European Group Taxation - Formula Apportionment versus Current Inclusion

Abstract

The European Commission's proposal to establish a common corporate tax base reduces both compliance and administrative costs for European groups. The proposal would replace separate entity accounting with a profit allocation based on formula apportionment. Since formula apportionment rests on the source principle, the group faces an incentive to invest in low tax member states. Some member states might face a loss in both real economic activity and tax revenue. Moreover, anti-avoidance tax rules concerning non-EU countries must be harmonised.

Residence-based group taxation based on separate entity accounting could be an alternative. The subsidiaries' profits and losses are attributed to the parent of the group (current inclusion), and the group's profit is taxed at the corporate income tax rate of the parent. The parent's state of residence grants a foreign tax credit. Current inclusion prevents tax distortions regarding the location of investments, if no limitations on the foreign tax credit exist. Given that applicable exit taxation rules infringe upon EC law, a serious drawback of residence-based current inclusion might be the incentive to move the tax residence of the group's parent to a low tax member state.

Keywords: Common Consolidated Corporate Tax Base, Current Inclusion, European Group Taxation, European Law, Exit Taxation, Formula Apportionment, Mergers Directive, Separate Entity Accounting

JEL Classification: H20, H21, H25