Assessment of Reform Proposals and Alternative Recommendations

The proposed coexistence and reinforcement of the residence and source based taxation principle might lower the attractiveness to relocate income to low-taxed jurisdictions and to relocate the residence of companies. Nevertheless, the new measures could also increase tax competition between OECD member states with the coordinated minimum tax level being the lower bound. Furthermore, the risk of double taxation increases if all jurisdictions try to expand their access to the tax base of multinational enterprises. The design of far-reaching reform proposals should be considered carefully and provides the opportunity to replace existing unilateral and diverse BEPS countermeasures.

So far, all OECD initiatives to adjust the system of corporate taxation, including the well-known BEPS Action Plan, exclusively aim at protecting tax revenues of member states at the expense of improving conditions for investment and, thus, employment including underlying revenues from taxes and social security contributions. The proposed reforms step in the same direction. The OECD’s two-fold strategy intends to ensure market countries a fair share of taxation right (Pillar One). Simultaneously, the proposed global minimum taxation and deduction disallowance regulations aim to restrict tax competition and to strengthen both the residence and the source principle (Pillar Two). With regard to Pillar Two, a global minimum tax likely distorts ownership structures if not all countries adopt worldwide taxation and credit foreign taxes. In addition, the location of real investment will be distorted if some countries refrain from adopting the deduction disallowance regulation. Severe economic distortions can only be prevented if corporate taxation is fully harmonized on a global basis including tax rates. This has been known and recognized for decades now.31

Furthermore, minimum taxation measures already exist around the globe in the form of controlled foreign corporation legislation (CFC legislation) and interest and royalty deduction limitations rules. The EU Anti-Tax Avoidance Directive has already put forward a harmonized approach for both CFC and interest deduction limitation rules within the EU member states until the end of 2019.32 An extension of these concepts, as proposed by the OECD, thus, increases tax complexity, administrative costs and the risk of double taxation.

As an alternative, referring to minimum taxation, we first recommend to rely on existing CFC legislation for outbound investment. Regarding inbound investment, we recommend to levy withholding taxes at source comprehensively and consistent on all cross-border transactions. Extending withholding taxes in an internationally coordinated way ensures source taxation and thus the allocation of taxing rights.33 In line with the existing system, double taxation can be avoided by crediting withholding taxes in the residence country, the proposal would dry out tax havens.

31 Tanzi (1995). 32 Anti-Tax Avoidance Directive (ATAD): Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market, OJ L 193/1 (19 July 2016), at 1–14. 33 Fuest et al. (2013), p. 319.

Second, referring to the allocation of taxing rights to market countries according to Pillar One, we recommend to concentrate on indirect taxes to generate tax revenues at the location of user participation. The role of value added taxes (VAT), as an already existing mean to tax consumption in market countries, is surprisingly not at all considered in the current political discussion.34 Yet, billions of tax revenue are at stake if consumption taxes are not collected appropriately.35 Enforcing VAT on digital services thoroughly is a crucial step to generate and protect tax revenue in market jurisdictions.36 Furthermore, the increasing relevance of the sharing economy contributes to a defragmentation of the economy and the appropriateness of small-business VAT exemption regulations is debatable for highly digitalized interactions between market participants with systematic and complete knowledge of transactional data. Platform providers could be integrated in the process of consequent VAT collection.37 Moreover, enforcing VAT on non-monetary transactions, i.e. the exchange of user data for services such as Google or Facebook, could be a viable solution to ensure tax revenues at the market jurisdiction and is in line with existing tax principles.38

Overall, we highlight the potential disadvantages of the recent OECD reform proposals if they are not harmonized globally and our briefly sketched recommendations – to expand the concept of withholding taxes and to shift the focus on VATs – could provide pragmatic short-term solutions to some of the most pressing tax issues in the era of digitalization.

34 The OECD has recently presented a recommendation on the collection of VAT: OECD (2019c). 35 The VAT gap is estimated to exceed EUR 150 billion in the European

Union in 2015. CASE and IHS (2017), p. 8; Olbert and Spengel (2019), p. 3. 36 An assessment by the ZEW for the German Ministry of Finance estimates that the total revenue of digital services exceeds 5.7 billion Euro in

Germany in 2016. ZEW (2017), p. 20. 37 See also Bräutigam et al. (2019) for a discussion of reform proposals. 38 It has been admitted among legal scholars that such non-monetary transactions are subject to VAT. See Pfeiffer (2016), p. 161.