The need for research into unitary taxation of transnationals

It is clear that the current method promoted by the OECD of assessing taxes payable by transnationals is seriously flawed as it treats their dealings with affililates as if they were transactions between independent firms. There is a need for more research into the alternative of unitary taxation which treats transnationals as integrated firms, says Sol Piccioto.

THERE is currently considerable ferment in the area of international tax, especially on issues of evasion and avoidance, the use of tax havens, the links with capital flight and corruption, and problems of transfer pricing and mispricing. These are all of significant concern to developing countries, and raise issues which should be and are being researched.

There is, however, one topic which is in many ways central to these various issues, and which is under-researched: unitary taxation (UT) of transnational corporations.

From a policy perspective, UT has been put forward as an alternative approach to the accepted methods of dealing with transfer pricing. These methods are based on separate accounting and 'arm's length' pricing, which have been criticised as contrary to basic economic understanding of TNCs as integrated firms, and resulting in practice in distortion of multinational activity and leading to world welfare losses. Many international tax lawyers favour the unitary approach.

A unitary approach would tax multinationals not according to the legal forms devised by their tax advisers, but according to the genuine economic substance of what they do and where they do it. The key would be to require each firm to submit to the tax authorities of each country where it does business a 'combined report' providing consolidated accounts for the whole global group, ignoring all internal transfers. This would provide the tax authorities of each country where the firm has a business presence with an overview of its worldwide business. The report should specify the group's physical assets, workforce and revenues from sales to third parties. The overall worldwide profits would then be divided up among jurisdictions according to a formula weighing these three factors.

Consensus under strain

For various reasons, the policy-making community, dominated by the OECD Fiscal Affairs Committee, has for many years opposed this option. This seems to stem from an understandable fear of the difficulties that might result from upsetting the historically developed consensus around the arm's length principle. Consequently, the unitary approach has never been seriously evaluated by any official body, and has been very little researched.

Yet this consensus, always fragile, is coming under increasing strain. In the context of current fiscal pressures facing most developed states, tax avoidance by TNCs has come increasingly into the spotlight, and tax authorities are under pressure to come up with better solutions. The OECD Fiscal Affairs Committee has launched an initiative to deal with 'base erosion and profit-shifting', although it seemed reluctant to contemplate any significant departure from current approaches. Political pressure has been put behind this initiative in a joint statement by the German and UK finance ministers, who have asked for a progress report to the next G20 meeting in Russia in February 2013.

Developing countries are particularly affected by this policy impasse. They have been urged to strengthen their scrutiny of transfer prices, and strongly pressed to apply the OECD 'consensus' approach, which is backed by considerable efforts in capacity building. Yet this is likely to create significant difficulties for countries themselves, as well as for the system.

Transfer pricing audit based on the arm's length principle is notoriously difficult to administer, requiring considerable specialist expertise and being very time-consuming. At the same time, the OECD Guidelines on Transfer Pricing, which provide the biblical elaboration of the approach, are also both biblically complex and flexible, allowing a variety of different methods in practice. The UN Tax Committee, which is tasked with adapting the OECD approach to the particular needs of developing countries, is completing a revision of its Manual, which extends the scope of flexibility in practice. It includes chapters explaining the methods used by Brazil, China, India and South Africa, which show considerable divergences and indeed conflicts.

The likelihood is that this general strengthening of scrutiny of transfer pricing will both consume enormous administrative and professional resources, and result in conflicting tax assessments on TNCs. When such conflicts become overt, they have to be dealt with by the 'mutual agreement procedure' provided by double tax treaties, which is notoriously slow and inevitably arbitrary.

This should therefore be a good moment for policy-relevant research on this issue. From the perspective of the issue of transfer pricing alone, a good case can be made for research into whether unitary taxation could provide a better alternative, especially for developing countries. There are widespread concerns over the (non-) functioning of the current mechanisms for international allocation of the tax base: an editorial in the Financial Times recently (20 October 2012) claimed that '[c]urrent practice has turned tax into a largely voluntary gesture' for multinationals. Complex calculations and negotiations between tax authorities and taxpayers are in many cases followed by international negotiations on the split of the tax base in individual cases, so that the entire process is time-consuming, complex, opaque and includes a substantial degree of room for movement in any given case. In principle, unitary taxation potentially offers a simpler and much more transparent mechanism for reaching the same ends.

This case is greatly strengthened once it is understood that the unitary approach would deal not only with transfer pricing, but with all types of profit-shifting by TNCs, including their use of tax havens. Such research should clearly be carried out as objectively as possible. Indeed, it is surprising that the question of UT seems to have been identified as politically controversial, since it raises some very technical questions. Yet very little research has been done into such questions, perhaps largely because it has been considered controversial.

