Ethical and Legal Responsibility of Multinational Corporate Groups for a Fair Share of Taxes

When tax systems do not oblige multinational corporate groups to pay their fair share of taxes although the groups are responsible for doing so from an ethical perspective, tax systems lead to and even intensify inequality. To answer the question whether there are reasons to deem multinational corporate groups responsible, the present paper differentiates between ethical responsibility and legal responsibility to pay a fair share of taxes. Ethical responsibility refers to ethical concepts such as a utilitarian approach, a framework according to John Rawls, contractual rights concepts (Payne and Raiborn 2018; Gribnau and Jallai 2017), or the ethical and theoretical discussion that understands firms as moral actors (French 1979, 1984, 2017; Pettit 2007, 2017; Bratman 2017) or real entities (Phillips 1994; Robé 2011; Sikka and Stittle 2019). In general, ethical responsibility implies doing what is right and fair (Carroll 1979, 1991). Legal responsibility is the responsibility to obey the law, which is justified by various reasons, e.g., by the idea that membership in a community obligates one to follow the community's rules (Dagger and Lefkowitz 2014). Since legal responsibility originates in the fact that legislation results from democratic processes, legal responsibility is independent of whether it is founded on ethical concepts or on theories. If the law refers to the idea that the “group is not a tax subject”, there is no legal responsibility although there may be reasons for an ethical responsibility.

However, ideally, there is a broad overlap between legal responsibility and ethical responsibility because the law should be based on what a society considers is right and fair. Thus, the taxation of multinational corporate groups should ideally be founded on ethical and theoretical concepts (Paine 1994). Yet, since there are different answers to the question what is right and fair, the legal and the ethical responsibility may differ—see, e.g., Gribnau and Jallai (2017), who differentiate between mere compliance with the letter of the law and an ethical responsibility that may go beyond this. There may be a legal responsibility without an ethical responsibility and vice versa. Depending on how much the ethical and legal responsibilities differ, the circles may (not at all, partially, or completely) overlap. Figure 1 illustrates this connection.

Figure 1

As we mentioned in our introduction, we doubt that the “group is not a tax subject” idea of the current law is ethically founded. In consequence, we assume that there is an ethical responsibility of multinational corporate groups although a legal responsibility is missing. This gives reasons to rethink the current tax law.

To substantiate ethical responsibility for a fair share of taxes, it is necessary to substantiate what is right and fair in the context of taxing multinational corporate groups. Since values are abstract, this requires ethical concepts, e.g., the contractual rights concept, according to which companies implicitly close a contract with society to pay their fair share of taxes (Payne and Raiborn 2018). This view is supported by concepts of moral actors (French 1979, 1984, 2017; Pettit 2007, 2017; Bratman 2014, 2017) and the interpretation that firms are real entities (Phillips 1994; Robé 2011; Sikka and Stittle 2019; Gindis 2009).

A main argument for the Business Ethics view of companies as moral actors is that, according to French, companies (which may mean separate companies as well as multinational corporate groups) have a corporate internal decision structure (French 1979, 1984). This structure serves as the basis of corporate intentionality and generally consists of an organizational flowchart, procedural rules, and policies. Corporate internal decision structures transform the acts and intentions of human beings into corporate decisions. Therefore, companies are moral actors and as such can be held responsible. Importantly, this does not mean that the individuals behind them cannot be held responsible as well and vice versa: if an individual behind a company is held responsible, the company can also be held responsible. Thus, if there are reasons to blame both, the company and the individual behind it, both can be held responsible. Additionally, French (2017) elaborates a concept of corporate moral responsibility over time. For this, he distinguishes between synchronic and diachronic responsibility. Synchronic responsibility refers to responsibility at the time of an event whereas diachronic responsibility concerns the responsibility for an act at a later time (and that may differ from the synchronic responsibility). Pettit (2007, 2017) also uses elements of French's corporate internal decision structure for his argumentation of companies as moral actors. According to Pettit, conversable agents are to be held responsible for their actions. These agents are characterized by three criteria: an agent maintains certain purposes, forms reliable representations of their environment, and acts to satisfy their purposes. Conversable means understanding the meaning of words, speaking as subjects with whom others can interact, and forming normative judgments based on internal structures. Companies as moral actors may have a voice of their own that is not just the aggregate of the individual voices. Pettit demonstrates that, due to inconsistencies that arise, group decisions are not the logical inferences of the corresponding decisions of the majority of individuals behind them (Pettit 2007, 2017; more generally on this discursive dilemma, see Pettit 2001). By finding compromises, the group members construct the voice and mind of the group itself, in this case of the company as moral actor, which is autonomous from the individuals. Pettit concludes that as companies (which may mean separate companies as well as multinational corporate groups) can be conversable agents, they can be held responsible for their actions. Similar to French, Pettit argues that companies and individuals behind them can be held responsible simultaneously. Also, according to Bratman (2014, 2017), we have reasons to argue that companies (which may mean separate companies as well as multinational corporate groups) are moral actors and, therefore, can be held responsible. He argues that there are group intentions that are not shared intentions and therefore lead to the responsibility of companies. Shared intentions are intentions that are shared among group members. Groups, or companies, may have implemented policies or procedures, especially decision-making procedures (e.g., decision-making based on majority votes). These procedures form a company's self-governance (broadly consistent with French's corporate internal decision structure). This can lead to procedure-based company intentions that can differ from shared intentions and therefore can lead to responsibility of companies.

