This article appears in the following Oxford Review of Economic Policy issue: BUSINESS TAXATION IN A GLOBALIZED WORLD [View the issue table of contents]
Taxation of outbound direct investment: economic principles and tax policy considerations
* Centre for Business Taxation, Saïd Business School, Oxford University, e-mail: michael.devereux{at}sbs.ox.ac.uk
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This paper reviews economic principles for optimality of the taxation of international profit, from both a global and national perspective. It argues that for traditional systems based on the residence of the investor or the source of the income, nothing less than full harmonization across countries can achieve global optimality. The conditions for national optimality are more difficult to identify, but are most likely to imply source-based taxation. However, source-based taxation requires an allocation of the profits of multinational companies to individual jurisdictions; this is not only very difficult in practice, but in some cases is without any conceptual foundation. The taxation of interest income on a residence basis is also hard to justify if the aim of the tax system is to tax only the income arising from economic activity in a given country.
Key Words: corporation tax • optimal international taxation
Comments on earlier versions of this paper from conference participants at the European Tax Policy Forum conference, London, April 2008, at the Conference in Honour of Richard Musgrave, Sydney, June 2008, and at the Centre for Business Taxation symposium, Oxford, June 2008 are gratefully acknowledged.
1 HM Treasury and HM Revenue and Customs (2007), United States Department of the Treasury, Office of Tax Policy (2007), Advisory Panel on Canada's System of International Taxation (2008), Australian Department of the Treasury (2002), and New Zealand Inland Revenue Department and New Zealand Treasury (2007).
2 See empirical evidence in Voget (2008).
3 Such a distinction is present in many tax systems.
4 See Stiglitz and Dasgupta (1971).
5 Huizinga and Nielsen (1997, 2002) analyse optimal tax policy when economic rents are taxed at less than 100 per cent, in the absence of cooperation among governments.
6 It is also possible that given his wealth, and lack of any further finance, the rate of return on asset A remains higher than the rate of return on asset B; in this case, investor A would invest only in asset A. However, we do not analyse this possibility.
7 However, if B can hold a minority share in asset A (which is managed and controlled by A), then B could also earnpAA. However, we do not examine this case either.
8 There is an extensive literature which analyses portfolio investment decisions in the presence of risks and differential taxes on capital income—see, for example, Brennan (1970), Gordon and Bradford (1980), and Bond et al. (2007). However, we abstract from these issues here.
9 Note, though, that although some countries may aim broadly to achieve CEN, no country has actually implemented a system which would achieve this. It would involve, for example, rebating foreign tax liabilities which were in excess of domestic liabilities.
10 This is the original sense of CON, as used by Devereux (1990), but ‘market neutrality’ is probably a more accurate name.
11 It is for these reasons that the empirical papers of Devereux and Pearson (1995) and Devereux and Loretz (2008) consider the proximity of European tax systems to full harmonization.
12 Devereux (2000) and Devereux and Pearson (1995) summarized the principles as Direct CEN and Direct CIN. If both of these hold, then so do the two principles set out here.
13 Strictly, where the marginal cost of public funds is unity.
14 See, for example, Halperin and Srinidhi (1987, 1991) and Harris and Sansing (1998).
15 Vann (2007) discusses a range of more practical problems with the arm's-length principle.
16 This may reflect the value of the selling company or the acquiring company, but, in either case, the price should reflect the post-corporation-tax valuation.
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  M. P. Devereux Business taxation in a globalized world Oxf. Rev. Econ. Policy, December 1, 2008; 24(4): 625 - 638. [Abstract] [Full Text] [PDF]
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