ec tax rev formula one

��

�� ! "��#� "� �$ � %�� # � � &'� (�)

*�� +� ,

� � �� $�� )�#��-�� &��.�/�# ��&�� #��## ��0��+�#�# )��.��++��#��1 ��# �� &2�( ($3*�� +� ,'4,��5 0��6��4��#��-�� / ,

&�-#/�� 7��# �� 7��#�# 1 � #�,�� / ��# # �� -� ��/�� $�� )�#��-�� &��.�/�# ��

&�-#/�� /�#8 �/��+ � #��+�8 1 � ��( 9: ��,� �;<5 '*� ��;��=*&) �>��=2�� >�� # 1�� #�-#/�� $ �# ! �� # ��# �.��-�� .�� #�-#/�� /�# �� .��-�� 7��#�� #� / ��/� �� #��# ��,�� 1 � , ��1 �,�� ?�� 9�<�;� �� #��#60��/ ,�

�� # ��-��# �� #�� ,�# �� @��

" � �1 �,�� #�++�#�� # ��+��+ � � ��+ �� -#��/��+ #��.�/�# �#�� 1 � � �# ��-��/�� 8 ��#�/ ��/� �� + �# �� ,�##� # ��,�� ,�##� #60��/ ,�

� ��( ��

&&%5 �>�(4�;��

�� + �# ��#��.�� % �� 1 � �# ��-��/�� ,�@ -� �� /��8 #� �� .�� #@#��,8 � ��#,�� @ 1 �, � -@ �@ ,��#8 ��/�� /8 ,�/ ��/��8 � � / �@�+8 ��/ ��+ � � ��#�8 �� ,�##� 1 � � ��-��# ��#�

��,�##� � �#� � �# / �� ,�#� -� -�� 1� , � � / �@��+ � �� #� ��@ � 5 �� 8 ��,�##� # )��,��8 � �� A ��#��##8 ;� %�� .��8 &�.�� "� �8 %��B �08 %B ��8 *&�� '4,��5 ��,�##� #60��/ ,� ��-#��5 ��0��/ ,

ArticlesFormula One. The race to find a commonformula to apportion the EU tax base

Joann Martens Weiner*

1. Introducing formulary apportionmentinto the EU

After years of work, the European Commission is onthe verge of proposing a new direction in companytaxation in the European Union. This new directionhas two components. The first component is acommon consolidated corporate tax base (CCCTB)at the EU level. The CCCTB is the driving force behindthe EU's tax reform efforts. The second component isthe apportionment formula, which has generally beentreated as a secondary issue in the EU's company taxreform process.1

The Commission has made significant progress indefining a common EU tax base. Yet it remainsrelatively distant from defining a common EUapportionment formula. With the Commission havingpromised to release in 2008 a legislative proposal onintroducing an optional common consolidated corpo-rate tax base into the European Union, it is time for theCommission to specify how it will distribute thecommon EU tax base to the Member States fortaxation at local rates.

Formulary apportionment is a compelling solu-tion.2 Continuing to use separate accounting andarm's length pricing to determine the amount ofincome earned in each of the EU Member States wouldlargely negate the benefits of achieving a common taxbase.3 Although the Commission's company tax studyleft open this possibility, it never appeared to take theoption of remaining with the separate accountingsystem seriously.4 The Commission also considereddistributing the tax base using macro-economicfactors, such as national income, or industry factors,such as industry average profitability, but it discardedthese options relatively early in the process.

The possibility of distributing the tax base accord-ing to value added generated considerable interestinitially, partly because it was an innovative, althoughuntested, approach to distributing income and partlybecause it was not associated with the formularyapportionment method used in the US states andCanadian provinces. Yet, that method also wasdiscarded, largely because when measured on anorigin basis it introduced the transfer pricing problemsand when measured on a destination basis itintroduced significant complexity. Moreover, whendecomposed into its separate elements, it became clear

that the value added formula became effectively a taxon labour (which makes up about three-quarters ofvalue added). Given the interests in creating an`employment friendly' business tax system, EU politi-cians would seem to be reluctant to introduce amethod that imposed such a heavy burden on labour.

This article examines the remaining option on thetable: formulary apportionment. It first describes thetheory behind formulary apportionment and discussesthe controversial issue over whether to consider salesand intangible property in the formula. It thendiscusses the use of game theory in choosing a formulachoice and applies this analysis to the situation facingthe European Union. A brief section concludes.

* George Washington University. This article was prepared for aspecial edition of the EC Tax Review on the EuropeanCommission's plans to propose adopting a common consoli-dated tax base with formulary apportionment. I would like tothank Jack Mintz for sharing his inspiration to apply game theoryto the EU company tax reform project and Richard Sansing,Marcel GeÂrard, and Benjamin Miller for their comments on thisarticle. Any remaining errors are my own. The author may bereached at [email protected].

1 The Tax and Customs Unit of the European Commission hasbeen directing this project and it has made its working papers,agendas, summaries, and contributions from interested partiesavailable on its website. See http://ec.europa.eu/taxation_cus-toms/taxation/company_tax/common_tax_base/index_en.htm.The Commission refers to formulary apportionment as a`necessary but unavoidable consequence' of creating a consoli-dated tax base at the EU level.

2 For a detailed examination of the main issues involved inimplementing formulary apportionment in the European Union,see Joann Martens-Weiner, Company Tax Reform in the EuropeanUnion. Guidance from the US States and Canadian Provinces onImplementing Formulary Apportionment in the EU (New York,Springer, 2006).

3 Formulary apportionment is the obvious answer, of course, onlyonce the decision has been made to move away from theinternational arm's length separate entity accounting principle.The arguments in favour of using formulary apportionmentwithin an economic union and the controversy over usingformulary apportionment on a worldwide basis are well-known.See Michael C. Durst and Robert E. Culbertson, `Clearing Awaythe Sand: Retrospective Methods and Prospective Documenta-tion in Transfer Pricing Today,' Tax Law Review 2003, vol. 57, no.1, pp. 37±136. For a counterpoint, see the Organization forEconomic Cooperation and Development, Transfer Pricing Guide-lines for Multinational Enterprises and Tax Administrations (OECD,Paris, 1995).

4 See Commission of the European Communities, CompanyTaxation in the Internal Market (Luxembourg, 2001).

100 EC TAX REVIEW 2008/3

ecTAXREVIEW

2008±3

ecTAXREVIEW

2008±3

2. The apportionment formula

A quarter-century ago, Peggy Musgrave analyzed theprinciples behind the use of a formula based on thelocation of a multi-jurisdictional firm's businessactivity to divide the corporate income tax base acrossjurisdictions.5 Although the US states had then usedthis method for several decades, Musgrave explainedthat the corporation income tax is a particularlyinappropriate tax instrument at the sub-national level,especially within the context of a formulary apportion-ment system. The combination of the different ratesand the apportionment formula creates, as Musgravesaid, àn uncertain and complex incidence pattern'.6

Because capital is highly mobile, the resulting alloca-tion in the taxing area is inefficient as capital moves tolocations where it would not locate in the absence oftax. Later empirical work by Weiner (1994) showedthat business investment is sensitive to these cross-state variations in the effective apportionment tax rateon capital.

