Title Page

European and Fiscal Affairs Departments

Taxing Multinationals in Europe

Prepared by Ernesto Crivelli, Ruud De Mooij, Erik De Vrijer, Shafik Hebous, and Alexander Klemm

INTERNATIONAL MONETARY FUND

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Copyright ©2021 International Monetary Fund

Cataloging-in-Publication Data IMF Library

Names: Crivelli, Ernesto. | Mooij, Ruud A. de. | Vrijer, J. E. J. de. | Hebous, Shafik. | Klemm, Alexander. | International Monetary Fund. European Department, issuing body. | International Monetary Fund. Fiscal Affairs Department, issuing body. | International Monetary Fund, publisher.

Title: Taxing multinationals in Europe / Ernesto Crivelli, Ruud De Mooij, Erik De Vrijer, Shafik Hebous, Alexander Klemm.

Other titles: International Monetary Fund. European Department (Series). | International Monetary Fund. Fiscal Affairs Department (Series).

Description: Washington, DC : International Monetary Fund, 2021. | No. 21/09 | Departmental paper series. | Includes bibliographical references.

Identifiers: ISBN 9781513570761 (paper)

Subjects: LCSH: International business enterprises—Taxation—Europe. | Corporations—Taxation—Europe.

Classification: LCC HD2753.A3 C75 2021

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Contents

• Acknowledgments

• Executive Summary

• 1. Introduction

• 2. The Corporate Income Tax and the Role of Multinational Enterprises in Europe

  • CIT Performance in Europe

  • MNEs and Foreign Direct Investment in Europe

• 3. Corporate Tax Spillovers in Europe

  • Corporate Tax Spillovers

  • Profit Shifting in Europe

  • Tax Competition in Europe

• 4. European Tax Coordination

  • European Tax Directives Related to the CIT

  • Tax Harmonization

• 5. Conclusions

• References

• Boxes

  • Box 1. IMF Work on Corporate Taxation in Europe

  • Box 2. Evidence on Profit-Shifting Strategies

  • Box 3. The G20-OECD BEPS Project

  • Box 4. CIT Obligations and Commitments in the EU Code of Conduct on Business Taxation (CoCBT)

  • Box 5. Border-Adjusted Profit Taxes

• Tables

  • Table 1. Revenue Impact of Transfer Mispricing of Intragroup Trade

  • Table 2. Revenue Loss due to Profit Shifting

  • Table 3. ATAD and G20-OECD BEPS

• Figures

  • Figure 1. Corporate Income Tax Statutory Rates and Revenue

  • Figure 2. Corporate Income Tax Performance, 2018

  • Figure 3. Multinational Enterprises in Europe

  • Figure 4. Foreign Direct Investment in Europe

  • Figure 5. Statutory CIT Rates in Europe, 1995–2019

  • Figure 6. Selected IP Box Regimes

  • Figure 7. Impact of Formula Apportionment on Tax Revenue from US MNEs under Various Allocation Keys (Average 2011–16)

Acknowledgments

This paper was prepared by a staff team consisting of Ernesto Crivelli (EUR), and Shafik Hebous and Alexander Klemm (all FAD), led by Erik De Vrijer (EUR) and Ruud De Mooij (FAD), under the general guidance of Jörg Decressin (EUR) and Victoria Perry (FAD), and benefited from excellent research assistance by Morgan Maneely and Nemanja Jovanovic and administrative assistance by Kelly MacKinnon.

The staff team benefited from bilateral discussions with country authorities in the context of Article IV consultations, the excellent exchange of views during the Managing Director’s dinner with European finance ministers at the time of the 2019 Spring Meetings, as well as from comments and advice by numerous colleagues at the IMF.

Executive Summary

There is mounting global awareness that the existing corporate income tax (CIT) system is no longer fit for purpose. The international policy debate reflects the urgency of agreeing on and implementing fundamental reforms. Significant problems originate when international spillovers increase via tax competition among countries and cross-border profit shifting by multinational enterprises (MNEs), with the aim of reducing their total tax payments. Some of this debate reflects dissatisfaction with the traditional means of allocating the overall tax base. In Europe, close connections among economies aggravate corporate tax spillovers within the region. The related revenue losses are even more damaging now that the devastating economic impact of the COVID-19 pandemic is putting severe stress on the public finances in many countries.

