Academic journal article Journal of Business Economics and Management

The EU Apportionment Formula: Insights from a Business Case

Academic journal article Journal of Business Economics and Management

The EU Apportionment Formula: Insights from a Business Case

Article excerpt

1. Introduction

In 2004, the European Union (EU) welcomed ten countries of Central and Eastern Europe. Bulgaria and Romania joined the EU in 2007, which brought the total number of member states (MS) to twenty-seven. Notwithstanding this big achievement, the enlargement of the EU makes some policy problems even more pressing. One such problem relates to the several tax obstacles that are currently harming the international competitiveness of multinationals. Multinationals, for example, face high compliance costs because of the different tax systems across the twenty-seven MS. Other tax obstacles concern the limitation on cross-border loss relief and the problems with transfer pricing for intra group transactions (EC 2001a).

To remove the underlying causes of all tax obstacles, the EU wants to introduce a Common Consolidated Corporate Tax Base (CCCTB). This new tax system should contribute to the Europe 2020 growth strategy that was established by the European Commission in March 2010 (EC 2010). In particular, it has the intention to increase the efficiency, effectiveness, simplicity and transparency within the European company tax system (EC 2001a; EC 2001b; EC 2006a). The tax liability of a company belonging to a CCCTB group would be determined by applying four distinct steps. Firstly, each group member has to calculate its taxable profit according to the same set of rules. Secondly, the individual tax bases are summed up to the consolidated tax base. Thirdly, the consolidated tax base is allocated to the different group members by means of an apportionment formula (AF). Finally, each MS has the right to apply its own tax rate to the specific share of the overall tax base (Schon et al. 2008).

In this paper we use financial data from a listed multinational in order to illustrate how several designs of the AF could affect the allocation of the consolidated tax base among different group entities. The design of the formula plays an important role in achieving an efficient and simple tax system (Spengel, Wendt 2007). Previous studies investigated the macro-economic effects of introducing an AF in Europe. Devereux and Loretz (2008) showed that the overall tax revenue would be likely to decline by 2.5% if companies could choose whether or not to participate to CCCTB. Runkel and Schjelderup (2011) found that central authorities would use apportionment weights as a corrective devise in order to reduce tax distortions. The simulation results of Bettendorf et al. (2010) showed that an AF does not weaken incentives for tax competition. Important to mention is that the results of these studies are highly dependent on the design of the formula. A drawback of the existing literature is the lack of confidential firm level data. However, using such data makes it possible to understand the complexity and relative newness of the European AF. In this research, the availability of unpublished data offered the opportunity to study the factors in detail. For example, we were able to use the sales by destination factor whereas previous research always relied on the sales by origin factor.

The simulation results show that including more factors and using more equal weights distributes the common tax base more equally. Moreover, this could reduce the incentive to shift factors from high to low tax countries, which improves the efficiency of the new tax system. The results also indicate that simplifying the factor definitions leads to rather minor changes in the allocation.

The paper is organized as follows. Section 2 gives an overview of the principles of the apportionment formula. The development of the research questions is presented in section 3. The data and methodology are given in section 4. Section 5 presents the results and discussions. Section 6 concludes.

2. Principles of the sharing mechanism

The Commission's working paper 'The mechanism for sharing the CCCTB' (EC 2006b) mentions three ways to share the consolidated tax base: one macro-based approach, and two firm-specific approaches namely, the Value Added Key (VA) and the Apportionment Formula (AF). …

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