Yet the US states have never considered giving upthe right to tax corporate income earned within theirborders.7 Likewise, within the European Union, theMember States have always balked whenever theEuropean Commission has attempted to take overcompetence for levying the corporate income tax oreven if the Commission has attempted to establishrules for how they should design the corporate tax.8 Inessence, neither the US states nor the EU MemberStates wish to cede the right to tax income earnedwithin their jurisdiction ± by both residents and non-residents ± despite the theoretical arguments againstlevying sub-national capital taxes.

Given the importance of the corporate income taxin the EU Member States, the European Commissionhas focused its attention on designing the mechanismto distribute the EU-level tax base to the MemberStates for taxation at local rates. Following Musgrave'sanalysis, the Commission is attempting to design aformula that leads to an outcome that is non-discriminatory and that achieves ìnter-jurisdictional'equity. Reaching these goals, as explained below, is aformidable task.

The Commission has listed four broad principlesthat should apply to any sharing mechanism.9 Theformula should be simple to apply and easy to audit; itshould be difficult to manipulate; it should distributeincome in a fair and equitable manner; and it shouldnot lead to undesirable effects on tax competition. Inits remarks to the Commission, the Business EuropeTask Force stressed that the àpportionment key' mustminimize the tax incentives to shift factors whilerecognizing that it must not simultaneously limit fairtax competition.10

Since the Commission insists that all Member Statesmust adopt the same formula, the Commission mayfind it very difficult to design a formula that meets allfour objectives in all 27 Member States.11 For example,a formula that distributes the tax base according to thelocation of tangible property might be relatively simpleto apply (compared with a formula that distributesincome according to the location of intangible

property, for example), but it might have undesirableeffects on tax competition (relative to a formula thatdistributes income according to the location of sales,for example). A formula that distributes incomeaccording to physical property may distribute incometo the factors that generate income, but such aproperty has adverse effects on tax competition.Whether a particular formula leads to a fair incomedistribution, of course, requires making a subjectivejudgment. Similarly, a formula that is composed ofelements that have third-party reporting, such asworker compensation, is harder to manipulate thanone that does not have third-party reporting. Yet, thisformula places a relatively heavy burden on labour,and thus might discourage employment in that state.

The Commission put forth a property, payroll, andsales formula in its paper prepared for the December2007 meeting of the CCCTB working group.12 TheCommission chose a multiple-factor formula so that itwould not be `too volatile' in the sense that the incomedistribution would not be overly sensitive to thelocation of one of the factors, and that a mix of factorswould better capture the income-generating factors aswell as help meet the varied interests of the MemberStates.

The Commission presented a multiple-factor ap-portionment formula that would include labour,assets, and sales as a `promising approach' to sharethe consolidated group tax base. The labour factorwould consist of equal weighted shares of payroll andnumber of employees, the asset factor would not

5 See Peggy Musgrave, `Principles for Dividing the State CorporateTax Base,' in Charles E. McLure, Jr. (ed.), The State CorporationIncome Tax. Issues in Worldwide Unitary Combination (California,Stanford University, Hoover Institution Press, 1984), pp. 228±246.

6 Ibid., p. 229 referring to Charles E. McLure, Jr., `The ElusiveIncidence of the Corporation Income Tax: The State Case,' PublicFinance Quarterly 1981, vol. 9, no. 4, pp. 395±413; and PeterMieszkowski and John Morgan, `The National Effects ofDifferential State Corporate Income Taxes on Multistate Cor-porations,' in McLure, see n. 5 above, pp. 253±263. See JoannMartens Weiner, Company Taxation for the European Community.How Sub-National Tax Variation Affects Business Investment in theUnited States and Canada, Harvard University Ph.D. dissertation(1994, unpublished) for calculations of effective tax rates in thestates.

7 A number of states do not levy a corporate income tax, whileother states, such as Ohio, have decided to tax gross receiptsrather than income. Yet, in so doing, these states still assert theright to levy an income tax. I am grateful to Ben Miller foridentifying the alternate taxes that the states may choose to levyinstead of an income tax.

8 For a history of these efforts, see the European Commission'sstudy.

9 See Commission of the European Commission, `CCCTB: possibleelements of a technical outline' (CCCTB/WP/057) and `CCCTB:possible elements of a sharing mechanism' (CCCTB/WP/060),both issued in November 2007.

10 The Business Europe comments are available on the Commissionwebsite. See n. 1 above.

11 The Commission may propose a different formula for a specificindustry, such as financial services, but if it does so, then all theMember States must also apply this common formula to thatspecific industry.

12 See CCCTB/WP/060, n. 9 above.

EC TAX REVIEW 2008/3 101

FORMULA ONE. THE RACE TO FIND A COMMON FORMULA TO APPORTION THE EU TAX BASE

include intangible property, financial assets, or in-ventory, and the sales factor would measure sales atdestination. The Commission did not establishweights for each factor, other than noting that thetwo elements of labour should have equal weights. Itconsiders the weights applied to each factor as atechnical matter for decision at the political level.

The Commission stressed that the formula must beuniform across the Member States. Divergent formulacould arise in defining the formula for specific sectorsas long as those formulae also remained uniformacross the EU. The Commission also established that itwould apportion all income and not distinguishbetween business and non-business income.13

The Commission has set forth an ambitious set ofgoals, and the upshot of this discussion is that theEuropean Commission will have to compromise indeciding how much importance it assigns to each ofits goals. For example, a formula that maximizesincome in one Member State is very likely to not bethe formula that maximizes income in all MemberStates. Likewise, a formula that is not easy tomanipulate, may have undesirable competitive ef-fects. The Commission may have to consider thepossibility of allowing the Member States moreleeway than it desires in defining the formula.Moreover, the Commission will need to anticipatethat the importance of these objectives may changeover time and across the Member States.

2.1. Theory

Sovereign states assert the right to tax income earnedwithin their borders, but when companies earnincome in several states, determining the appropriateprinciple for dividing that income across state borderscan be difficult.14 Using a formula based on where themulti-state company does business is one method toestablish the source of the company's income.

Formulary apportionment assigns income to thestate where the factors that generate that income arelocated. This method can follow one of two ap-proaches. Taken from a supply perspective, capital andlabour are generally considered to be the factors thatgenerate income. Taken from a supply-demandperspective, sales are also an income-generating factor.Neither approach has a clear theoretical claim todistributing income `better' than the other approach.For example, in her analysis of the principles fordividing the tax base across jurisdictions, Musgrave(1984) concluded that `There seems to be nostraightforward economic basis for choosing betweenthe two or for assigning respective weights under thesupply-demand approach' (p. 234).

