the international tax system. Continued attention should be focused on a coordinated and well-integrated approach to resolve the wider challenges that digitalization imposes to the international tax framework. This will be important to minimize significant spillovers and distortions.

Fundamental Reform Options

21. A fundamental reform option that would achieve neutrality toward investment and between debt and equity would be the introduction of an allowance for corporate equity (ACE). The idea of the ACE is to maintain deduction for interest expenses10 and give a tax allowance for equity. An alternative design, known as an allowance for corporate capital (ACC) developed in Boadway and Bruce (1984), eliminates interest deductions, but offers an allowance for notional return independent from the source of financing (interest or equity). Despite its theoretical advantages, no country, has implemented such a system. In theory, the base of the ACE is the total book value of the stock of equity based on tax accounting. When it is introduced for the first time, however, it is appealing to define the base as new equity relative to a reference year (incremental ACE), as this prevents loss of tax revenue regarding past decisions. Eventually, the base of the incremental system evolves to the total stock of equity. The Budget proposal for 2017 (Finanslovforslaget 2017) proposed an ACE for Denmark, but it has not been implemented. Based on estimates published by the Ministry of Finance (Finansministeriet, 2017) and ACE would boost GDP by 1.7 percent in the long run, through its positive impact on investment.

22. The current low interest rate environment is an opportunity to introduce the ACE at a relatively low short-term cost, but the decision should take into account the estimated long-term revenue implication. Theoretically, the rate of the ACE should be the “risk-free” rate at which shareholders discount the tax savings from the company’s future ACE.11 In practice, the risk-free rate is typically approximated with the yields on long-term government bonds. Figure 4 shows that the long-term yield on Danish government bonds has been following a downward trend reaching 0.64 percent in March 2018. Thus, the cost of introducing the ACE in the first year would certainly be moderate, though the exact figure will depend on many other factors including the size of economic rents in the economy and the share of loss-making firms. Over time, the cost of the ACE increases as the interest rate goes up and the base of the ACE converges to the total book value of equity. This long-run cost should be taken into account in advance, as abolishing the ACE later based on revenue concerns would only create tax uncertainty and undo all of the beneficial effects of the ACE. A cap on the rate of the ACE would relinquish the desirable neutrality properties of the ACE, and is hence generally not recommended. The Ministry of Finance has undertaken a study of the revenue estimates which suggests a long-run cost of DKK 8 billion after dynamic scoring (compared to total company tax revenue of DKK 65 billion in 2017), which could be reduced to DKK 5.4 billion in case of an interest rate cap of 3 percent.12

Figure 4.
Figure 4.

Long-Term (10-Year) Government Bond Yields in Denmark

Citation: IMF Staff Country Reports 2018, 178; 10.5089/9781484362556.002.A003

23. A few countries currently implement an ACE system and a similar system was recently proposed by the EC under the CCCTB. Except for Malta, all existing ACE systems—including Belgium, Cyprus, and Italy—have an incremental base. Belgium has had the total book value of equity as the base until 2017, but switched to an increment base starting in 2018. The rates are all linked to the yields on government bonds. Countries such as Austria, Croatia,13 Latvia, and Portugal abolished their ACE regimes. Some countries have had a form of an ACE, but eventually it was abolished (Appendix Table).

24. Empirical evidence suggests that an ACE reduces corporate leverage, including for banks. Table 5 provides an overview of empirical evidence on the impacts of ACE regimes on corporate debt and investment. The evidence on the impact on investment is mixed. Furthermore, appropriate-anti tax avoidance measures are important to accompany the adoption of the ACE (Hebous and Ruf, 2017; IMF, 2016).

Table 5.

Empirical Studies of Allowances for Corporate Equity

article image
Source: IMF Staff compilation

Multilateral Reform Options

25. In October 2016, the European Commission relaunched the proposal for a Common Consolidated Corporate Tax Base (CCCTB) in the EU. Under this proposal, Member States need to first agree on and implement a single EU-wide set of rules for computing the tax base of companies in the EU, and then consolidate that tax base and share it between relevant Member States using an apportionment formula. It would be mandatory for multinational groups with global consolidated revenues of at least EUR 750 million and optional for other companies. The proposed common tax base would include an ACE and a super-deduction for R&D expenditures. The proposal contemplates several anti-avoidance measures consistent with ATAD, including a net interest deduction limitation rule. Apportionment is proposed using three equally weighted factors representing labor, assets and sales. The CCCTB would constrain profit shifting within the EU. However, it may intensify CIT rate competition, reallocation of factors of production, and perhaps regulatory competition. Incentives to shift profits out of the EU would remain, and may become even more important, though resources freed from controlling intra-EU transactions could be concentrated on fewer transactions with the rest of the world.