Other approaches in favor of the responsibility of companies are the real entity approaches discussed in Legal Philosophy. According to these, companies are distinct corporate entities (Phillips 1994). Although there are many different real entity approaches, what they have in common is that they see corporations as “being with characteristics not present in their human members” (Phillips 1994). Therefore, companies can have moral obligations comparable to human beings and can generally be held responsible (Phillips 1994). In contrast to the firms as legal fictions-view, the Business Ethics and Legal Philosophy approaches presented above all argue in favor of the idea of holding companies responsible.

Yet, these critical approaches to the firms as legal fictions-view have not refuted it until now. We believe that this results from the fact that critical approaches do contradict economic mainstream theory with respect to the understanding of firms but do not do so from an alternative market theory perspective. For that reason, we refer to the political-cultural market theory as an alternative market theory. Since that market theory uses a microfoundation, it deals less with the question of what firms are, but rather with the question of how firms act. The ability to act in a social science sense, which may differ from the ability to act in a legal sense, is a strong argument for actor responsibility (Pettit 2017; French 2017). In consequence, if we come to the result that multinational corporate groups are able to act from a social science perspective, this is also a strong argument for holding them (and not only the shareholders) responsible for paying their fair share of taxes and for blaming them (and not only the shareholders) when they do not pay their fair share of taxes.

Explaining the behavior of multinational corporate groups from a social science perspective is rather complex when we choose a microfoundation. Following this methodological decision, we explain macro-phenomena by analyzing individual behavior because macro-phenomena result from the behavior of individual actors (Opp 2011). Firms or multinational corporate groups, thus, do not behave in a literal sense; only individuals do. In consequence, “firm behavior” or “multinational corporate group behavior” are the outcome of individual behavior. Thus, the question arises whether it is reasonable to even speak of “firm behavior” or “multinational corporate group behavior.” Some argue that there are differences in kind between the individual behavior of people in markets and the behavior of people in organizations. The reasons are that rules and further social mechanisms in companies coordinate the choices and behavior of individuals. In consequence, companies should be seen as corporate actors (Vanberg 1992).

Since this argumentation remains vague, the present paper argues that whether we have reasons to attribute an individual behavior to companies and especially to multinational corporate groups, depends on the underlying market theory. If, accordingly the “firm behavior” or “multinational corporate group behavior” is identical to the shareholders’ behavior, we do not have reasons to attribute an individual behavior to the firm or the group. In contrast, if the market theory argues that the “firm behavior” or “multinational corporate group behavior” usually differs from the behavior of the shareholders, there are reasons to speak of an individual behavior of the firm or multinational corporate group (Schmiel 2019, 2020). Yet, in the case of multinational corporate groups, we must be more precise. Although there are different group definitions, one group characteristic is that groups usually consist of at minimum one subsidiary controlled by a parent company (Endres and Spengel 2015). A typical form of control is that the parent company directly or indirectly holds the majority of voting rights of the subsidiaries. Figure 2 describes a simple group structure.

Figure 2

In the case of groups, it is thus not sufficient to ask whether the behavior of the group represents the behavior of the shareholders of the parent company. Rather, the question is whether the behavior of the group also represents the behavior of those shareholders of the subsidiary who are individuals. In the case of the simple group structure in Figure 2, this implies looking at the shareholders behind both the subsidiary and the parent company.

