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COPYRIGHT 2002 Berkeley Electronic Press
Abstract
The new economy has been viewed as a great challenge for existing tax principles. New type of transactions such as e-commerce have been studied in depth and theoretical inquiries as well as practical studies have pretty well explained how the existing tax rules can be applied to new economy transactions. It is now time to move forward. Next step in the field should focus on whether those results are suitable in light of tax policy principles. The aim of this paper is to study the consequences of current tax treatment of new economy transactions with respect to international tax policy. Particularly, since the mere application of existing principles to the new economy involves a shift of taxes from importing countries to exporting countries, it is important to analyze alternative proposals in order to preserve the balanced sharing of taxes between countries. This study is focused on the corporate income tax on cross-border sales of products or services.
Introduction
The evolution toward the new economy is a great challenge for existing tax rules. In fewer than 5 years, a tax lawyer will have seen on this issue multiple articles, several OECD meetings, new regulations by various national authorities and numerous Internet start-ups asking for advice on these new matters.
The first step of tax scholars has been to focus on how to apply the existing rules to the new economy. Now that the consequences of the current rules are pretty well defined, it is time to study whether those results are acceptable in light of tax policy principles. In order to keep this focus, the aim of this paper is not to describe the tax treatment of specific transactions of the new economy under the current regime, which has already been done in many articles (1). Rather, the purpose is to study the consequences of these treatments with respect to international tax policy and to analyze alternative proposals. For the sake of clarity, the scope of this paper has been limited to the corporate income tax and it will focus on the cross-border sales of products or services.
At first glance, the question whether international tax principles currently used are still adapted to govern the taxation of the new economy results in contradictory perceptions.
On one hand, transactions in the new economy does not appear to be so different from those of the "old economy" from a tax perspective. The traditional international tax rules and concepts can technically be applied by analogy to the new types of transactions. For example, it would be easy to treat cross-border commerce via the Internet the same way as purchases via telephone or mail has been treated. Under this approach, the new economy would only require common interpretation of the current rules among international tax authorities in order to avoid double taxation.
However, I will argue that this approach would entail a major shifting of taxes from net-importing countries to net-exporting countries. The reasons, which are developped in this paper, can be basically summarized as follows.
A major tax policy principle is that international tax sharing must be made in accordance to the relative "benefits" received by a company in each country ("cost/benefits approach"). For example, a company manufacturing widgets in country A and selling them in country B receive "production benefits" from country A governement and "distribution benefits" from country B governement. Thus, the taxes on the income from this activity must be shared between country A and country B.
As explained below, the current international tax rules (as determined by common tax treaties) do not respect this policy goal if a company exports its products without having a permanent establishment abroad: all the taxes are allocated to the exporting countries although they should be shared with the importing country.
The consequence of this inaccuracy with respect to the cost-benefit approach have not been material in the past since little cross-border business was possible without establishing a permanent establishment in the importing country. For example, cross-border mail-order or phone-order business has never been an important business. The development of the new economy changes the amounts at stake because cross-border e-commerce and transactions on digitalized products will be possible at a much larger scale. The "inaccuracy" which was a non-material issue in the old economy will result in large tax shifting in the new economy.
This perceived problem would not be an issue if these types of transactions were balanced in the international trade so that tax shiftings due to imports could be compensated by exports. However, sale via e-commerce and transactions of digitalized products are dominated by few net-exporting countries, which benefit most from this tax shifting. Thus, the simple application of traditional rules to the new economy transactions tend to shift taxes from net-importing to net-exporting countries and modify the balance previously agreed upon by two countries.
At this point, it is important to assess if this evolution could have any consequences in the international relationships context. On the one hand, if, due to the new economy, a large amount of taxes are shifted to the other party without any consideration, it is politically and financially unlikely that the same traditional principles will continue to apply. On the other hand, tax relationships are only a part of multiple networks of bilateral and multilateral links between two countries. In this respect, tax shifting is playing a minor role in comparison to military or economic issues. However, it seems not too naive to think that, in the event tax relationships become unbalanced because of a new context, the two countries will take this modification into account either by changing their tax convention or by compensating this tax unbalance in other (non-tax) negotiations.