26. Denmark should study carefully the revenue and other implications of the CCCTB proposal, which Denmark cannot implement unilaterally, but can support in the EU. The tax base appears narrower than Denmark’s current base, though the difference is likely to recede as Denmark increases the R&D super-deduction and if it introduces an ACE. The allocation by formula may also reduce the share attributed to Denmark, given Denmark’s strong position as a producer and R&D developer, while the domestic market is (and hence sales are) small. However, even a small revenue loss may be acceptable if weighed against the reduced need for control of intra-EU transactions.

Annex I. Country Experiences with the ACE

article image
article image
Source: IMF Staff Compilation

References

  • Boadway, R. and N. Bruce, 1984, “A General Proposition on the Design of a Neutral Business Tax,” Journal of Public Economics, Vol. 25, pp. 231239.

    • Search Google Scholar
    • Export Citation
  • Bond, S.R. and M.P. Devereux, 1995, “On the Design of a Neutral Business Tax under Uncertainty,” Journal of Public Economics, Vol. 58(1), pp. 5771.

    • Search Google Scholar
    • Export Citation
  • Célérier, C., T. Kick, and S. Ongena, 2017, “Changes in Cost of Bank Equity and the Supply of Bank Credit,” CEPR Discussion Papers, No. DP12172.

    • Search Google Scholar
    • Export Citation
  • Cristea, A.C. and D.X. Nguyen, 2016, “Transfer Pricing by Multinational Firms: New Evidence from Foreign Firm Ownerships,” American Economic Journal: Economic Policy, Vol. 8(3), pp. 170202.

    • Search Google Scholar
    • Export Citation
  • Danmarks Nationalbank, 2017, “The Global FDI Network: Searching for Ultimate Investors, Working Papers of Danmarks Nationalbank, No. 120.

    • Search Google Scholar
    • Export Citation
  • De Mooij, R., and S. Hebous, 2018, “Growth-Enhancing Corporate Tax Reform in Belgium,” Nordic Tax Journal, forthcoming.

  • De Mooij, R., and S. Hebous, 2017, “Curbing Corporate Debt Bias: Do Limitations to Interest Deductibility Work?IMF Working Papers, No. WP/17/22.

    • Search Google Scholar
    • Export Citation
  • Fane, G., 1987, “Neutral Taxation under Uncertainty,” Journal of Public Economics, Vol. 33 (1), pp. 95105.

  • Finansministeriet, 2017, “BNP-virkning ved ACE,” Notat. Available at: https://www.fm.dk/~/media/files/oekonomi-og-tal/fm-regnemetoder/bnp_virkning-ved-ace.ashx?la=da

    • Search Google Scholar
    • Export Citation
  • Hebous, S. and M. Ruf, 2017, “Evaluating the Effects of ACE Systems on Multinational Debt Financing and Investment,” Journal of Public Economics, Vol. 156, pp. 131149.

    • Search Google Scholar
    • Export Citation
  • IMF, 2016, “Tax Policy, Leverage and Macroeconomic Stability,” IMF Policy Paper.

  • IMF/OECD, 2017, “Tax Certainty,” IMF/OECD Report for the G20 Finance Ministers.

  • Keen, M., and J. King, 2002, “The Croatian Profit Tax: An ACE in Practice,” Fiscal Studies, Vol. 23(3), pp. 401418.

  • Klemm, A., 2007, “Allowances for Corporate Equity in Practice,” CESifo Economic Studies, Vol. 53(2), pp. 229262.

  • Martin-Flores, J. and C. Moussu, forthcoming, “Is Bank Capital Sensitive to a Tax Allowance on Marginal Equity?European Financial Management.

    • Search Google Scholar
    • Export Citation
  • OECD, 2017, “R&D Tax Incentive Country Profiles 2016: Denmark,” Measuring R&D Tax Incentives, Directorate for Science, Technology and Innovation, Organisation for Economic Cooperation and Development.

    • Search Google Scholar
    • Export Citation
  • Panteghini, P. M., M. Parisi, and F. Pighetti, 2012, “Italy’s ACE Tax and Its Effect on a Firm’s Leverage,” CESifo Working Paper Series, No. 3869.

    • Search Google Scholar
    • Export Citation
  • Petutschnig, M. and S. Rünger, 2017, “The Effects of a Tax Allowance for Growth and Investment— Empirical Evidence from a Firm-Level Analysis,” WU International Taxation Research Paper Series, No. 201709.