Issues for investigation

The following are among the issues which could be researched; a focus on tax and development would demand that the issues be approached especially from the perspective of developing countries:

Experience of the unitary approach: What can be learned from previous experience of applying UT, both internationally and within federal states, especially the US? How far is the current EU proposal for a common consolidated corporate tax base (CCCTB) compatible with the US state version? How does UT compare with the present system, in terms of ease of operation, as well as outcomes, for firms and for countries?

Harmonisation of definitions of the tax base: What are the main divergences between countries in their tax base definitions? Could convergence be achieved, e.g. by reference to international accounting standards? What might be the economic implications or welfare effects of tax base harmonisation? What would be the implications for administration of tax assessments, compared with the present system?

Identifying a unitary business: What would be the implications of strict or loose definitions of what constitutes a unitary business? How would or should these definitions apply, for example, to joint venture arrangements which are common in developing countries? What would be the implications for administration of tax assessments, compared with the present system?

The apportionment formula: What would be the effect of different variations of the usual three-factor formula (assets-labour-sales) (i) on international allocation of the tax base of TNCs, and (ii) in welfare-economic terms? How would allocation on such a basis differ from that under the present system?

Managing a transition to UT: How far can aspects of the UT approach, e.g. the requirement to submit consolidated accounts (a combined report), be compatible with the existing legal framework especially in tax treaties? What are the implications for this framework of a gradual shift, e.g. by regional adoption of UT, such as under the CCCTB? What changes to the legal framework would be necessary for a transition to UT, and how could it be managed with least disruption? What would be the administrative cost implications, especially for developing countries, of such a transition?                                           

Sol Piccioto is Emeritus Professor of Law at Lancaster University in the UK. He is also a Research Associate and member of the Centre Advisory Group at the International Centre for Tax and Development (ICTD). The above is reproduced from the ICTD website (, on which the fully referenced version of the article is available.

The case for unitary taxation

Mick Moore

Transnational corporations have subsidiary companies in more than one country. Some have them in dozens of countries and some have hundreds of subsidiaries. They inevitably do much of their international business with one another. Unilever, for example, does not manufacture its range offoods, beverages, cleaning agents and personal care products separately in each of the many countries in which it operates. Nor does it brand and market completely separately in each country. Its many subsidiaries and affiliates trade with one another across international borders - in market-ready products, in components, in packaging, in management expertise, in the right to use its 400+ separate brands, in intellectual property and in capital (i.e. inter-company loans).

How, then, should Unilever Worldwide be taxed? There are two main possible answers. The first and most logical isunitary taxation: Unilever could be taxed on its total worldwide profits, allocated according to the location of its activities. It could present annually to the tax authorities of the countries in which it operates a single set of accounts. These would include profits for the firm as a whole, and identify the proportion of its activities (number of employees and wage bill, assets, and sales) in each country where it does business. Its tax bill could then be apportioned among all those countries according to an internationally agreed formula based on a weighting of these factors. That isformulary apportionment.

The second way of taxing Unilever is to disregard that it is a worldwide entity. In this approach, each subsidiary would report to, and be taxed by, the revenue authorities in the country in which it is located. And the parent company would report to the tax authority in the country in which it is formally headquartered. But there it would need to report only the income it actually receives from the other parts of the whole Unilever group, usually as dividends. Other income could be transferred through a chain of intermediaries to holding companies in countries where it is not taxable, either because the country has no income or profits tax, or because it exempts foreign source income.But Unilever does not have to submit accounts for the whole of Unilever Worldwide to any one tax authority.

The latter is sort of what happens at present - although tax law is much more complex, and national tax rules vary enormously. What is wrong with the current system? It is not that it is a bit messy. Any system for taxing transnational corporations is likely to be messy. It is rather that the current system disregards the economic reality of Unilever as a worldwide business, and also provides very strong incentives for the managements of transnational corporations to shift their profits around the world through pure accounting devices. It diverts valuable management, accounting and legal skills into gaming the tax man. It is unfair between countries, because some get much less in tax revenue than they have earned by hosting transnational businesses. And it is a major source of business for tax havens, where little or no tax is paid.If transnational corporations were not using tax havens for this purpose, it would be easier for global authorities to crack down on their more nefarious uses, including money laundering and tax evasion by wealthy individuals.

If we had a system of formulary apportionment, there would be little reason for transnational corporations to put so much effort into shifting profits around the world on paper, and much less incentive to use secret tax havens.                                            

Mick Moore is Chief Executive Officer of the International Centre for Tax and Development (ICTD) and Professorial Fellow at the Institute of Development Studies (IDS) in the UK. This is extracted from the article 'Are you getting excited about "formulary apportionment"?' which appears on the ICTD website (

*Third World Resurgence No. 268, Dec 2012, pp 32-34