1. What are the policy goals of international taxation?
International taxation is a matter dominated by bilateral agreements which are a compromise of different, and sometimes contradictory, goals (2). The first imperative is that taxation should not get in the way of the operation of a world economy based on open markets. This implies an international tax system which is fiscally neutral and minimized distortions (A). The second goal is to protect national tax revenues. Each government should receive taxing jurisdiction on a fair share of the profits generated by the international business (B).
a) International tax neutrality
The principle of tax neutrality requires that any equitable tax system treat economically similar income equally (3). Neutrality is a clear principle in domestic taxation since two companies can easily be compared. However, it is less simple when applied to international taxation. Suppose a company resident in country A and conducting some activities in country B. It could be compared to (i) the other companies resident in country A which operate locally or (ii) the other companies which conduct a business in country B.
These two comparisons defines the two main competing approaches to international tax neutrality (4).
i. Capital-export neutrality
The first comparison (usually called "capital-export neutrality") guarantees that companies in country A do not have a tax incentive (or disincentive) to do business abroad. Under this approach, income derived from international transactions must be subject to the same tax burden as income derived from a local business.
In theory, this capital export neutrality could be achieved either through a foreign tax credit approach or through an exemption approach.
--Foreign tax credit
The country of residence (A in our example) may tax the company on its worldwide income and mitigate the potential double taxation by allowing a foreign tax credit for any tax paid in other countries. These countries would usually include country B, which could have levied a withholding tax or imposed a tax on income imputed to a permanent establishment located in its jurisdiction. The credit would ideally be refundable to the extent it exceeds the tax that would otherwise apply in the country of residence.
--Exemption approach
An alternative approach could be that the company would be taxed on a worldwide basis in country A and exempted in country B.
Capital export neutrality is achieved through both approaches. In the case of sale of products abroad without having a permanent establishment, the income derived from this type of sale is generally not exempted in the importing country. In the event the exporting company is also subject to tax in the importing country (for example, because it has a permanent establishment or because there is a withholding tax), capital export neutrality is achieved through a foreign tax credit.
ii. Capital-import neutrality
The aim of the comparison with the other companies conducting business in country B (usually called "capital-import neutrality") is to ensure fair competition within the B market. A full competitive neutrality would require that every product/services sold in a given market be subject to the same tax burden on the generated income. The nationality of the seller as well as the place of production should be indifferent.
Two approaches could theoretically be used to achieve this goal.
--Foreign tax credit
The country where the product/service is sold (B in our example) could tax the company on its income related to sales in country B and mitigate the potential double taxation by allowing a foreign tax credit for any other income tax levied in other countries. Such countries would generally include the country where the product has been produced or the country of residence of the seller. It should ideally be refundable to the extent it exceeds the tax levied by the country B.
--Exemption
The income derived from transactions in country B is taxed in country B and exempted in other countries, including the country of residence.
Capital import neutrality is typically enforced through an exemption approach, like the French regime of territoriality.
A quick overview of the policy approaches in the world shows that there is no consensus on the type of neutrality to be favored. It is common to say that capital-import neutrality encourages the most efficient competition within a given country while it is generally assumed that pure capital-export neutrality would result in the most efficient international allocation of capital (5). The economical reasons behind this classical conclusion are the following.
If capital-import neutrality is respected, revenues from investments made by a foreign company in country A ("imported capital") are subject to the same taxes as investments made by a local company in country A. For example, a branch from a foreign company in country A and a company established in country A are treated the same way. Thus, the competition between all activities realized in country A is not modified by different tax regime. Capital-import neutrality is the most efficient tax regime as for competition issues.
If capital-export neutrality is respected, revenues from investments made abroad by a...
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