The anti‐tax‐avoidance directive: An initiative to successfully curb profit shifting?

• Published date: 01 June 2022
• Author: Nora Alice Paulus
• Date: 01 June 2022
• DOI: http://doi.org/10.1111/jpet.12565

Received: 10 July 2021

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Accepted: 11 December 2021

DOI: 10.1111/jpet.12565

ORIGINAL ARTICLE

The anti‐tax‐avoidance directive: An initiative

to successfully curb profit shifting?

Nora Alice Paulus

Department of Economics, IAAEU &

University of Trier, Trier, Germany

Correspondence

Nora Alice Paulus, Department of

Economics, IAAEU & University of

Trier, Behringstraße 21, D‐54296 Trier,

Germany.

Email: paulusna@uni-trier.de

Abstract

On July

1

6

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2016 the Economic and Financial Council of

the European Union adopted the Anti‐Tax‐Avoidance

Directive (ATAD). The proposed controlled‐foreign‐

company (CFC) rule in the ATAD requires a minimum

tax rate in the host country of a multinational's

controlled‐foreign subsidiary to avoid the reattribution of

the subsidiary's income to the country of its parent

company. The Directive allows member states to remain

free to set the CFC threshold autonomously by laying

down a minimum standard. Member states can thus ei-

ther opt for a loose CFC rule by setting the minimum

required control threshold (i.e., 50% of the country's own

corporate income tax rate) or impose a tight CFC rule by

applying a higher threshold. Against this background, the

present paper analyses the effect of CFC rules on tax

competition for foreign direct investments. It appears

that, although CFC rules are effective in curbing offshore

profit shifting, they can induce nonhavens to compete

aggressively for mobile capital. In this context, CFC rules

can exacerbate capital outflows from the large to the

small country to a larger extent than in standard models

of tax competition. Moreover, the paper highlights that

governments choose between two extreme options when

decidingontheirCFCrule.Eithertheyoptforthelowest

or the highest possible control threshold.

J Public Econ Theory. 2022;24:529–546. wileyonlinelibrary.com/journal/jpet

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This is an open access article under the terms of the Creative Commons Attribution‐NonCommercial‐NoDerivs License, which permits

use and distribution in any medium, provided the original work is properly cited, the use is non‐commercial and no modifications or

adaptations are made.

© 2021 The Authors. Journal of Public Economic Theory published by Wiley Periodicals LLC

1|INTRODUCTION

Over the past years, the “harmful”tax avoidance practices of multinational firms (like, Star-

bucks, Google, Amazon, among others) have been the subject of numerous political debates.

Indeed, more and more countries have seen a need to react to the tax avoidance practices of

multinationals by questioning the current tax regimes.

In June 2012, the heads of states and governments of the G20 countries urged the Organi-

zation for Economic Cooperation and Development (OECD) to pursue its work in fighting

harmful tax competition between jurisdictions and to implement an action plan against base

erosion and profit shifting (BEPS).

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One year later, the OECD published its Action Plan on

BEPS, addressing the perceived deficiencies regarding current tax regimes. However, the rules

released in the BEPS Action Plan were recommendations and the member states could decide

whether to implement them into domestic law, or not. On July 16, 2016, the Economic and

Financial Affairs Council of the European Union adopted the Anti‐Tax‐Avoidance Directive

(ATAD). Unlike BEPS, the ATAD is a supranational law and EU Member States had to im-

plement the according measures into domestic law by January 1, 2019. The ATAD comprises

five antiabuse measures that are, interest‐limitation rules, controlled‐foreign‐company (CFC)

rules, the exit tax, the general antiabuse rule (GAAR), and antihybrid rules. The focus of the

present paper is on the two first ATAD measures.

The interest‐limitation rule denies the deduction of net interest payments to an affiliate that

exceeds 30% of the firm's earnings before interest, taxes, depreciation, and amortizations

(EBITDA). Traditionally, tax systems enable interest payments to be deducted from the cor-

porate tax base, while denying the deduction of returns on equity (see Haufler & Runkel, 2012).

Consequently, a firm's affiliate, located in a tax haven, can operate as an “internal”bank,

providing loans to the parent firm in high‐tax countries. The firm can thus reduce its taxable

profit by increasing the level of intracompany loans. The interest‐limitation rule of the ATAD

aims at tackling the problems associated with debt‐financing.

The CFC rule requires that a firm's controlled‐foreign subsidiary pays a minimum tax rate in the

host country to avoid the reattribution of the subsidiary's profits to its parent company. More

precisely, if a firm's affiliate that is classified as a “controlled‐foreign‐corporation”operates in a

jurisdiction where the tax rate is below the required minimum, the country of the parent firm can

deploy CFC rules. It follows that this country can tax the profits generated by the affiliate in the tax

haven by adding them to the tax base of the parent firm (see Haufler et al., 2018).

While the ATAD proposes the same interest‐limitation rule for all the EU member states, it

allows them to remain free to set the CFC threshold autonomously by laying down a minimum

standard. In this context, each member state is obliged to deny any deduction of net interest

payments that exceed 30% of the firms' EBITDA. However, more flexibility is granted in the

implementation of the CFC regulation. So, countries can either opt for a loose CFC rule by setting

the minimum required control threshold (50% of the country's own corporate income tax rate) or

impose a tighter CFC rule by applying a higher threshold. Against the background that CFC rules

do not have to be implemented in a coordinated way across jurisdictions, the following questions

arise. What is the effect of CFC rules on tax competition for foreign direct investments? Do

countries compete more aggressively via tax rates when CFC rules are in place? Moreover, have

member states an interest to choose between either tight or loose CFC rules?

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For further information, see G20 Leader's Declaration at Los Cabos, Mexico (June 18–19, 2012, p. 48).

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