Thus, we do not have reasons to ascribe individual behavior to the group from a market theory perspective when the multinational corporate group behavior represents the behavior of the individual shareholders behind the subsidiaries and the parent company. Yet, we do have reasons to speak of an individual multinational corporate group behavior from a market theory perspective when the multinational corporate group behavior generally differs from the behavior of the individual shareholders behind the subsidiaries and the parent company. Figure 3 summarizes this.

Figure 3

To analyze the connection between the behavior of the individual shareholders and the behavior of the multinational corporate group, we apply Coleman's micro-macro explanation (Coleman 1994; Opp 1992, 2011). On the macro-level, we can observe a correlation between taxation and the behavior of multinational corporate groups. Taxation is a variable of the macro-level and is linked to the micro-level. Since taxation influences relevant issues on the micro-level, it also influences individual behavior. Individual behavior leads to group behavior. Figure 4 summarizes these results.

Figure 4

Obviously, the relevant question is how taxes influence issues that influence individuals. This requires knowledge of how individuals behave and how individual behavior is aggregated to the behavior on the macro-level. Therefore, answering the question whether there are reasons to deem multinational corporate groups ethically responsible needs a market theory to explain how individuals behave in markets and in firms.

The mainstream market theory argues that individuals maximize or, because of their bounded rationality, at least try to maximize their utility, which is often interpreted as financial utility in terms of their net present value (Mas-Colell, Whinston, and Green 1995; Furubotn and Richter 2005). This also holds true for shareholders which expect to maximize their shareholder value (Furubotn and Richter 2005). Certainly, shareholders of large corporations or groups usually do not decide for or manage the corporation or the group. The shareholders (principals) authorize an executive board (agents) to manage the company, and mainstream market theory argues that managers behave in the interests of the shareholders. The market mechanism guarantees this correspondence between the shareholders’ interests and the managers’ behavior. This reasoning varies depending on the assumed grade of market perfection. Thus, the reasoning from a theory that assumes perfectly competitive markets differs from the reasoning of new institutional economics. In perfectly competitive markets, all actors are perfectly rational. Thus, managers do not have the possibility to behave opportunistically (Mas-Colell, Whinston, and Green 1995). Rather, managers must behave in the interest of shareholders. If they do not, they will have to suffer negative consequences. Managers who do not maximize the shareholder value risk their jobs. The reason is that in perfectly competitive markets, a shareholder value that is lower than the “real shareholder value” provides incentives to buy these shares and to replace the managers (Furubotn and Richter 2005). Furthermore, in perfectly competitive markets, there is no problem finding ways to maximize shareholder value. There are, e.g., no misinterpretations or misunderstandings by employees or other actors who have to implement the managerial decisions (Cyert and March 2003). Additionally, because of perfect rationality, there are no agency problems when employees or other actors implement the decisions (Furubotn and Richter 2005).

According to new institutional economics, the common goal of markets is to reach a higher level of individual utility (Furubotn and Richter 2005). Not only perfectly competitive markets but also markets under bounded rationality force managers to behave in the shareholders’ interests. The reason is that the new institutional economics assumes actors have alternative options. Because of this, shareholders are symmetrically powerful. Since actors do not differ regarding their power, they do not have power to influence the behavior of other actors. Rather, each share reflects the same power and managers follow majority interests. Shareholders who do not agree with managers’ behavior and who have a better alternative will opt out. Thus, the fact that shareholders hold their shares shows that managers behave in their interest or at least that remaining a shareholder of that firm is the best option. Although there is bounded rationality, misinterpretations do not occur. Agency problems matter but there are suitable mechanisms to reduce them (Furubotn and Richter 2005).

According to these hypotheses, mainstream market theory explains the behavior of groups regarding taxation as follows: taxation influences the individual utility of the shareholders. Since managers behave in the interest of the shareholders, they (try to) maximize the shareholder value after taxation (Timonen 2008). As there are no problems of misunderstanding or misinterpretation by employees and other actors who realize managers’ decisions, the group behavior is the summation of managerial behavior, which, in turn, reflects the interests of shareholders. Figure 5 shows this influence of taxation on managers’ and groups’ behavior.

Figure 5

Since the group behavior represents the individual behavior of the shareholders, multinational groups are not able to behave from the perspective of these market theories. Moreover, since there is no reason to speak of individual group behavior and because of the relation between ethical responsibility and the ability to act from a social science perspective, there is no reason to deem multinational corporate groups responsible for paying their fair share of taxes. When multinational corporate groups do not pay their fair share of taxes, this does not lead to inequality. At most, there is an ethical responsibility on the part of the individual shareholders.

