FULL TAXATION: THE SINGLE TAX EMPEROR'S NEW CLOTHES.

AuthorParada, Leopoldo
  1. INTRODUCTION 730 II. THE SINGLE-TAXATION PARADIGM 732 A. The Origin 733 B. Single Taxation and BEPS 735 C. The Conceptual Frustration of Double Taxation 741 and Double Non-Taxation III. FULL TAXATION AND THE NEW INTERNATIONAL TAX ORDER 747 A. Full Taxation as an Element of Single Taxation 747 B. The Inconsistencies of Full Taxation 748 1. Indeterminism 749 2. Overinclusiviness 757 3. Instrumentalism 764 IV. FULL TAXATION AND INTERNATIONAL LAW 771 A. Taxing More and Lower Than Once 772 B. Full Taxation and Customary Law 776 V. CONCLUSIONS 783 I. INTRODUCTION

    It has recently been argued in the international tax literature that the OECD Base Erosion and Profit Shifting project (BEPS) reflects and effectuates full taxation, namely an international norm that would suggest that all of a company's income should be taxed in places where it has real business activities, ultimately representing a modern approach to the single-taxation paradigm. (1) This Article builds upon this concept and argues that although rhetorically attractive, full taxation is still conceptually inconsistent, particularly because it is incapable of providing any hints as regards where and who should finally be taxed. (2) Moreover, it adopts an overinclusive and instrumental approach, the purpose of which appears to be only to legitimatise the use of coordinated provisions whose rationale exclusively attends to avoiding the complete absence of taxation in cross-border transactions. (3) This approach, innocuous at first sight, suggests, however, the unprincipled purpose of taxation just for the sake of taxation, putting at risk countries wishing to attract real economic activities and stigmatising the outcome of double non-taxation in a permanent way.

    Part II briefly analyses the origins of single taxation and how this notion--inconsistent in itself--is embraced by BEPS. Part III analyses the concept of full taxation, arguing that although rhetorically attractive, the concept is still conceptually inconsistent. The analysis reinforces the view of some commentators that full taxation is agnostic in regards to the tax base and the tax rate that one should look at when determining that all company's income should be taxed, and stresses additional risks associated to its indeterminism. (4) This Part also argues that full taxation reflects an overinclusive and instrumental approach, the purpose of which appears to be solely to legitimise provisions under which if one country does not impose taxation, another country automatically pulls the trigger and does it, ultimately suggesting the unprincipled purpose of taxation just for the sake of taxation. Part IV argues against the idea of full taxation being recognised as a new international tax norm from a strict international law perspective. Indeed, no international law provision prohibits full taxation. Nor could full taxation be considered international custom. However, it is perhaps too early to venture a definitive answer in this regard, especially considering the dynamics of international custom. Part V concludes.

  2. THE SINGLE-TAXATION PARADIGM

    Single taxation has captivated both policymakers and academics for good reasons. After all, the idea is simplistically seductive: if income resulting from cross-border transactions is taxed exactly once--but no more and not less than once--both double taxation and double non-taxation are prevented. This Part analyses the origins of the single-taxation paradigm and how the notion of single taxation--inconsistent in itself--is officially embraced by BEPS. It also argues that the conceptual frustration behind the notions of double taxation and double non-taxation seems to be the only apparent engine that gave origin to the ideal of an international single-tax system.

    1. The Origin

      The academic theory of single taxation first came about in the late 1990s. (5) At that time, Reuven Avi-Yonah defended--not without scholarly resistance--the idea of an international tax regime, which would basically consist of the bilateral tax treaty network and the domestic tax laws of the major trading nations, (6) also forming part of customary international law. (7)

      The pillars of this regime would be two basic principles: the single tax principle, which argues that income should be taxed once--no more and not less--and the benefit principle which means that active business income must be taxed primarily at source and passive investment income primarily at residence. (8) Therefore, Avi-Yonah's single tax idea appears to be accompanied by a distribution rule--the benefit principle--which suggests that single taxation implicates not only that income is taxed but also where that income should be taxed. (9) Single taxation and the "benefit principle" combined would provide the comfortable idea of an international tax regime. (10)

