How Do Multinational Companies Respond to Destination-based Taxes?

Accounting

Social Sciences Research Network

De Simone L; Olbert M

Marcel Olbert

2022

We exploit a 2015 regulatory change in the European value-added tax (VAT) system to study how multinational companies (MNCs) respond to taxation on the basis of the location of their customers (destination-based taxation), rather than based on their location of incorporation (origin-based taxation). Difference-in-differences results suggest that MNCs reported disproportionately high digital business-to-consumer (B2C) sales in Luxembourg, the country with the lowest VAT rate, under the origin-based system, but that the destination-based system effectively curbed this behavior. Contrary to conventional wisdom, we document that pre-tax profits of MNCs in the digital B2C service sector were insensitive to origin-based corporate income taxes across all sample countries prior to the regime change, suggesting VAT considerations played an important role for MNCs' tax strategies in the digital economy. However, income tax-motivated profit shifting substantially increased after VAT-planning strategies became obsolete with adoption of the destination-based VAT system. Collectively, our findings indicate that destination-based taxes effectively curb tax planning incentives, but that MNCs refocus their strategies around tax bases that remain taxed at origin. Our results inform potential consequences of the recently-agreed global reform to tax a share of corporate profits based on customer locations beginning in 2023.

Consumption Taxes; Value-added Taxes; Digital Economy; Tax Avoidance; Profit Shifting

Social Sciences Research Network

No

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