The International Monetary Fund (IMF) has published a policy paper on Corporate Taxation in the Global Economy. Through its paper, the IMF has stressed that international tax rules should be reformed to prioritize reducing the glaring inequalities that lower-income countries face when it comes to their taxing rights. The IMF also supports the replacing the arm’s length approach with unitary taxation and formulary apportionment or residual profit allocation (RPA), so that tax is paid where real business happens – not where profits are surreptitiously shifted toss. In addition to RPA, the paper also assesses the international tax reform proposal on minimum taxes.
Residual Profit Allocation
Under the residual profit allocation (RPA) scheme broadly, the normal return will be allocated to source countries and sharing the residual on a formulaic basis. Such schemes can substantially reduce profit shifting, as would other unitary approaches while retaining the familiarity of the arm’s length principle for straightforward cases. But much depends on the way in which residual profits are allocated: tax competition is more limited the greater the weight placed on allocation by the destination of sales (or similar criterion), given the relative immobility of final consumers. The residual profit allocation approach sets the scene for constructive discussion of the allocation of taxing rights in relation to some part of international corporate profits, though securing agreement on such apportionment will be difficult.
Minimum taxes on outbound investment can offer significant though incomplete protection against profit shifting and tax competition and generate positive spillovers for other jurisdictions (other than those with low tax regimes). Meanwhile, minimum taxes on inbound investment can be especially appealing for low income countries (LICs). These schemes have the merit of being readily designed to complement current norms. But there is a tradeoff between ease of administration and risk of such bluntness as to potentially jeopardize investment. Further, distortions remain (through for instance the relocation of parent companies) and underlying weaknesses of the system are patched rather than fixed. While minimum taxation has advantages over current arrangements, it is not clear that it alone would prove a robust long-term solution.
The economic impact and administrability of these schemes require further analysis—especially for emerging and developing countries. Even for advanced economies, little is known, for instance, about the nature and extent of residual profits. Data and research gaps for LICs remain substantial.