Yet, mainstream market theory has at least two flaws (Schmiel 2019). First, it is based on unrealistic assumptions that are not empirically confirmed, such as that of perfectly rational behavior. In fact, actors are faced with a large number of possible options and cannot assign objective probabilities to possible states of nature (Witt 2009). Second, neoclassical theory cannot endogenously explain many of the events we are confronted with in reality, such as innovations and learning of individuals, bankruptcy, the use of money, or the existence of institutions such as firms or multinational corporate groups (Shubik 2007). Thus, with respect to tax avoidance, neoclassical theory cannot adequately explain why some multinational corporate groups avoid taxes and others do not (Hanlon and Heitzman 2010). New institutional economics tries to mend this with so-called hybrid models, which combine contradictory assumptions, such as the idea that decision makers are perfectly informed about some matters but ignorant of others (Furubotn and Richter 2005). Since the logical value of the conjunction of two premises that contradict each other is “false”, any statement can be inferred from falsity (Albert 1985; Schmiel and Sander 2021).

According to the political-cultural market theory (Fligstein 2001; Fligstein and McAdam 2012; Schmiel and Sander 2021), actors try to secure their economic survival. They cannot maximize or minimize; perfectly rational behavior is not possible. Actors can only behave subjectively rationally or reasonably. To do so, they follow the culture of the field (Fligstein 2001).

The political-cultural market theory interprets markets as social and political arenas that enable structured exchange. That implies power and political behavior of market actors being relevant characteristics of markets. Market actors differ regarding their power. There are powerful actors who can influence the behavior of other actors and the rules of the field and there are less powerful actors who cannot do so. Powerful actors try to maintain, and less powerful actors try to develop a system of domination. To do so, they follow a certain market culture that helps actors justify their behavior as reasonable through its interpretative frameworks for actors and its definition of social relationships. The market culture reflects the interests of powerful actors. Managers behave according to the market culture of actors they perceive as powerful (Fligstein 2001). When the relevant market culture entails an interpretative framework that recommends reducing taxation by tax avoidance strategies, managers behave accordingly. In contrast, when the relevant market culture argues for paying a fair share of taxes, managers follow this recommendation. Whether managers’ behavior is in the interest of certain shareholders depends on the shareholders’ power. In contrast to mainstream market theory, we can expect that managers follow the culture of the field, and this may be in line with the shareholders’ interests, but it is also possible that it differs from them. Thus, the managerial decisions on the micro-level reflect the interests of powerful actors but not automatically the majority of shareholder interests. Rather, there may be a small number of powerful shareholders, a single shareholder, or even an external actor who enforces their interests against a majority of shareholders with less power (Pfeffer and Salancik 2003; Bourdieu 2005; Fligstein 1996, 2001; Nienhüser 2008; Davis and Cobb 2010). This also holds true for the parent company. Although the parent company usually holds, directly or indirectly, the majority of voting rights, the political-cultural market theory argues that this does not imply that it has the power to realize its interests. It is certainly possible, but there is no mechanism that guarantees the correspondence between individual shareholder behavior and multinational corporate group behavior.

Furthermore, employees or other actors interpret managerial decisions, and we can expect that there are different interpretations. It is not clear how to realize decisions and how to choose the means to realizing them (Cyert and March 2003). Thus, the behavior that we ascribe to corporate actors on a macro-level is the result of managerial behavior on the micro-level (Coleman 1994; Opp 1992, 2011). In contrast to the economic mainstream approach, the behavior on the macro-level is usually not the analytical aggregation (summation) of the shareholders’ behaviors. Instead, the relation between individuals is relevant also from the micro-level to the macro-level, and social structures and social conditions influence individual behavior (Gräbner and Kapeller 2018).

Finally, in contrast to mainstream economics, from the perspective of the political-cultural market theory (Fligstein 2001) there are no reasons to assume that actors have perfect alternative options. Beyond perfectly competitive markets, we cannot expect that shareholders will always have an adequate alternative unless all alternatives, e.g., giving shares away, will be accepted as adequate. Thus, remaining a shareholder does not prove that managers behave in the shareholders’ interests.