However, on practical terms, one formula maydominate another. For example, Musgrave arguedthat the formula should include sales if thatjurisdiction's entitlement to tax considered thatdemand as well as supply created value. If jurisdic-tions adopted this approach, then the appropriateformula would double-weight the sales factor andweight property and payroll by one-quarter each.15

Martens-Weiner recommends this formula for the

European Union on the basis that the corporate taxbase should be distributed to both the productionand the manufacturing base.16

Corporate tax incidence theory also suggestsincluding sales in the formula. For example, inapplying the theoretical conclusion that the apportion-ment formula acts as a tax on whatever factorsincluded in the formula, McLure (1984) justifiesincluding sales on the basis that, in terms of incidence,consumers and workers primarily bear the corporateincome tax, not capital owners.17 More recently,Gentry reviewed recent empirical evidence on corpo-rate income tax incidence in the open economy andconcluded that these studies show that labour, andnot capital owners, may bear a substantial burden ofthe corporate income tax.18

Although the Commission advocates a formula thatincludes destination-based sales, its CCCTB workinggroup has reached an impasse in finding an acceptableapportionment formula. The majority of MemberStates and EU business representatives generally agreewith the Commission's proposal to include propertyand payroll factors in the formula. As discussed below,both groups object to including sales in the formula.In a compromise effort, the groups insist that if theformula includes sales, then they must be measuredon an origin basis.

Thus, the Commission faces a formidable task infinding a common formula to apportion the EU taxbase.

2.2. Should the formula include a sales factor?

Although there is some disagreement about the use ofthe number of employees, the greatest disagreementarises over the sales factor. Members of the EUbusiness community, EU Member States and expertsfrom the United States who participated in theDecember working group expressed divergent viewsabout the sales factor.19 The Commission noted that`the most controversial issue was whether a `sales'

13 Many US states allocate non-business income to specific statesand use a formula to apportion business income across thestates. This distinction has arisen primarily due to state-specificconcerns that are not necessarily applicable in the EuropeanUnion.

14 The Article refers to states, rather than jurisdictions, provinces, orMember States, for ease of exposition.

15 Musgrave cautions, however, that determining the location ofsales is difficult. Although it is easy to determine the location of asale when a company makes the final sale to an externalconsumer, it is considerably more difficult to determine thelocation of the final sale when the company makes a sale to anintermediate company that transforms

16 See Martens-Weiner, n. 2 above.17 See Charles E. McLure, Jr., `Comments on Musgrave' in Charles

E. McLure, Jr. (ed.), The State Corporation Income Tax. Issues inWorldwide Unitary Combination (California, Stanford UniversityPress, 1984), pp. 250±252.

18 See William M. Gentry, `A Review of the Evidence on theIncidence of the Corporate Income Tax,' OTA Paper 101, USDepartment of the Treasury, December 2007.

19 The European Commission has posted a list of the participants inthis meeting on its website. See n. 1 above.



factor should be included at all in the formula due toits conceptual and practical difficulties'.20

In their remarks to the CCCTB meeting, the USexperts indicated that they advocated a multiple-factorformula and indicated that the formula should includea sales factor. However, the group was undecidedwhether to measure sales at destination or, if it wouldhelp reach agreement, to measure them at origin.Recent academic papers published by Europeaneconomists also favour including sales in the appor-tionment formula, essentially on the ground thatdestination-based sales are relatively immobile.21 TheCommission has indicated that it views destination-based sales as less mobile than sales by origin since thecompany cannot control where its customers arelocated. It also views a sales by origin factor asduplicating the property and payroll factors.

By contrast, the EU business community opposesincluding a sales factor in the formula, especially if thefactor measures sales on a destination basis. EUbusinesses oppose the sales factor for several reasons.First, if applied on a destination basis, the sales factorwould attribute income to the consumption, ratherthan the production state, which is an allocation thatthe business group argued would `impose a significantshift from the current principle of attributing theultimate taxing rights to the source state' as estab-lished in the OECD's work on international taxation.22

The EU business community is also concerned thatbecause the location of the final sale is not fixed, theMember State tax authorities will impose harsh anti-abuse rules if the location of sales influences theincome allocation. The group cites as an example thepossibility that a company might contract with anindependent sales agent to conduct sales in therelevant market, thus shifting sales from the `intended'state to the chosen state. The EU business groupargued that not only would these tax-planningopportunities undermine the legitimacy of the salesfactor, but also they would likely trigger complex anti-avoidance rules. In addition, the EU business com-munity believed a destination-based sales factor couldbe easily manipulated, and would, therefore, runcounter to the desire to create a formula that is stableand not easily manipulated.

The US experts, some of whom were state taxofficials, did not agree with the EU business view. Theyargued that a company would not as a matter ofbusiness judgment give up control over distributionsolely for a tax advantage. They also indicated thatconsolidating the related entities takes care of theapportionment issue so that to the extent third partiesare used for distribution purposes the ultimateconsumer would be reflected in the apportionmentfactor of the distribution company.

Finally, although theory may not indicate whethersales should be included in the formula, practiceshows that the apportionment formula does include asales factor. Although there may sound argumentsagainst including the sales factor in the formula, inpractice, the two major locations that have adoptedformulary apportionment, the US and Canada, includesales in the apportionment formula.

The US states long ago began using a multiple-factor apportionment formula that includes property,payroll, and sales measured on a destination basis, andthe early formulae imposed a relatively heavy weighton the property factor (some of the first apportion-ment formulae included only a property factor). But,in response to competitive pressures, they have movedaway from the equally-weighted three-factor formulathat a state advisory group developed in 1957 andhave gravitated towards a more heavily weighted salesfactor.23 Many states have arrived to the point of usinga sales-factor only apportionment formula. The USstates have never adopted the two-factor property andpayroll formula recommended by a US Congressionalcommittee in the 1960s.24 The table below shows thevarious formulae the states use to apportion corporateincome as of 2008.

The Canadian provinces have a very differentexperience. When designing their apportionmentsystem from scratch in 1947, the federal government,along with the provinces, chose a two-factor payrolland sales formula. The provinces entered into agree-ments with the federal government to apply thecommon formula and the common federal tax basein exchange for the federal government agreeing toincur the collection costs for the corporate income tax.The provinces have remained with that commonformula (and common base) for more than 50 years.Perry (1989) attributes this consistency to the fact thatalthough the allocation rules might have been fairlyarbitrary when introduced, the fact that the provinceshave followed them for so many years makes it

20 See European Commission, CCCTB: Possible elements of thesharing mechanism, CCCTB/WP0/60.

21 See Marcel GeÂrard, `Reforming the taxation of multijurisdictionalenterprises in Europe: a tentative appraisal', European Economy,Economic Papers of the DG Economy and Finance, EUCommission (2006), p. 265 and Marcel GeÂrard, `Reforming theTaxation of Multijurisdictional Enterprises in Europe', CESifoEconomic Studies 2007, vol. 53, pp. 329±361 and Nadine Riedland Marco Runkel, `Company Tax Reform with a Water's Edge',Journal of Public Economics 2007, vol. 91, pp. 1533±1554.

22 This argument is based on the continued use of the permanentestablishment notion in determining whether a company has asufficient taxable presence in a jurisdiction. The US states arefinding it increasingly difficult to ignore that the use of intangibleproperty in a state generates income, just as the use of tangibleproperty in a state generates income. Yet, the traditional view isthat a taxpayer must have a physical presence in a state before ithas created a taxable connection.

23 The formula is contained in the Uniform Division of Income forTax Purposes Act (UDITPA). UDITPA fests for rules for dividingincome of manufacturing and merchandising entities intobusiness income, which is apportioned using the equally-weighted property, payroll, and sales formula, and non-businessincome, which is allocated to specific states. UDITPAS alsodefines the apportionment factors.