      Therefore, from a theoretical perspective, single taxation (or the single tax principle, as its creator denominates it) would avoid income being overtaxed, as well as undertaxed or not taxed at all, resting always in the assumption that all the countries would maintain both a personal and a corporate income tax. (11)

    2. Single Taxation and BEPS

      The single-tax notion is officially endorsed in BEPS, although with a switch in priorities from avoiding double taxation to avoiding double non-taxation, (12) challenging the fundamental consistency of the singletax notion. (13) Consider the example of the OECD anti-hybrid rules (linking rules) proposed in the OECD BEPS Action 2. (14) These rules recognise that taxpayers make use of disparities in countries' tax characterisations of financial instruments or entities to create hybrid instruments (15) or hybrid entities (16) that might result in no or low taxation. (17) BEPS Action 2 puts in place a pragmatic solution that does not attend to the disparities themselves (18) but rather to the tax outcomes generated by them, especially double non-taxation. (19) Indeed, the rules have two parts. First, they provide that if a deductible payment is not recognised as ordinary income in the recipient state, a deduction should be denied in the payor state. This is technically known as the primary response (20) Similarly, if for any reason the payor state did not react by denying such a deduction, the recipient state could tax what, in principle, was not taxable under the domestic rules in the recipient state. This is what is known as the defensive rule (21) In both cases, the underlying assumption is simple: taxation must occur somewhere--but where does not matter. (22)

      Nevertheless, and although it is correct to argue that the OECD anti-hybrid rules aim to avoid international double non-taxation, such a consequentialist approach (23) brings to the fore the inconsistencies of the single-tax notion itself, an idea that is far from being a settled principle in international tax law. Let me illustrate this with another example involving again the application of the OECD anti-hybrid rules. Assume a deductible payment of interest coming from a subsidiary to its parent company due to a loan transaction between the two entities. The deduction of the interest payment is denied in Year 1 because the interest payment is not recognised as income in the recipient state in Year 1 because the country of the parent company considers the payor entity as transparent for tax purposes. (24) However, in Year 2, the inclusion of income occurs because of an inclusion-t iming difference. As the rule denying the deduction of the interest payment does not provide any tool to undo the disallowance of the deduction in Year 1, the ultimate outcome will be economic double taxation. (25) In other words, avoiding double non-taxation in this case may result in the absurdity of creating new situations of double taxation, that is, a flagrant violation of the same principle that these provisions aim to protect. (26)

      Moreover, in most of the cases involving a double non-tax outcome, what we really have is a one-year deferral; that is, non-taxation seems to be in the end more apparent than real. (27) Let me illustrate that using the same example as before but adding two additional facts. First, the subsidiary holds a sub-subsidiary in the same country. Second, the subsidiary and the sub-subsidiary are part of the same tax group. (28) Now, let us assume that in Year 1 the subsidiary pays interest to the parent and the sub-subsidiary generates income from other sources of the same amount. (29) That is, disregarding anything else and looking at the single picture in Year 1, it is evident that the subsidiary will benefit from deducting the amount of interest paid, which will not be included as income in the parent company due to the tax transparency treatment of the subsidiary in the country of the parent. A double non-tax outcome will certainly arise.

      However, if we now consider that in Year 2 the subsidiary pays no interest but has income in the same amount of interest paid in Year 1, the result will be that this income will be taxed twice, once in the state of the subsidiary and once in the state of the parent, assuming of course that no tax credit applies. (30) In other words, just adding an additional calendar year to our analysis may dramatically change our original "non-tax perception," making it disappear but under the cost of accepting double taxation in Year 2. Once again, the paradox is that protecting single taxation cannot be done without violating single taxation.

      Things become even more bizarre if one considers the reality of withholding taxes in cases involving hybrids and the OECD BEPS. Let's take again the simple example of a subsidiary paying interest to its parent company due to a loan transaction between the two entities. Whilst the subsidiary is considered in its country of establishment as a taxable entity, the same entity is regarded as tax transparent in the country of the parent company. Therefore, the interest paid will be...

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