Which countries should have the right to tax the profits of US-based multinationals that operate globally? A year ago we pointed out that this seemingly arcane question had the potential to become a major point of conflict between the US and the EU. Back then we warned of the potential for an “enormous job-and-revenue grab by Europe,” utilizing the international tax system to claim a larger share of tax revenues from US-based multinationals, and in the process reducing the tax revenues that could be collected by the US government.
Now the US Treasury is agreeing with our warning. In a paper released today, the Treasury raises objections to a series of so-called “state aid” cases launched by the European Commission. The cases would retroactively imposes billions of dollars of additional taxes on US companies–money that would go to European countries and could no longer be collected by the US government. Moreover, the cases are based on a novel interpretation of international tax rules.
Here’s what Robert Stack, Deputy Assistant Secretary for International Tax Affairs, says on the Treasury blog.
These investigations have major implications for the United States. In particular, recoveries imposed by the Commission would have an outsized impact on U.S. companies. Furthermore, it is possible that the settlement payments ultimately could be determined to give rise to creditable foreign taxes. If so, U.S. taxpayers could wind up eventually footing the bill for these State aid recoveries in the form of foreign tax credits that would offset the U.S. tax bills of these companies.…we emphasize that the Commission should not seek to impose recoveries under this new approach in a retroactive manner because it sets a bad precedent for tax policymakers around the world. Finally, we explain that the Commission’s approach undermines U.S. tax treaties and international transfer pricing guidelines already accepted broadly in the global tax community, and undermines the work done as part of the BEPS project.
Some background here is useful. Several years ago, the finance ministers of the developed countries decided that multinationals, through legal means, were paying too little taxes. They commissioned a rewrite of the global tax rules called the BEPS project (for “Base Erosion and Profit Shifting”). The BEPS rules, when they came out, accomplished two tasks. First, they closed a large number of legal loopholes that companies had used to reduce their taxes. Second, the BEPS rules enunciated a basic principle for the future: That profits should be taxed “where economic activities generating the profits are performed and where value is created.”
While we’ve had our issues with the BEPS rules, this principle is basically a good one. However, it leaves open the delicate question of actually determining where economic value is created in a world of intangibles. For example, in a supply chain where the product design and marketing is done in the US, and the manufacturing is done in China, how should the profits be split for tax purposes? Should China be able to unilaterally decide that all the value was generated in China, and should all be taxable?
Obviously not. We wouldn’t want China unilaterally making this decision. The same is true for the EU.
To summarize: The European Commission has the right to impose whatever rules it wants on state aid. But it doesn’t have the right to unilaterally decide what share of multinational income it gets to tax.
