How Do Multinational Companies Respond to Destination-based Taxes?

Abstract

We exploit a 2015 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 low-VAT countries under the origin-based system. However, a switch to a destination-based system effectively curbed this tax planning behavior.
This corporate response to VAT reform also impacted the location of employees. The results are most pronounced for corporate activities in Luxembourg, the country with the lowest VAT rate. We further find that MNCs shift more income to low corporate income tax countries after the VAT reform. Collectively, our findings indicate that destination-based taxes curb tax planning, but there are "real'' effects and MNCs refocus their strategies around tax bases that remain taxed at origin.

Keywords: Consumption Taxes: Value-added Taxes; Digital Economy; Tax Avoidance; Profit Shifting; OECD Pillar 1

JEL Classification: H22, H24, H25, H32, M48