24 In 1977, all but one state used the three-factor formula; with itssingle-factor sales formula, Iowa was the exception. A USSupreme Court ruling in 1978 upholding the Iowa formula ledthe way for states to move away from the three-factor formulaand 18 states use or are planning to use a 100 per cent salesfactor formula. See Moorman Mfg. Co. v Bair, 437 US 267 (1978).



Table 1 US state apportionment formulae, 2008

Apportionment formula States

Equal-weight (property, Alabama, Alaska, Delaware,payroll, sales are District of Columbia, Hawaii,weighted 1/3 each) Kansas, Montana, North

Dakota

Equal-weight or hybrid Missouri (firms choose eitherequal weight or single factorsales), Oklahoma (firms meet-ing certain investment criteriacan choose double-weightsales, otherwise equal-weight)

Double-weight sales Arkansas, California,(property 25%, payroll Connecticut, Florida, Idaho,25%, sales 50%) Louisiana, Maine, Maryland,

Massachusetts, New Hamp-shire, New Jersey, NewMexico, North Carolina,Rhode Island, Tennessee,Utah, Vermont, Virginia, WestVirginia

Triple-weight sales Indiana, Ohio, Pennsylvania(property 20%, payroll20%, sales 60%)

Super-weight sales (weights Arizona (15-15-70), Michigangiven for property, (3.75-3.75-92.5), Minnesotapayroll, sales factors) (11-11-78)

Single-factor sales Georgia, Illinois, Iowa,Kentucky, Louisiana,Nebraska, New York, Oregon,Wisconsin

Other hybrids Colorado, firms choosebetween three-factor even-weighted and a two-factorsales and property formula;Mississippi, retailers, whole-sales, service companies,lessors use single-factor sales,wholesale manufacturers useeven-weight three factor, retailmanufacturers use three-factor double-weighted sales.

No general corporate Nevada, South Dakota, Texasincome tax (gross receipts tax),

Washington, and Wyoming

Source: Federation of Tax Administrators.

difficult for any province to abandon the uniformrules.25

Although some provinces have broken out of thefederal agreement, Mintz (2004) makes the same pointthat even though these provinces could establish theirown allocation formula, they have chosen to remainwith the uniform federal allocation formula.26 Mintzalso recognizes that even though some provinceswould now like to modify the formula, the nature ofthe negotiations over the formula as a zero-sum gameprevents the provinces from deviating from theexisting formula. The Canadian experience, therefore,shows that once a formula is chosen, even if it is not`ideal' over time, that there are great benefits to

cooperate in maintaining that formula for purposesof creating certainty and stable expectations.

The European Commission faces a conundrum indeciding whether to include sales in the apportion-ment formula. On the one hand, the US states andCanadian provinces include sales in their apportion-ment mechanism and, therefore, provide a real-worldexample of the formula that sub-national jurisdictionshave chosen to use. The US states provide an exampleof a non-cooperative situation where, when given thechoice, many states choose to apportion all incomeaccording to the location of sales.

On the other hand, the EU Member States and theEU business community, none of which has everapplied an apportionment formula within the Eur-opean Union, firmly oppose incorporating a salesfactor in the apportionment formula. Thus, it appearsthat `practice' may deviate from `theory' regarding thesales factor.27 The European Commission may wish toconsider whether the political and economic structureof the EU, which is composed of sovereign nationalgovernments with years of experience in administeringa corporate income tax, may explain why the MemberState tax authorities and the EU business communityreject the destination-based sales factor.

2.3. Should the formula include intangible property?

In addition to the debate over the sales factor, the EUMember States and EU businesses have not yetdetermined whether to include intangible property inthe formula. As with the sales factor, there arearguments for and against including some measureof intangible property in the formula.

Intangible property presents a particular dilemmain the apportionment mechanism. By its very nature,intangible property and intangible income are neithereasily measured nor easily located. Yet, intangibleproperty is an increasingly important element in amultinational firm's business. As the BusinessEuropetask force noted, given the high value of intangibleassets and the high level of income they generate, theCommission should undertake a `thorough impactanalysis' before deciding to exclude them from theproperty factor.

The Commission has considered whether toinclude intangible property according to the present

25 See J. Harvey Perry, `A Fiscal History of Canada ± The PostwarYears', Canadian Tax Paper (Canadian Tax Foundation, 1989),no. 85.

26 There are minor deviations from the formula and tax base. Theprovinces set their own investment tax credits and tax rates. SeeJack Mintz, `Corporate Tax Harmonization in Europe: It's AllAbout Compliance', International Tax and Public Finance 2004,vol. 11, pp. 221±234.

27 One dilemma that arises is in this area is that some analystsadvocate a destination-based sales formula with no other factorson the argument that the company cannot manipulate thelocation of consumption. Perhaps the difference arises from thedifferent legal rules concerning where a sale takes place (i.e. attitle passage, free on board, delivered at frontier, etc.). I amgrateful to Ben Miller for highlighting the importance of thisdilemma.



discounted value of income flow the propertygenerates measured, for example, by the value ofroyalties paid for its use.28 Others have suggestedmeasuring intangible property according to theexpenses incurred for developing the intangibleproperty.

Because intangible property and income are somobile, the Commission is concerned that multi-national companies could easily manipulate its loca-tion and thus violate one of the key principles of thesharing mechanism ± that it not be susceptible tomanipulation. Many US states that do not apply theùnitary' concept (which is similar to consolidation)face a situation where multi-state companies engage ina tax planning strategy that allows them to shiftintangible income to their operations located in afavourable tax location. They accomplish this incomeshifting by transferring their intangible property totheir controlled out-of-state passive investment com-pany (PIC) that is located in a tax favourable state. ThePIC then licenses the intangible property back to theoperating company, which makes tax-deductibleroyalties for the right to use the intangible property.As a result, the operating company receives a taxdeduction and the PIC pays little or no income tax onthe royalty income.

The states address this potentially abusive situationeither by considering that the presence of intangibleproperty in the state creates a taxable presence in thestate for the out-of-state company, or by treating theentire company as a unitary business. Under theunitary business principle, the state treats the holdingcompany as an integrated unitary entity with theoperating company and transactions between theoperating and the holding company are eliminatedas internal transactions. Thus, the location of incomebecomes irrelevant, in a sense.

Although many states consider that the `presence'of intangible property in a state creates a taxableconnection with that state, the international commu-nity does not generally reach this conclusion. Thatcommunity still relies on the physical presencestandard of a permanent establishment, as containedin the OECD Model Convention and the worldwidenetwork of bilateral income tax treaties, to determinewhether a non-resident entity has established asufficient connection with the state to be subject totax.29 By taxing on a consolidated basis, the Commis-sion will address the PIC issue that some states face, atleast with respect to transactions within the EuropeanUnion.

