Profit Disclosure in International Corporations with Taxation Based on The 'Separation Principle' or on the 'Principle of Unity'

Abstract

Transfer pricing within multinational firms has been a much discussed issue of corporate taxation over the last decade. Politicians and tax authorities suspect a tax loophole of threatening extent as under the prevailing system of “separate tax accounting” firms may use transfer pricing to shift tax bases to those entities of the firm with the lowest tax burden. Against this background, the EU Commission is propagating the so-called unitary taxation of multinational firms within the EU. Under unitary taxation the consolidated tax base of the firm is allocated to the countries in which the firm has branches or affiliates by the use of an allocation factor. Each country would than tax its share of the firm’s consolidated tax base with its own tax rate. The Commission’s proposal has been known under the term of Common Consolidated Corporate Tax Base (CCCTB`). Unitary taxation is generally believed to be immune against profit shifting.This paper compares the possibilities of a multinational firm to minimize taxes through accounting measures under separate and unitary taxation. For this purpose we analyze the effect of different tax accounting strategies on the net present values of individual investments and of investment chains of a multinational firm. We use a neoclassical investment model.