Residual profit splitting: a theory-based approach to tax multinationals

Abstract About 140 countries have agreed to reallocate the rights to tax international corporate profits and to introduce minimum tax rates. The agreed plan is the product of pragmatism and a search for consensus, but ambitious. It requires far-reaching system changes such as a move towards unitary profit taxation, better known as formula apportionment. The formulary apportionment of profit earned by a multinational enterprise (MNE) assumes international agreement on common rules for the determination of taxable profit. This is a critical departure from the well-established tradition of separate entity accounting (SEA) and may still turn out to be a serious design flaw of the reform. This paper argues for a reform that retains SEA and addresses the flaws in the current system of corporate taxation at their root rather than merely fixing symptoms. To this end, a reform aimed specifically at the rules governing the taxation of intangible assets is recommended. The proposed system can be interpreted as a theory-based generalization of the withholding tax solution of Article 12B of the UN Model Tax Convention to cases where an MNE maintains a physical presence in the source country or intra-group supplies of goods and services entail allocable costs.