Despite the difficulties created by intangible prop-erty, the Commission has noted, however, thatexcluding intangible property from the apportionmentfactor might be very unsatisfactory for the EuropeanUnion since doing so would ignore an importantincome-generating asset for multinational companies.Yet, including intangible property introduces complexproblems concerning their value and location. AsMcLure (1997) explained in his paper prepared forthe US Treasury conference in 1996 dealing with thepossible implementation of formulary apportionmentat the international level, determining the location and

the value of intangible assets is likely to lead to anànalysis similar to that under the separate accountingstandard'.30 Therefore, it is not likely to reduce thecomplexity that is so problematic in the currentseparate entity accounting with arm's length pricingstandard.

One other point should be made. Excludingintangible property from the apportionment formuladoes not mean that intangible income is not taken intoconsideration. If the formula does not contain anintangible factor then the income generated fromthose intangibles will be distributed according to thelocation of the more easily measurable factors. Inmany ways, this outcome is the most sensible outcomeif intangible income is considered to be attributed tothe entire company, not to a particular location.

2.4. An alternate formula

As the above discussion shows, the Commissionappears to be at an impasse over whether to includesales or intangibles in the formula. To exit from thisimpasse, the Commission may wish to consider thebenefits and drawbacks of the following modifiedthree-factor formula.31

As the Commission has already suggested, it canmeet the interests of the newer EU Member States bydividing the payroll factor into two elements ± onethat is based on the number of employees and one thatis based on the amount of compensation. Each ofthese elements would be weighted by one-sixth.

Following this line of thinking, the property factorcould also be divided in half. One share could be theratio of tangible property to total property and theother share could be the ratio of intangible property tototal intangible property.

Similarly, the sales factor could be divided in half.One share could be the ratio of sales at origin to allsales at origin and the other share could be the ratio ofsales at destination to all sales at destination.

This multiple-factor formula achieves several objec-tives that the two or three-factor formulae fail toachieve. First, by incorporating six elements, no singleelement is `too' vulnerable to factor shifting. Second,by incorporating intangible property, it addresses the

28 See Ana Agundez-Garcia, `The delineation and apportionment ofan EU consolidated tax base for multi-jurisdictional corporateincome taxation: A review of issues and options,' Working PaperNo. 9, October 2006.

29 The permanent establishment Article is not identical within thetreaty network, with some countries establishing a relatively lowthreshold and other countries establishing a relatively highthreshold. These differences are especially pronounced incomparing treaties with developed and those with developingcountries.

30 See Charles E. McLure, Jr., ÙS Federal Use of FormulaApportionment to Tax Income from Intangibles,' Tax Notes, 11March 1997.

31 I put forth this formula as a suggested way to stimulatediscussion over issues that may arise when the formula includessales and intangible property, not because I recommend the EUadopt this formula. I have long advocated that the EU adopt aformula that double-weights sales and applies a one-quarterweight to property and payroll formula.



issue that intangibles now make up a significantelement of many multinationals. Third, by incorporat-ing a sales factor, it recognizes the role of demand ingenerating profits. By measuring one element on adestination basis, it recognizes that the role of a marketstate may be separate from the manufacturing state.32

Although the above formula addresses the concernsof those who believe that the apportionment formulashould include sales and intangible property, theformula also introduces significant complications overhow to value and locate intangibles and where toassign final sales that appear to have led the EUstakeholders to be cautious about including thesefactors in the apportionment formula. In consideringthe advantages of adopting a formula similar to theone suggested above, the European Commission andthe Member States may wish to consider whether thebenefits of introducing a sales and an intangible factoroutweigh their costs.

3. An application of game theory

In recent work with Jack Mintz, we explored howgame theory may help to evaluate the process bywhich the EU may reach agreement on a formula fordistributing the EU tax base.33 This article closelyfollows that analysis, but it modifies the game to focuson the choice of the apportionment formula.

The EU's negotiations over the apportionmentformula can be viewed as a game among the 27 EUMember States, which are choosing their strategies tomaximize their payoffs that would result if themembers reached an agreement.34 In determiningthe strategy and irrespective of whether playerscooperate in this process, each player takes intoconsideration the other players' set of incentives. Theprocess is simultaneous; and, the game will reachequilibrium when each government's chosen strategyrepresents the best response to every other govern-ment's strategy. Ultimately, the game will reach astable, or Nash, equilibrium. A Nash equilibriumoccurs when none of the players has an incentive tochoose another strategy given the strategies that otherplayers have chosen. An equilibrium strategy becomesstable since each participant has no incentive todeviate from its chosen strategy. If, however, a playercan improve its position after learning the position ofanother player, then the resulting outcome is not aNash equilibrium.

One important insight from game theory ± whetherplayers cooperate or not ± is that each playerunderstands the other player's point of view and takesthose views into account when designing a strategy.Another important insight is that an equilibrium maynot exist, and that multiple equilibrium outcomes mayexist.

The variety of apportionment formulae in the USstates illustrates this possibility. Although many stateshave adopted a super-weighted sales formula, otherstates have remained with the three-factor formula. Interms of game theory, the fact that not all states choosethe same formula may result, in part, from the differentindustrial make up of the state and the possibility that

optimal strategies may change.35 For example, a statewith numerous capital-intensive industries mightprefer a different formula from a state that hisnumerous high-tech industries.

In addition, a state may choose a revenue maximiz-ing strategy at one time, and an investment promotingstrategy at another time. These strategies imply adifferent formula, thus confirming that multiple out-comes are possible. In the EU context, the possibilitythat the Member States may not converge on the sameformula indicates that there may be no singleapportionment formula that each player would chooseas its optimal formula. In fact, since the amount ofrevenue that each Member State obtains from thecorporate tax changes each year suggests that therevenue-maximizing formula also changes each year.

Sheffrin and Fulcher performed such an experi-ment on the US states using a two-factor sales andpayroll formula and allowed each state to choose theformula that maximized the amount of incomeapportioned to the state. They found that over athree-year period, one-third of the states would havehad to change their formula to continue to meet itsrevenue maximizing strategy. The revenue maximizingformula also depended on the industrial compositionof the states, with states that were dominated bylabour-intensive industries preferring a different for-mula from states dominated by merchandising in-dustries. States with a well-balanced industrial mixshowed less dispersion over the formulae than stateswith a less balanced industrial mix.36

32 Richard Sansing provided the following helpful example. Oneway of comparing separate accounting with formulary apportion-ment is with the following example.

I make a widget for 7 in Poland and sell it for 11 in Germany.All of my workers and property are in Poland. Under separateaccounting, the income of 4 from this transaction depends on thetransfer price.

A 100 per cent sales factor apportionment formula isequivalent to a transfer price of 7; an apportionment formulawith 0 per cent weight on sales is equivalent to a transfer price of11; a 50±50 weighting on sales and input factors is equivalent toa transfer price of 9.

See the working paper by Sansing and Anja De Waegenaere,`Transfer pricing, formulary apportionment, and productiveefficiency', which makes this point. I am grateful to RichardSansing for providing this example.

33 See Jack Mintz and Joann M. Weiner, `Some Open NegotiationIssues Involving a Common Consolidated Corporate Tax Base inthe European Union', paper presented at the NYU University ofConnecticut Law School EC Tax Policy symposium, 14 March2008, and forthcoming in Tax Law Review.

34 This discussion follows Jack Mintz and Richard Bird, `Sharing theInternational Tax Base in a Changing World, Essays in Honourof Richard Musgrave', Public Finance and Public Policy in the NewCentury (MIT Press, 2003), pp. 405±446.

