EU Adopts Innovative Multilateral Pilot Tax System

January 9, 2007

It's becoming increasingly obvious that the Europeans could teach us Americans a thing or two about business tax policy.

On December 23rd, the European Commission approved a pilot project that would allow for formulary tax apportionment for certain businesses that conduct multilateral operations in the EU. The real innovation, however, is that businesses participating in the project would be able to calculate their profits using their home country tax rules.

This means that businesses in the EU would not have to spend time and money figuring their taxable basis in the countries where they have operations; they would merely calculate their taxable basis using their home country regime, then apportion that income using some combination of employees, payroll, sales and assets.

What this practically means is that countries in this pilot project would only have to face the complexities of figuring out the tax laws in one EU country. They would spend zero time and money computing income using foreign country rules, including issues surrounding the definition of income and the availability of tax incentives.

This will almost certainly be a positive development for the flow of commerce between EU countries. Even better, it's simplification without harmonization: each EU country remains free to design their tax system however they want, but they cannot impose the administrative burden of that design on non-resident businesses.

Contrast this with the current system in the U.S., where many argue that the mere presence of customers in a state–without any physical presence like a plant or an employee–should trigger tax compliance, collection and remittance obligation. With this obligation comes the privilege of figuring out the definition of income and the formulary apportionment factors in each state.

Of course, state government groups like MTC, NGA and NCSL are not oblivious to the compliance burdens faced by multistate businesses in the U.S. The problem is that their proposed solutions to date, such as the Streamlined Sales Tax Project, have mainly focused on harmonization as the solution.

U.S. lawmakers (federal and state) should hope that this EU project never gets beyond its current pilot status. Otherwise, they will have to tell U.S. multistate businesses why their European counterparts–who already receive a competitive advantage because of the U.S. system of worldwide taxation–now get a competitive advantage on their multilateral operations in the EU as well.

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