    • Search Google Scholar
    • Export Citation
  • Princen, S., 2012, “Taxes Do Affect Corporate Financing Decisions: The Case of Belgian ACE,” CESifo Working Paper, No. 3713.

  • Schepens, G., 2016, “Taxes and Bank Capital Structure,” Journal of Financial Economics, Vol. 120, pp. 585600.

  • Statens Offentliga Utredningar, 2016, “Översyn av skattereglerna för delägare i fåmansföretag— Betänkande av Utredningen om Översyn av 3:12-reglerna,” SOU 2016:75.

    • Search Google Scholar
    • Export Citation
  • Van Campenhout, G., and T. Van Caneghem, 2013, “How did the notional interest deduction affect Belgian SMEs’ capital structure?Small Business Economics, Vol. 40(2), pp. 351373.

    • Search Google Scholar
    • Export Citation
  • Waerzeggers, C. and C. Hillier, 2016, “Introducing a General Anti-Avoidance Rule (GAAR),” Tax Law IMF Technical Note, Vol.1(1), IMF Legal Department.

    • Search Google Scholar
    • Export Citation
  • Waerzeggers, C. and C. Hillier, 2016, “Introducing an Advance Tax Ruling (ATR) Regime,” Tax Law IMF Technical Note, Vol. 1(2), IMF Legal Department.

    • Search Google Scholar
    • Export Citation
1

Prepared by Alexander Klemm, Shafik Hebous (both FAD), and Cory Hillier (LEG). This paper has been prepared as part of FAD’s initiative to support IMF surveillance with analyses of international tax issues. It has benefited from discussions with the Danish authorities, business representatives, and tax experts. We gratefully acknowledge useful comments from the Danish authorities, Victoria Perry, Miguel Segoviano, and Tigran Poghosyan.

2

Profit shifting methods abound, but prominent ones include transfer pricing (e.g., overpricing of imports from affiliates in low tax jurisdictions), intra-company debt (i.e., affiliates in high tax countries borrow from affiliates in low tax jurisdictions and pay interest to them), and royalties for uses of patents or trademarks.

3

Except that losses on sale of assets can be deducted immediately rather than remaining in the pool.

4

Companies cannot benefit much from using the flexible depreciation rules to circumvent the loss-offset limitations, because they must not exceed the maximum annual rate, even if they took less depreciation in previous years.

5

For example, since 2013 the European Commission has been investigating whether some tax ruling practices (i.e., potential state aid in the form of reduced effective tax rate for specific companies) in some EU Member States were compliant with EU state aid rules. These include cases such as GDF Suez ENGIE, Amazon, and McDonalds. The Commission has made findings of state aid through tax rulings against Ireland (in relation to Apple), the Netherlands (in relation to Starbucks), Luxembourg (in relation to Fiat) and Belgium (for its excess profits rulings). As of 2018, such rulings are no longer in place, although several EU Member States have appealed against the Commission’s decisions.

6

For high-income earners, this also increases incentives to save. For low-income earners, this incentive is much weaker, because there is also a means-tested noncontributory pension. The withdrawal rate of means-tested pensions reduces the return on savings for these individuals, and this is usually more important than the tax advantage of contributory pensions. High-income earners simply expect to receive the minimum noncontributory pension and are not affected by withdrawal at the margin.

7

The revenue consequences should be manageable, as total taxes on shares made up about 1.8 percent of total tax revenues (2016).

8

Other mechanisms also exist that could be adapted to reduce the overall rate of taxation on dividends, such as a shielding deduction (e.g., the Norwegian skjermingsfradrag) to reduce the taxable dividend. The shielding deduction could equal a statutory rate of return on the owner’s share investment.

9

See, for example, the recent review in Sweden (Statens Offentliga Utredningar, 2016) of their so called 3:12 rules in relation to the taxation of dividends and capital gains for owners of closely held companies to determine the extent of income shifting in Sweden, and if the rules in place were being misused.

10

Empirical evidence suggests that thin-capitalization rules do not resolve debt bias (De Mooij and Hebous, 2017).

12

Preliminary estimates by IMF staff, based on a commercial database (ORBIS), excluding banks, and assuming a notional interest rate of 2 percent, suggest a long-term reduction in the corporate tax base by 12 percent. The data used has various weaknesses compared to administrative data, notably equity is defined using an accounting rather than tax approach and includes participations, which leads to double counting. Moreover, no positive behavioral effects were included. Nevertheless, this simple estimate is relatively close to the figures by the Ministry of Finance.

13

Keen and King (2002) discuss the Croatian experience with the ACE.

Denmark: Selected Issues
Author: International Monetary Fund. European Dept.