35 Some states adopt a super-weighted sales formula after aneighboring or competing state adopts that type of formula,suggesting that the situation was not a Nash equilibrium becausethe optimal strategy changed once the other state revealed itsstrategy.

36 See Steven M. Sheffrin and Jack Fulcher, `Alternative Divisions ofthe Tax Base: How Much is at Stake,' in Charles E. McLure, Jr.(ed.), The State Corporation Income Tax. Issues in WorldwideUnitary Combination (California, Stanford University, HooverInstitution Press, 1984), pp. 192±216.



The analysis assumes that it is plausible for memberstates to reach equilibrium and come to an agreementon a common apportionment formula. For govern-ments, then, the payoffs are a combination ofrevenues, economic efficiency gains and distributiveimpacts that accrue to each Member State as part of theagreement (with the tradeoffs varying across MemberStates according to their particular situation). Govern-ments have incomplete information, meaning thatwhile players in this situation are aware of the game'sparticipants, some factors of the game are not commonknowledge, e.g. the relative importance of businessactivity or income shifting to or from the state.

The negotiations over the formula may be viewed asa cooperative game where the Member States arenegotiating a binding agreement for dividing up thejoint payoffs (a binding agreement is not necessary toachieve cooperation, and cooperation may be impos-sible if there are too many players).37 Although someplayers have more information than others, as long asthe players are credible and the information has apositive effect, players generally benefit from commu-nicating with one another since they can increase theirjoint payoffs relative to the outcome they wouldachieve under a non-cooperative game.

The following features characterize a cooperativegame:

. Pareto-optimality: The joint payoff should be takenfrom a set of payoffs that achieves the highest levelof payoff for the coalition of all players in the game.Pareto-optimal payoffs are those in which no otherplayer can be made better off without making someplayer worse off.

. Coalition-stability: Some players may participate in acoalition and exclude non-cooperative players if thecoalition is in their interest. The equilibrium of acooperative game comprises outcomes that arestable within the coalition in the sense that thesubset of non-participants can block any otheroutcome.

. Individual rationality: The players must reach abinding agreement that makes each player at leastas well off as it would be in a situation where theplayers cannot reach agreement. The game must be`individually rational,' meaning that each playerdoes better than the player would achieve if it didnot cooperate.

. Side-payments: Negotiation of side-payments maylead to cooperation. Side-payments (transferableutility) expand the possible outcomes for coopera-tion (the core of a game). Without side-payments,cooperation is more difficult to achieve.

Each of the above features can be applied in thecontext of the EU Member States agreeing on acommon apportionment formula.38 For example, indiscussing potential EU apportionment formulae, ifthe Member States care solely about revenues in thesense that each Member State must collect at least asmuch revenue under the new system as it does underthe current system (a pareto optimality condition),then the Member States have suggested that theformula must maintain the current revenue alloca-

tion.39 This condition implies that even if all otherMember States are made better off under the newsystem, if one Member State is projected to collect lessrevenue under the current system, then under thepareto optimality criterion, the solution must berejected.

For the tax base to increase in all of the MemberStates, then the proposed common consolidated EUtax base must be larger than the sum of the individualtax bases. However, because the CCCTB will allowcross-border loss offsetting, the EU Member States arenot convinced that the CCCTB could be larger thanthe sum of the national tax bases.

Yet, it is entirely possible that the CCCTB will belarger than the sum of the individual Member State taxbases. A CCCTB that eliminated tax preferences and,thus, broadened the tax base could very well granteach Member State a larger piece of the pie than it hasat present. In fact, the European Union Member Statesand the European Commission appear implicitly toanticipate this outcome by presenting the new methodas improving the investment allocation across the EUand, thus, the EU's economic efficiency.

In terms of coalition stability, the availability of`enhanced cooperation' among a subset of at least one-third of the Member States illustrates one way to reacha stable coalition. There are some restrictions with thiscoalition; under the terms of the EU Treaty, thecoalition may not exclude other members fromjoining. This coalition will also need to introduceanti-abuse measures to protect its tax base againstfactor and income shifting to the non-participating EUMember States.

In terms of individual rationality, each MemberState must perceive that it benefits from the chosenformula, whether determined by tax revenue or byimproved competitiveness. If revenue is the concern,this criterion means that Luxembourg, for example,would need to collect roughly 16 per cent of its totalrevenues from the corporate income tax, whileGermany would need to collect just 3 per cent oftotal revenues.

Finally, the EU is familiar with the notion of side-payments, as it has long offered trade-offs to MemberStates to obtain their agreement on EU-wide propo-sals. The `rebate' granted to the United Kingdom andthe state aid granted to Ireland are examples of howthe Commission makes facilitating side payments toreach an agreement. With the CCCTB, however, theCommission strictly rejects the notion that it will allowMember States to make such deviations from the

37 See GeÂrard, n. 21 above.38 In commenting on the article, Marcel GeÂrard indicated that he is

not as optimistic as I am, noting that much depends on theformula and on the initial distribution of the apportionmentfactors. See GeÂrard, n. 21 above for details.

39 It will be extremely difficult, and likely impossible, to attain therevenue maximization goal, given the sharp tax rate reductions inmany Member States over time. Maximizing the tax base sharemay be a better objective than maximizing tax revenue. Evenwith this strategy, however, the `maximizing' formula is not likelyto be the same in 2010 as in 2008.



common apportionment formula (and common con-solidated tax base) merely for the purposes of reachingan agreement.

Without an agreement, the EU Member Statesengage in a non-cooperative tax policy game. In a non-cooperative game, governments take independentfiscal actions regarding the national level and mix ofpublic goods, services and taxes. In non-cooperativegames, governments are usually assumed to be firstmovers and they anticipate the reactions of the privatesector to their fiscal decisions.

The essence of the results from non-cooperativemodels is that governments will generally make non-optimal choices. In this case, they will chooseapportionment factors that lead to inefficient invest-ment allocation relative to a coordinated solution,depending upon the nature of `fiscal externalities'present.

Fiscal externalities are the effects that one govern-ment's decision has on the welfare of other govern-ments. In some cases, fiscal externalities are positive,leading the other country to benefit from the firstgovernment's choice. Such an outcome could occur ifa jurisdiction applied a relatively heavy weight onassets (property) in the apportionment formula so thatinvestment moved out of the country. On the otherhand, a fiscal externality may be negative so that thechosen formula diverts investment from the otherjurisdiction.

Within the US, the states compete with theirapportionment formulae, usually by increasing theweight on the sales factor to encourage additionalbusiness investment in the state or to attract mobilecapital to the state.40 Such ìnvestment flight' leads totax base èrosion' in the low sales factor weightcountry and to tax base èxplosion' in the high salesfactor weight country.

Table 2 below illustrates the incentives for theMember States to alter the weight on the propertyfactor in the apportionment formula. As shown below,governments have an incentive to reduce the weightson the property factor to attempt to reduce theapportionment tax rate and the effective tax rate oncapital and, thus, maximize the attractiveness of thestate for investment.41 The apportionment tax rate isthe product of the tax rate and the weight on capitalwhile the effective tax rate is the marginal tax rateunder apportionment and depends on the distributionof capital across all locations.