This departmental paper aims to contribute to the European policy debate on CIT reform in three ways. First, it takes a step back to review the performance of the CIT in Europe over the past several decades and the important role played by MNEs in European economies. Second, it analyzes corporate tax spillovers in Europe with a focus on the channels and magnitudes of both profit shifting and CIT competition. Third, the paper examines the progress made in European CIT coordination and discusses reforms to strengthen the harmonization of corporate tax policies, to effectively reduce both tax competition and profit shifting.

The most striking feature of the CIT in Europe is the continuous and ongoing decline in statutory CIT rates from an average of 35 percent in 1995 to 21 percent by 2019. Nonetheless, the CIT has remained an important source of revenue, averaging about 3 percent of GDP during this period, which reflects the rising share of corporate profits in GDP and some broadening of the taxable CIT base. Empirical evidence suggests that MNEs’ profits tend to be taxed less than profits of domestic peers, reflecting profit shifting from high- to low-tax affiliates.

Evolving MNE business models increasingly rely on complex global supply chains and intragroup trade in services and intangible assets. This challenges a key assumption of the current CIT framework, namely that corporate activities and profit sources can be easily defined and separated by national borders. Equally important is the ongoing expansion of cross-border digital activities and trade, which raises questions about another cornerstone of the existing CIT system: basing taxing rights on the physical presence of the producer.

The empirical literature documents a wide variety of tax planning devices to shift taxable MNE income from high- to low-tax jurisdictions, and there is a wide range of estimates regarding the estimated tax revenue losses from individual profit-shifting mechanisms (micro approach). Studies based on a macro approach find generally larger effects, with some European countries losing and others gaining sizable shares of their tax bases and revenues.

Strong tax competition in Europe appears to have been a major driving force behind the steep decline in CIT rates that has brought the average European CIT rate below the average rate in OECD countries. The implied revenue losses of such a large drop in CIT rates are significant for all countries involved. Tax competition in Europe is also reflected in the proliferation of preferential tax regimes for income from intellectual property (IP boxes). It is yet too early to tell whether the new G20-OECD minimum standard on such IP regimes will be effective in curbing this type of tax competition.

To effectively reduce tax competition and profit shifting in Europe, deeper coordination of CIT policies will be needed. Efforts to better harmonize corporate taxation in the EU have a long history but have not advanced as far as in other areas of taxation, such as the VAT. The latest initiatives comprise the proposal by the European Commission—revived in 2016—to introduce a Common Consolidated Corporate Tax Base (CCCTB) and a 2019 proposal by France and Germany at the Inclusive Framework of the OECD to introduce minimum effective taxation of MNEs. Each of these reforms would constitute real progress in reducing CIT spillovers. Jointly, they would complement each other and be even more effective.

Effective minimum taxation of MNEs would reduce the intensity of tax competition and profit shifting, thereby setting a floor under CIT revenues. A minimum tax will also reduce existing pressures on foreign direct investment (FDI)-receiving countries, including low-income and developing countries, to set tax rates below the minimum. For MNE residence countries, it would provide a backstop to outward profit shifting. The revenue effects of an effective minimum tax can be significant, depending on the level of the minimum rate and the scope of its application.

Full CCCTB implementation would consolidate not only corporate tax bases but also EU-wide MNE profits. The latter would be apportioned to individual countries based on a formula that includes both production factors and sales by destination. While the CCCTB would greatly reduce the scope for profit shifting in Europe, it would still leave room for tax competition to attract mobile production factors, although this effect would be muted by using sales in the apportionment formula. Joint implementation with a minimum tax would further mitigate strategic spillovers. EU-wide revenue effects of the CCCTB reform, particularly if this included cross-border loss relief and new deductions for equity and R&D expenses as presently proposed, would likely be small initially but grow over time. Since the CCCTB would significantly affect the relative CIT revenues of individual countries, finding agreement among all EU Member States may require a stepwise implementation of the CCCTB. As a first step, the formula apportionment could be applied to above-normal profits only.

The long years of debate on these issues have resulted in promising reform proposals. At the current juncture, it is time for action.