While economists often assume that not only perfect markets but also markets in general are able to force managers to behave in the shareholders’ interests (Furubotn and Richter 2005), the political-cultural market theory denies this. Thus, managerial decisions may be in the interest of the majority of the shareholders, but there is no mechanism that guarantees that. Figure 6 describes these connections.

Figure 6

Since according to the political-cultural market theory, there is no mechanism that guarantees the correspondence of the group behavior on the macro-level with the shareholders’ interests on the micro-level, we do have reason to doubt the legal fiction interpretation and to attribute individual behavior to multinational corporate groups. Because of this, there is also a good reason to attribute individual ethical responsibility to the group. Thus, it is reasonable to deem not only the shareholders but also the multinational corporate group ethically responsible for paying a fair share of taxes. It is, however, certainly difficult to define in detail the fair share of taxes of the multinational corporate group. Although we have not dealt with the question what a fair share of taxes is and in particular, how much taxes multinational corporate groups should pay to fulfill their ethical obligations, we do have reasons to argue that tax avoidance is in conflict with ethical responsibility and leads to inequality.

Unlike the assumptions of the mainstream market theory, the assumptions of the political-cultural market theory do not contradict reality. Furthermore, empirical studies that deal with the determinants of firm behavior in the United States in the 1970s or the influences on mergers in the United States in the 1980s show that the political-cultural market theory is able to explain different real-life issues (Fligstein 2001; Fligstein and Mc Adam 2012).

The present paper finds that, while the mainstream market theory contradicts these ethical concepts, such as a utilitarian approach, a framework according to John Rawls, or contractual rights concepts, and also the perspective that companies should be seen as moral actors or real entities, the political-cultural market theory provides an alternative view that is in line with them. From the perspective of the political-cultural market theory, there are reasons to deem multinational corporate groups ethically responsible for paying their fair share of taxes. Thus, this theoretical approach supports the ethical perspective (Payne and Raiborn 2018) that companies should generally be held responsible for paying their fair share of taxes.

The present paper provides a theoretical foundation from a market theory perspective for ethical responsibility and thus a necessary though insufficient first step to transforming society. A further important step in this direction is to introduce or at least to approximate a legal responsibility of multinational corporate groups. Section 2.1 shows the possible relation between ethical and legal responsibilities. According to Figure 1, there may be an overlap between them, or they may differ, so that we have an ethical responsibility without a legal responsibility (left circle) or a legal responsibility without an ethical responsibility (right circle). Since we argue that a market theory perspective also gives reasons to deem multinational corporate groups ethically responsible, it makes sense to deal in detail with the missing legal responsibility of multinational corporate groups that the current law expresses in its idea that the “group is not a tax subject”.

Usually, legal responsibility relates to the ability to be a legal actor, and that implies the ability to act in a legal sense, e.g., to close a contract (Stout 2017). Certainly, there are differences in legal systems regarding the extent of ability to act but that is not important for the following analysis. According to national corporate law, the separate companies, not the multinational corporate groups, are legal actors (Petrin and Choudhury 2018). Although corporate law does not treat multinational corporate groups as legal actors, it is at least aware of them. However, it does not assign legal obligations to the multinational corporate group but merely to the parent companies if at all. According to certain national corporate law systems, parent companies are, e.g., liable for the debts of their subsidiaries if certain conditions are fulfilled. In Germany and in other legal systems as well, the parent company is liable if there is an agreement between the parent company and their subsidiary about profit and loss absorption (Petrin and Choudhury 2018; Belenzon, Lee, and Patacconi 2018).

Furthermore, accounting law is also aware of multinational corporate groups and considers them. Many national accounting law systems differentiate between individual and consolidated financial statements (Ratliff 2003; IFRS Foundation 2020), but they deem the parent company and not the multinational corporate group responsible for providing the consolidated financial statement.