Suppose that the EU is considering apportioningincome solely on the basis of the location of capital(which is an option that some have proposed). Thisformula leads to an apportionment tax rate equal tothe statutory tax rate and to an effective tax rate that isa function of the distribution of capital and the localtax rate. Thus, a country, such as Belgium, with a hightax rate will have a relatively high marginal tax rate.Germany, which has both a high tax rate and a largeshare of EU capital, has the highest effective tax rate inthe European Union.

Germany, viewing this relatively high effective taxrate may consider proposing a formula that weightscapital by just one-quarter (and, to be equitable,

applies a one-quarter weight to payroll and, thus, aone-half weight to sales). Germany benefits from thisnew formula because its apportionment tax rate,which is the product of its tax rate and its share ofcapital falls. All other countries are affected as well.Due to the nature of the apportionment process, thetax rate in any jurisdiction depends on the distributionof property across all jurisdictions. Thus, as the shareof property increases in one area, it affects thedistribution of property in all other areas and,consequently, the effective tax rates in those areas.

40 Note that because the sum of the weights must be less than orequal to one, then an increase in the weight on the sales factorimplies a reduction in the weight on the other factors in theformula. In practice, the states have weighted the property andthe payroll factors identically and reduced those weights by thesame amount when they have increased the weight on the salesfactor.

41 Other payoffs are possible. Anand and Sansing, see n. 32 above,define state welfare as the sum of taxes collected, producersurplus accruing to the states inhabitants, and consumer surplusaccruing to a state's residents. This analysis does not take intoaccount the different mobility of capital across the states. Ifcapital is relatively fixed, then a state may prefer to maintain arelatively high weight on capital.

Table 2. Calculations of EU apportionment tax ratesunder different capital factor weights

Weight on capital = 1 Weight on capital = 1¤4

EU Apportion- Effective Apportion- EffectiveMember ment tax tax rate ment tax tax rateState rate rate

(1) (2) (3) (4)

Austria 34% 2.60% 8.5% 0.65%Belgium 34 6.80 8.5 1.70Czech Rep. 28 ±3.83 7.0 ±0.95Denmark 30 ±1.69 7.5 ±0.42Estonia 26 ±6.15 6.5 ±1.53Finland 29 ±2.86 7.25 ±0.71France 35 6.75 8.75 1.68Germany 38 9.28 9.5 2.32Greece 35 3.00 8.75 0.75Hungary 16 ±15.97 4.0 ±3.99Ireland 12.5 ±29.69 3.13 ±7.42Italy 33 2.32 8.25 0.58Latvia 15 ±17.16 3.75 ±4.29Lithuania 15 ±17.16 3.75 ±4.29Netherlands 30 10.07 8.63 2.51Poland 19 ±12.92 4.75 ±3.23Portugal 27.5 ±4.19 6.88 ±1.04Slovakia 19 ±13.13 4.75 ±3.28Slovenia 25 ±7.13 6.25 ±1.78Spain 35 4.78 8.75 1.19Sweden 28 ±3.45 7.0 ±0.86UK 30 2.09 7.5 0.52Average 27 ±3.98 6.80 ±1.00

Note: The tax rates are calculated according to thedistribution of foreign direct investment across the memberstates. FDI data are not available for Cyprus, Luxembourg,and Malta so the table does not include these countries.For details, see Table 13 in Joann Martens-Weiner, CompanyTax Reform in the European Union (New York, Springer, 2006).



A one-quarter weight on capital, however, may notbe an equilibrium weight for the capital factor in theEU because each player has an incentive to reducefurther the weight on capital to attempt to make itsstate relatively more attractive to investment. For thisreason, many analysts of US state apportionmentstrategies suggest that a zero weight on capital (or a100 per cent weight on sales) is the inevitableoutcome if states may freely vary their apportionmentformulae.

Some outcomes may be stable for a subset ofcountries, depending on the relative mobility ofcapital. Several studies on the effects of changes inthe US formulae show possible outcomes. Forexample, Anand and Sansing (2000) show that stateswill choose a formula that represents the relativemobility of the factors in their state so that statesdominated by immobile natural resources may preferto maintain a relatively high weight on capital.42 Thus,states that have relatively fixed factors, such as naturalresources, will remain with the Massachusetts formulawhile those with relatively mobile factors will movetoward a sales-based formula. Edmiston enhanced thiswork by showing how a state `strategically reacts' to apolicy change in a neighbouring state. Thus, if aneighbouring state increases the weight on thedestination-based sales factor then that state maybelieve that it must also move to such a formula toremain an attractive location for business investment.Since the destination-based sales factor tends toreduce the tax burden on in-state business activity atthe expense of out-of-state sales, many states view thissuper-weighted sales formula as an effective develop-ment too, although the empirical evidence on thesuccessfulness of this strategy is inconclusive.43

Omer and Shelley find that sub-national competi-tion for mobile business capital, employment and salesleads state government to engage in an apportionmentcompetition with other states.44 Weiner found astatistically insignificant impact on business invest-ment in states that reduced the weight on the propertyfactor.45

In terms of game theory, state actions show thatmany of them attempt to move to a formula that theyperceive to be in their best interest. However, althoughan individual state might improve its position bymoving to a particular formula, once other states adoptthat formula, the first-moving state loses its advantage.In the end, all states would have been better off if nostate had attempted to gain a strategic advantage. Inparticular, the US states would be better off under anycommon formula than with differing formulae. Thefact that the Canadian system has generated suchminimal controversy by comparison with the statesseems to confirm this point.46

This outcome illustrates a case of a `prisoner'sdilemma' where each player in pursuing its own self-interest makes everyone worse off than if they had notpursued their own self-interests. Avoiding this out-come requires that the players enter into a bindingcommitment. The European Commission can assistthe Member States reach this binding agreementthrough making side payments that guide the

members toward a cooperative agreement that maynot be possible without the side payments.

Maintaining a cooperative agreement may bedifficult, however, given the demonstrated desire forfiscal sovereignty in the Member States. The EUMember States wield considerably more independentpower than their counterparts in the US states andCanadian provinces.

To give an example of a difficulty that the EUCommission may face in maintaining a bindingcommitment, consider a situation in North Carolina.47

To encourage a company to expand its manufacturingin the state, the North Carolina Tax Review Boardallowed the company to reduce the weights on itsproperty and payroll factors during the `start-up phase'of its new production facility and to then reduce theweight on the property factor for subsequent years.

Suppose that an EU Member State approached theEU Commission and requested such an àlternative'formula. Would the Commission have the ability todeny the request? What if the Member State inquestion was suffering an isolated economic shockand appeared to deserve special treatment? By whatcriteria would the Commission determine that thespecial treatment was no longer necessary?

The European Commission has also suggested thatEU multinational companies should have the right torequest an alternate apportionment formula in caseswhere the statutory apportionment formula does notfairly represent income earned in a Member States.This èscape clause' could prove to be very problematicfor the Commission's attempts to create a uniformapportionment formula, as requests to use alternativeapportionment methods may overwhelm MemberState tax authorities.

