Preventing multinationals from shifting reported income to low-tax countries is receiving attention in Australia, along with other countries, as companies like Apple and Google record high sales but low profits by placing patent ownership in a low tax country like Ireland. The OECD has been given the task by the G20 to try and fine a solution that distributes company tax more equitably than at present but it is no easy task. Getting nations to agree on a fair formula for tax would make achievement of agreement on combatting global warming seem easy.
A new paper by Eric Toder of the US Tax Policy Center and Alan Viard of the American Enterprise Institute published this week attempts to provide a way forward with what they call “major surgery” on the corporate tax system. They propose two alternatives: Either build a tax based on a broad international agreement on how to allocate corporate income among countries, or kill the corporate income tax entirely and replace it with a direct tax on shareholders. In such a system, capital gains would be taxed as they accrue rather than when they are realised upon the sale of shares.
The broad international approach, a difficult thing to achieve as noted above, would require an agreement with other countries on a uniform rule for allocating corporate income among jurisdictions. For instance, countries could apportion income by formula, or agree to tax income from intangibles (such as patents) based on the location of sales. How to allocate profits of multinationals is easier said than done.
The second structural reform option would eliminate the corporate income tax and instead tax shareholders of publicly traded corporations at ordinary income rates on their dividends and capital gains. To make this shareholder taxation fully effective, it would be necessary to tax capital gains as they accrue, whether or not they had been realised through the sale of shares. Under this approach, tax would depend only on the residence of the shareholder, not the residence of the corporation or the source of its income. Owners of closely-held businesses would pay individual income tax on their firm’s profits, just as partnerships and S corporations (corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes) are taxed today in the US.