Finally, according to current tax law, multinational corporate groups are usually not subject to tax, but the separate group members are. National tax orders sometimes entail specific group taxation, particularly the consolidation of the group's income, but usually apply these rules only to national groups. National tax orders tax the separate entities, and international tax treaties also merely apply to the separate group members. The prevailing principle regarding the taxation of multinational corporate groups is the arm's length principle. It is laid down in national legislation as well as in international taxation, e.g., in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD 2017a) and usually in article 9 of double tax treaties. According to the arm's length principle, prices between associated enterprises should be determined as prices between independent entities. The OECD Guidelines point out that the arm's length principle treats the group members “as operating as separate entities rather than as inseparable parts of a single unified business” (OECD 2017a) and therefore generally does not see groups as tax subjects. Similar to corporate law and accounting law, tax orders are also aware of multinational corporate groups (PWC 2020). According to the so-called country-by-country reporting rules that have been implemented worldwide in more than 80 countries (KPMG 2020), companies have to inform the respective responsible authorities about groups’ profits, taxes, and economic activity (OECD 2015b). Nevertheless, as with corporate law and accounting law, this obligation does not apply to the group but usually to the parent company. Thus, to summarize, multinational groups are not legally responsible according to corporate law, accounting law, or current tax law. If anything, the parent company is responsible in this way. In consequence, there is an ethical responsibility but not a legal responsibility for multinational corporate groups. Describing the relation of (tax) legal responsibility and ethical responsibility in the light of Figure 1 means that we are in the left circle.

Since legislation should be founded on ethical or theoretical concepts, the ethical responsibility questions the prevailing taxation of multinational corporate groups. In the light of Albert's comparative institutional approach (Albert 1985), we should analyze taxation alternatives in comparison to the prevalent taxation. In consequence, we examine whether alternative forms of taxation take the ethical responsibility more into account than the prevalent taxation, whether they are, in fact, able to reduce tax avoidance, and whether they are realizable.

As mentioned in section 4.1, jurisdictions usually reject the idea that groups are actors from a legal perspective. Parent companies or the group members alone, not the multinational groups themselves, are legally responsible according to corporate law, accounting law, or tax law. Thus, the prevailing tax law is characterized by the idea that the “group is not a tax subject”.

From the perspective of multinational corporate groups’ ethical responsibility, this idea of the predominant arm's length principle that treats group members like independent separate entities is not reasonable. Furthermore, the application of the arm's length principle is complex (Couzin 2013). Additionally, it has facilitated tax avoidance (Heckemeyer and Overesch 2017; Liu, Schmidt-Eisenlohr, and Guo 2020). This is particularly the case in intercompany transactions without easily identifiable comparable transactions between independent companies. It is no wonder that the arm's length principle reaches its limits, particularly when it has to deal with intangible goods. The only advantage of the arm's length idea is that it is easy to manage between the relevant countries and that it is well-established and therefore obviously realizable.

If this predominant idea that the “group is not a tax subject” is one extreme, the opposite extreme would be to treat the group as an ethical and legal actor and consequently, as a tax subject. Treating the group as tax subject first implies full profit consolidation; second, a loss offset; and third, intercompany transaction elimination. From the perspective of the political-cultural market theory, treating groups as tax subjects is in line with ethical responsibility and, therefore, reasonable. Yet, it is by no means self-evident that treating groups as tax subjects reduces the extent of tax avoidance. Finally, treating groups as taxpayers requires considerable coordination and commitment of the concerned jurisdictions since it is necessary to agree on one obligatory solution and, especially, on one way of determining the allocable profit of multinational corporate groups since accounting rules may differ (Schreiber et al. 2020; Murphy and Sikka 2017; Murphy, Jansky, and Shah 2019). Therefore, the realizability of the “treating the group as tax subject” idea is at least doubtful (Schreiber et al. 2020; Bird 2018).

However, there are not only these two extremes of not seeing the group as tax subject or treating the group as tax subject, but also alternatives in between that should be considered. In the following, we will thus examine whether the currently much discussed (Eden and Treidler 2019a, 2019b; Samari 2019; Schreiber et al. 2020; OECD 2019a, 2019b

In a first round of public consultation, the OECD received more than 300 public comments (OECD 2019b).