By one estimate from North Carolina, which hasrecently modified its procedures, the state received upto 30 requests each year to use an alternateapportionment formula. Although the notion ofproviding an escape clause is attractive, as it will allowthe tax authorities to provide relief in cases where thestatutory formula leads to a result that is all out ofproportion to the business activity conducted in the

42 See Bharat, Anand and Richard Sansing, `The weighting game:formula apportionment as an instrument of public policy',National Tax Journal 2000, vol. 53, no. 2, pp. 183±99.

43 See Kelly Edmiston, `Strategic Apportionment of the StateCorporate Income Tax', National Tax Journal 2002, vol. 55, no.2, pp. 239±262.

44 See Thomas Omer and Marjorie K. Shelley, `Competitive,Political, and Economic Factors Influencing State Tax PolicyChanges', Journal of the American Taxation Association 2004, vol.26, Supplement.

45 See chapter 4 in Joann Martens Weiner, n. 6 above.46 The fact that there are two studies of the Canadian system, one in

1994 by Joann Martens Weiner (see n. 6 above) and one by JackMintz and Michael Smart, Ìncome shifting, investment, and taxcompetition: Theory ad evidence from provincial taxation inCanada', Journal of Public Economics 2004, vol. 88 suggests thatthe common formula has minimized the deviations in policy thatare necessary to conduct fruitful empirical research.

47 See Philip Morris USA Inc., v E. Norris Tolson, Secty of Rev. ofthe State of North Carolina, North Carolina Court of Appeals, 7March 2006, No. CA05-340.



state. However, it may also lead to less defensibleactions in the Member States who may wish to usedeviations from the EU apportionment formula to lureinvestment from other Member States. The EU'sbusiness code of conduct could be modified toprevent such actions, but it may encounter politicalobstacles along the way.

4. Concluding remarks

In many ways, by reaching broad agreement on aCCCTB with formulary apportionment, the EuropeanCommission has already overcome the greatestobstacles to achieving company tax reform in the EUand primarily `technical' issues remain to be solved.Yet, if the European Commission fails at devising aformula that will distribute income in a manner that allEU Member States can accept, it will fail to reach thegoal of introducing its system.

The analysis here has asserted that the EU canapply the principles of game theory to determinewhere the equilibrium among the Member States lies.It is too early to determine whether that formula willinclude sales and intangible property or not. How-ever, the analysis here suggests that the EU Commis-sion would profit from taking into consideration thestrategies of certain influential Member States todetermine a formula that would maximize theirindividual payoffs and then attempt to devise asystem that may include side-payments that will leadthe Member States to reach a cooperative outcome.Given the EU Commission's role as taking the EUinterests as a whole into account, it is in the bestposition to guide the Member States away from a non-cooperative outcome and towards a stable equili-brium.



�� # � �� -��# �� 1 - 0#8 ! ��#8 �� #��1# � ��# 1 �� +�� /��/��

�� -��# �,� �� #��+ ��# � � � 1 �� + ��#5

��#� -� �#� �� -#�� 1 � �1 �,�� - 0#8 ! ��#8 � #��1# ��/�� / �� /�#5 ��0��/ ,

��

�� # @ �� +��@ � �� -��/�� #�C ,��@ ��.�,��8 � � �� # ��/0�� 1�/�� @�

,�� .�� 1�/�� @ �/��#5

� �/��#� 1 �� /� �@��# � �� ! ��#

� ��+��@ �� ,��+� ��# � 0�� @ � �1 �,�� - �� # �� /�#

� � ,��+� 1 � �.��@ ��-��/��

� �,�� .�� #� $ ��/#

� #�++�#�� # 1 � �� #

� �1 �,��.� �� +��@ �� #�� # 9�- �� *#8 C ��/� *#<

�� 0�� / ,8 @ � �� 1�� ! ��# �� "�� 1�� -� �#� � �#�� .�� #�,�� / �@ 1 � � ! �� 1 @ �� #��

� �� A &��/� �� -�� 0�+ �� "��/� �� #��## �� C ,,��/�� C ,��@=C �� C ,��

� '.�� ,�� '�� C ,,��@ �� /�� @� �� $�� - �� D��,� �� $��

��

" � .�� /��8 �� 1�##� ��# � '�� #�� .� �� 1 � ��4� 4�� / .��+� 1 ��.�� ,��# � 'C �� /��/�� -��# �� 7��@8 �� .��# �� /�� #8 / #��#8 �// ��#8 �/��,�/#8 -�#��## 1��/��/� �#8 �� -�/ 11�/��# �� / ,�� #�.� �1 �,�� - �� '�� $ �� # �@ �.��-�� #�-#/��-��#�

�� 11��# � � 1 �� + 1��#5

� &�� ##��# � @�� /��#�.��@ ��/�� '�� C ,,��@ 9'*< ��.�� ,��#8 � � ��, �E�� 1 �� '*8 �� ,��,�� # 1 'C �� # �� +�#��

� )�� / .��+� 1 ��/� ��8 ��/� ��8 �� # /�� #�/��@ 1� , � � ��+�� # �� / ,�/ �+��

� � #��/��.� ��,�4#�.�+ ��1��/� # ��/� 1 /�#�# 1 � � '�� C �� 1 F�#��/� ��.�� 'C �� /�#�#

� *-��#�� / .��+� 1 ,�! � ��.�� ,��#� � .��-�� 1��/� # ��/� 1 � ��4�� .�� # '* / ��#� � - �� 1 �� # 1 �+ #��+ � �#�� / #�#��/@ �� 7��@� '�� / ��#� ��# 1� , � � .�� # ��.�� '* / ��# �� 1� , ��

'* � ��##��#G �� C ,�� #�.� #�/�� # / ,��#�+ '�� 8 ��/��#8 � 0 ��.��#8 C�#� ��8

��+�#�� 8 �� /�� -��/�� #�

$ � 7��@8 ��,��##8 �� .��#��@ 1 ��# ��/��# ,�0� 'C $�� .�� + ��1 �,��.� �1 �,�� # ��/� '��

'�� 4�4C ��15 ��F� ��0�-��

'�� #5 "� :��#�� 9C ��,�<G �� '�� G �� C ��G ��2�D� &��.�#G ��D�.� �� 0G ��F� ��H ��G C� 2��-�� G D� ��!�� '�C�C�D� ��,,��

�## /�� '�� #5 C ��#� ��#5 ��#��5 D� F�G ��+��,5 C� ) //� A "� :��#��G"��5 F� F��#��G "��/�5 )� �� A �� )��G 2��,�@5 2� &/ �� A D� ��,,G2��/�5 C� "� 0�� #G ��5 D� ��# G ��@5 �� "�� EE�8 D� D�+��8 "� %�� A D�� ,-��G ��,- ��+5 �� '�.�+�� A F�� @G $ � %�� #5 )�D� ��-��G� ��+��5 D� ��#8 �� ) �� A &� :�#7��#G &��5 "�� 2��/IJ � ��#G &��5 F��!�.-��+G *�5 �� '�� A )� ��.��G C ,,�##� 5 )� �� A )� &/ ��G C �� 1F�#��/�5 C� ) //� �

�� !��

ec tax rev formula one

Documents