Corporation Tax and the Digital Single Market

By Diego Zuluaga, Institute of Economic Affairs & EPICENTER

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Tax policy has featured prominently in discussions of the EU’s digital economy for some time. Unfortunately, much of the debate has revolved around public perceptions that tech multinationals are not paying as much as they should. This reinforces the mistaken view that the main benefit of the innovative industries – or any industry, for that matter – is their contribution to the public coffers rather than the products they bring to market, the choice they offer to consumers and the employment that they support. The Digital Single Market strategy unveiled on 6^th May did not seek to reverse this impression, highlighting instead the Commission’s view that “profits should be taxed where the value is generated” – a judgement that is widely open to interpretation.

Corporation tax is a powerful lever to encourage (or deter) business investment. Its importance is magnified in the case of digital companies, which derive a large part of their income from highly mobile intangible assets like patents, trademarks and copyrights. It explains why Ireland, which taxes corporate profits at a comparably low 12.5 per cent, hosts the European headquarters of many global tech giants. It also explains why other member states with higher statutory rates – e.g. the UK, the Netherlands and Luxembourg – grant more favourable treatment to intellectual property via ‘patent boxes’ (whose reach was recently curbed) and other exemptions. In practice if not rhetoric, national governments are aware of the benefits of a competitive tax environment.

Despite public statements to the contrary, the same is true at EU level. Rate-setting for corporation tax remains a member state competence, and the resulting tax competition between jurisdictions has resulted in less wasteful spending by governments, greater capital investment by firms (with a positive impact on employment and wages), and lower prices for consumers than would otherwise be the case. Even the OECD, which has of late made “unfair tax competition” one of its hobby horses, has acknowledged the positive role of companies’ ability to choose the location of their activity. Numerous empirical studies support this view.

That is why recent EU moves to limit business mobility for tax purposes should raise concerns among policy-makers keen to promote innovation. In particular, the Commission’s plans to revive the Common Consolidated Corporate Tax Base (CCCTB) are unnerving. The CCCTB (which we examined in detail here) would apply to businesses operating in more than one member state. It would compute a company’s annual EU-wide taxable income and then assign shares to the different member states where that company operated. The formula to calculate national shares would take into account revenue, payroll numbers and wages, as well as some assets – but, critically, it would exclude intangible assets because they are deemed too mobile. By limiting companies’ ability to share profits and revenue with subsidiaries in low-tax jurisdictions, it would effectively set a floor on payable taxes. The end result would be to undermine tax competition within the Union and to make the EU as a whole less attractive as an investment destination.

Tax policy should adapt to the evolving economic reality, not the other way around. Some member states, particularly France and Germany, may be attracted to the idea of tax base harmonisation along the lines of the CCCTB as a way to artificially raise the amount of corporation tax owed to them by a given multinational. Yet this static view assumes that investment, employment and asset allocation by companies will remain the same after harmonisation. Given the widely documented disincentives of higher rates, it is reasonable to expect businesses to reconsider their EU undertakings over the medium and long term, and some of them to set up shop elsewhere.

If it is to encourage innovation and investment, the Commission must be bolder when it comes to corporation tax reform. It is an inefficient levy with relatively high deadweight losses, and many would regard it as unfair given that corporate income is also taxed at the individual level through dividend and capital gains taxes. Ideally, it should be abolished and the tax burden shifted to individual shareholders, thus avoiding the income attribution problems inherent in current corporation tax regimes.

However, as outlined above, tax-setting powers are a national competence, and even if the Commission decided to encourage countries to move to a more efficient system for taxing corporate income, there is no guarantee that they would follow suit. But more modest reforms are possible. If the Commission decides to move forward with the CCCTB, it will need to make important changes to the original proposal to avoid the negative consequences we have outlined. The first would be to include intangible assets in tax base calculations, acknowledging the growing role of intellectual property in value generation and in the digital economy in particular. The second is to remove all caps and limits to tax competition, which is incontrovertibly a phenomenon that should be encouraged. Finally, the CCCTB should remain optional, as originally intended by the Commission.

The stated goal of the DSM is to remove barriers to access to, investment in and adoption of digital technology. From a company’s perspective, corporation tax is just another cost of doing business, and to the extent that tax burdens are made more onerous, investment, employment and trade will suffer. A competitive tax environment that promotes business mobility is a crucial stepping stone of the EU’s digital economy.