Fairness and the Arm's Length Principle in a Digital Economy

Forschungsberichte des Fachbereichs Wirtschaftswissenschaften der Hochschule Düsseldorf Ausgabe 42 (2018) ISSN: 2365-3361

30 Pages Posted: 26 Jul 2018

See all articles by Stefan Greil

Stefan Greil

University of Hamburg

Christian Schwarz

University of Applied Sciences Duesseldorf

Stefan Stein

QUANTUM Steuerberatungsgesellschaft mbH

Date Written: July 6, 2018

Abstract

The OECD Base Erosion Profit Shifting (BEPS) Initiative as well as the current fairness oriented public discussion regarding the taxation of digital business models highlight the importance and complexity of the arm’s length principle. In a theoretical model of an internationally fragmented digital good’s production process, we show that fairness considerations of tax authorities (namely inequity aversion) can result in a falling apart between a perceived “fair” and arm’s length distribution of profits across tax jurisdictions.

Our model predicts that a multinational firm follows the fundamental paradigm of international taxation, i.e. the arm’s length principle, to properly incentivize internal agents involved in the production of a digital good. However, with inequity averse tax authorities, we find that tax authorities “prefer” a more equal distribution of profits compared to the arm’s length profit allocation. From a multinational firm’s perspective, inequity aversion among tax authorities dampens the strategic effect to – in accordance with arm’s length principle – shift profits to low tax countries.

Keywords: corporate income tax, profit-shifting, arm's length principle, fairness

JEL Classification: H26, H25, F23

Suggested Citation

Greil, Stefan and Schwarz, Christian and Stein, Stefan, Fairness and the Arm's Length Principle in a Digital Economy (July 6, 2018). Forschungsberichte des Fachbereichs Wirtschaftswissenschaften der Hochschule Düsseldorf Ausgabe 42 (2018) ISSN: 2365-3361, Available at SSRN: https://ssrn.com/abstract=3209205 or http://dx.doi.org/10.2139/ssrn.3209205

Stefan Greil

University of Hamburg ( email )

Hamburg, Hamburg 20146
Germany

Christian Schwarz (Contact Author)

University of Applied Sciences Duesseldorf ( email )

Münsterstraße
156
Düsseldorf, 40476
Germany

HOME PAGE: http://https://wiwi.hs-duesseldorf.de/personen/christian.schwarz/Seiten/default.aspx

Stefan Stein

QUANTUM Steuerberatungsgesellschaft mbH ( email )

Magirusstraße 35/2
Ulm, DE 89077
Germany

HOME PAGE: http://www.quantum-tax.de

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