Royalty Taxation Under Tax Competition and Profit Shifting

45 Pages Posted: 31 Oct 2018

See all articles by Steffen Juranek

Steffen Juranek

Norwegian School of Economics (NHH) - Department of Business and Management Science

Dirk Schindler

Erasmus School of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Andrea Schneider

University of Münster - Institute for Public Economics

Date Written: 2018

Abstract

The increasing use of intellectual property as a means to shift profits to low-tax jurisdictions or jurisdictions with so-called ‘patent boxes’ is a major challenge for the corporate tax base of medium- and high-tax countries. Extending a standard tax competition model for capital-enhancing technology, royalty payments, and profit shifting, this paper suggests a simple fix: It is optimal to set a withholding tax on (intra-firm) royalty payments equal to the corporate tax rate and deny any deductibility of royalties. As the tax applies to the full payment, the problem of identifying the arm’s-length component in a digital economy (OECD BEPS Action 1) does not apply. Most importantly, the denial of royalty deductions is the Pareto-efficient solution under coordination and the unilaterally optimal policy under competition for mobile capital. In the latter case, a weakened thin capitalization rule is a crucial part of the policy package in order to avoid negative investment effects. Our results question the ban of royalty taxes in double tax treaties and the EU Interest and Royalty Directive.

Keywords: source tax on royalties, tax competition, multinationals, profit shifting

JEL Classification: H250, F230

Suggested Citation

Juranek, Steffen and Schindler, Dirk and Schneider, Andrea, Royalty Taxation Under Tax Competition and Profit Shifting (2018). CESifo Working Paper No. 7227, Available at SSRN: https://ssrn.com/abstract=3275401 or http://dx.doi.org/10.2139/ssrn.3275401

Steffen Juranek (Contact Author)

Norwegian School of Economics (NHH) - Department of Business and Management Science ( email )

Helleveien 30
Bergen, NO-5045
Norway

Dirk Schindler

Erasmus School of Economics ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Andrea Schneider

University of Münster - Institute for Public Economics ( email )

Wilmergasse 6 – 8
Münster, 48143
Germany

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