B2- Fiscal Policy Analysis: work programme and organisation Joint Research Centre the European Commission's in-house science service Intangibles & Profit Shifting: An assessment of policy reforms B2- Fiscal Policy Analysis: work programme and organisation Diego d'Andria Co-authors: María Teresa Álvarez-Martínez, Salvador Barrios, Jonathan Pycroft, Maria Gesualdo, Dimitrios Pontikakis Salvador Barrios JRC-B2 04 July 2016 Disclaimer: The views expressed are purely those of the authors and may not in any circumstances be regarded as stating an official position of any affiliated institution.

Tax policy focus on knowledge economy (e. g Tax policy focus on knowledge economy (e.g. EC Action 2003 "Investing in research") Many intangible assets (patents, trademarks) come from innovative activity Profit shifting found to be more likely with intangible assets (Grubert 2003, Dischinger and Riedel 2011, Beer and Loeprick 2015) Extend CORTAX CGE model: make profit shifting sensitive to share of intangible assets simulate policy reforms to curb profit shifting change tax treatment of intangible assets Motivation

Overview of the Model CORTAX (CORporate TAXation) CORTAX: Originally by CPB Netherlands (Bettendorf and van der Horst 2006) Applied general equilibrium model: households, firms, government Multi-country: EU28 + JPN + USA (+ tax haven) Comparative static (steady state equilibria) Calibrated on 2012 data (Eurostat, OECD, ORBIS, UN) Overlapping generations (old, young); inter-temporal optimization Labour/leisure optimization; workers immobile across countries 2 types of firm: DOMESTIC, MULTINATIONALS (HQ + SUBSIDIARIES) Debt and equity financing; capital fully mobile across countries Production of a single tradable final good Multinationals perform transfer pricing between EU members + profit shifting to the tax haven Governments tax corporate, labour, financial incomes. Revenues are transferred to the old generation Overview of the Model CORTAX (CORporate TAXation)

The CORTAX model FIRMS Domestic Multinational headquarters Tax revenue Transfer FIRMS Domestic Multinational headquarters Multinational subsidiary Tax haven Profit shifting Transfer pricing Household OLG ( young, old ) Government Budget (balanced) L, K, F W, Rk, Rf G Asset, bond Debt, equity The CORTAX model

Roadmap future developments Work in progress: Include knowledge 2 sectors: a final good, and an intermediate good ("knowledge") Output Local factor Value-added Labour Capital Knowledge Capital Labour Knowledge stock Local factor Simulate tax incentives for R&D, IP boxes, effects of amortization schemes Endogenous growth: Higher knowledge stock  productivity ↑, knowledge spillovers  GDP ↑ However: Higher knowledge stock  share of intangibles ↑  cost of profit shifting ↓ Roadmap future developments

Summary of simulations Profit shifting ↔ intangibles Adjust elasticities Curbing profit shifting (anti-avoidance rules) Profit shifting costs ↑ Changing depreciation rates for intangibles as part of overall asset depreciation (similar to suggestions in BEPS actions 1 and 8) Model closure: ex post on the labour tax (to keep total revenue neutrality), or ex ante on CIT rate (to maintain the original CIT revenues) Summary of simulations

Base semi-elasticity of profit shifting = 1 Use ratio: intangible assets / total assets Raise semi-elasticity if ratio above average, lower if below average Based on estimations in Beer and Loeprick (2015) New range: 0.32 (CZE) to 2.31 (FRA) EU average = 1 Elasticity is for multinational HQ (ownership) Currently working on parameterisation 1. Adjust elasticities

1. Simulations adjust elasticities for intangible share Country CIT_rate Allowance Capital Employm. GDP Welfare AUT 0.04 0.13 BEL 0.17 0.16 0.66 0.24 DNK 0.01 0.03 FIN FRA -0.15 -0.16 -0.23 -0.25 DEU 0.02 0.06 GRC HRV IRL 0.05 0.55 ITA LUX NLD 0.14 0.19 PRT 0.08 ESP -0.02 -0.05 -0.04 SWE -0.07 GBR 0.22 0.1 CYP -0.03 CZE 0.07 EU-Average -0.01 0.00 Countries with high shares (FRA, IRL) shift profits more easily from (FRA) or to (IRL) that country. 1. Simulations adjust elasticities for intangible share

profit shifting 2. Raise the cost of Profit shifting costs ↑ Policy proposals Modelled by reducing elasticity of profit shifting Start with intangible-adjusted values If greater than 1  0.7 (compare controlled foreign corporation (CFC) rules) Policy would be about transparency & sharing information; finding 'arm's length' equivalents 2. Raise the cost of profit shifting

2. Simulations raise cost of profit shifting Country CIT_rate Allowance Capital Employm. GDP Welfare AUT -0.01 -0.07 -0.02 BEL 0.02 0.03 DNK -0.05 -0.04 FIN -0.06 FRA 0.04 0.05 0.17 0.11 DEU 0.01 GRC HRV IRL -0.36 -0.16 ITA LUX -0.08 -0.03 -0.13 NLD -0.11 PRT ESP 0.07 SWE GBR CYP -0.17 CZE -0.09 EU Countries with high shares (FRA) no longer lose profits as before. 2. Simulations raise cost of profit shifting

3. lower depreciation rate for intangibles Depreciation rates for intangibles ↓ Modelled by doubling the depreciation time for intangibles i.e. broadening the CIT base First, with base elasticities Second, with adjusted elasticities 3. lower depreciation rate for intangibles

3. Simulations lower depreciation rate for intangibles CIT_rate Allowance Capital Employm. GDP Welfare Adjt elast. for intang. EU -0.01 0.05 0.00 Adjt elast. for intang. + Profit shifting cost ↑ Deprec. rate for intang. ↓ -0.90 -2.19 -0.33 -0.05 -0.12 -0.02 -0.13 Updated to new values 21jul16 3. Simulations lower depreciation rate for intangibles

Profit Shifting Index 100.0 111.4 56.2 101.6 112.6 57.9 INDEX   INDEX BASE BASE (no change) 100.0 SIMU1 Adjust elasticity for intangible share 111.4 SIMU2 Adjust elasticity for intangible share + Profit shifting cost ↑ 56.2 SIMU3 Depreciation rate for intangibles ↓ 101.6 SIMU4 Adjust elasticity for intangible share + 112.6 SIMU5 Depreciation rate for intangibles ↓ + Profit shifting cost ↑ 57.9 Profit Shifting Index

Conclusions Ongoing developments Raising the cost of profit shifting: GDP neutral at EU level Differential impact across countries Effective in curbing profit shifting Reducing depreciation allowance for intangibles: Little impact on profit shifting Small negative for GDP (with country variation) Ongoing developments Estimation of parameters Separate knowledge sector Innovation policy (tax incentives) Currently a benefit of intangibles is the potential to increase profit shifting  curbing profit shifting, reduces attractiveness of intangibles Holistic solution: introduce measures to reduce profit shifting and incentivise (openly) intangibles as governments wish. Conclusions diego.d'andria@ec.europa.eu