The Shifting Economic Allegiance of Capital Gains

Abstract

Technological advances and the digitalization of the global economy have created an economic environment beyond the imagination of the original designers of the international tax system. Much scholarly attention has been paid to the question of how these economic transformations should affect which country is able to tax a multinational company’s income. But which country should be able to tax capital gains income from the sale of that company’s shares is an important and overlooked question.

This Article answers this question. It concludes that taxing authority over capital gains income must be reallocated to the countries in which companies conduct business. In our modern, digitalized economy, this reallocation is necessary to align international sourcing rules with international tax law’s underlying principles.

The current international sourcing rules were developed in the 1920s. These rules were informed by the benefits principle, which justifies taxation based on the resources that a country provides to taxpayers, and the accompanying approach of granting taxing authority to the country with the closest economic allegiance to an item of income. Applying this approach, the original designers of the international tax system granted taxing authority over capital gains income to the investor’s residence country rather than the countries in which a company operates (the source countries).

This Article argues that in our modern economic environment the economic allegiance of capital gains income has shifted away from the residence country and towards the source countries. The unique nature of value creation in the digital economy and multinational companies’ broad shareholder bases have especially driven this shift. Because of this shift, source countries must be granted taxing authority over capital gains income if we are to maintain a coherent and equitable international tax system that is aligned with its driving norms.

While this Article is a primarily a proof of concept, it also seeks to begin a conversation about ways to implement this reallocation. It discusses two possible approaches. First, a centralized global pooling and redistribution of capital gains tax revenues. Second, an annual mark-to market tax on the company-level on increases in company value apportioned amongst source countries based on a set formula.

Keywords: taxation, international taxation

JEL Classification: K34, N40