Figure 7

As presented in Figure 7, Pillar One consists of three components, Amount A, Amount B, and the Tax Certainty element (OECD 2020a). Amount B shall provide a fixed return for “certain baseline marketing and distribution functions” (OECD 2020a, 11), consistent with the arm's length principle, while the last element shall increase tax certainty and cover dispute prevention and resolution for and beyond Amount A. We focus on Amount A, which is the groundbreaking innovation as it abandons the arm's length principle for certain activities, thereby at least partially recognizing the multinational corporate group, and which introduces a new tax nexus that is not linked to physical presence. According to Amount A, a deemed residual profit shall be allocated using a formulary apportionment method; this approach is to be applied at the multinational group level or the business line level. Due to digitalization and new business models, physical presence is no longer an adequate nexus for taxation in certain circumstances because an “active and sustained manner in the economic life of a market jurisdiction” (OECD 2020a, 19) is possible even without physical presence, as is the case with automated digital services, which can be provided to customers without using, e.g., the local infrastructure. Moreover, Amount A shall cover consumer-facing business, i.e., “those businesses that generate revenue from the sale of goods and services of a type commonly sold to consumers, including those selling indirectly through intermediaries and by way of franchising and licensing” (OECD 2020a, 21). Amount A shall thus cover automated digital services as well as consumer-facing businesses. Additionally, the new taxing right will apply only to groups that exceed various thresholds that still need to be developed (OECD 2020a, 2020b). The current proposal states that the Amount A tax base will be quantified using an adjusted profit before tax-figure based on consolidated group financial accounts and considering both profits and to some extent losses. Moreover, a specific reallocation percentage is to be determined to identify the share of residual profit that will be allocated to market jurisdictions (OECD 2020a). Once Amount A has been determined, the next step is the allocation to market jurisdictions using allocation keys. According to the proposal, the allocation “is based on in-scope revenue derived from each eligible market jurisdiction” (OECD 2020a, 128), so the proposal is still rather vague, and specification is needed regarding the allocation key as well as the profit to be allocated.

Although the proposal of the OECD Inclusive Framework does not fully reject the arm's length principle, it at least partially recognizes the group for tax purposes and therefore takes the ethical responsibility more into account than the arm's length principle, which generally refers to group members as independent separate entities. Hence, we have a partial overlap of the ethical responsibility and the legal responsibility. Nevertheless, since ethical responsibility does not automatically imply the reduction of tax avoidance, we should also analyze the approach regarding this issue. Furthermore, it is necessary to ask whether the approach is realizable.

As indicated above, the partial recognition of the group for tax purposes requires considerable coordination and commitment of the concerned jurisdictions and could enable tax avoidance. The profit measure of Amount A will be determined using consolidated group financial accounts prepared under IFRS. Consolidated financial accounts prepared under national GAAP that produce equivalent or comparable outcomes and whose use does not lead to significant distortions can be applied as well (OECD 2020a). Nevertheless, the determination of allocable profit and whether this determination may lead to tax planning opportunities is still unclear (Förster, Greil, and Hilse 2020). Furthermore, reducing tax avoidance requires a clear distinction between baseline activities and non-baseline activities. Additionally, segmented accounts would be needed to include only in-scope revenues. While one major problem of the application of the arm's length principle is finding comparable transactions, especially regarding unique goods, formulary apportionment methods are undoubtedly highly dependent on the choice of tax base as well as on the choice of apportionment factors (Brauner 2020). While opponents argue that the possibilities for tax avoidance by shifting what is chosen as the allocation key will remain high, Brauner (2020) finds that the costs of shifting currently discussed allocation keys like assets, personnel, or sales are far higher than those of shifting intangibles to avoid taxes under current tax rules. Even so, it is important that apportionment factors are linked to economic factors that are important for the group and cannot be artificially constructed by the group. The relevant factors should be designed in a way so that groups would harm themselves with tax avoidance activities (Avi-Yonah and Benshalom 2011). Additionally, we have to expect tax avoidance opportunities to be increased by the implementation of Pillar One (Förster, Greil, and Hilse 2020). The reason is that Pillar One introduces a new nexus and a new taxing right covering digital businesses but generally does not address all existing problems of the arm's length principle, especially with respect to intangible assets. Instead, the formula-based apportionment regarding automated digital services and consumer-facing businesses is used alongside the arm's length principle (De Wilde 2020; Förster, Greil, and Hilse 2020). As a result, the possibilities for tax avoidance are even more likely to increase since the options for tax avoidance regarding the arm's length principle remain and new possibilities are added (Förster, Greil, and Hilse 2020).

Another aspect to consider about tax law is whether it is realizable. Amount A requires determining a deemed residual profit of a multinational corporate group. In general, the suitability of accounting law, such as IFRS or similar national GAAP, for determining the tax base is debatable (Förster, Greil, and Hilse 2020). Additionally, the IFRS can be interpreted differently by countries, which may hinder the determination of the allocable profits (Murphy, Jansky and Shah 2019; Murphy and Sikka 2017) and, therefore, the realizability. The OECD has already presented preliminary estimates on the effects of introducing the current proposal (OECD 2020e): The introduction of Pillar One and Pillar Two may lead to an increase in global corporate income tax revenues of 1.9% to 3.2%. Depending on the specific design that is still to be determined, this would approximately amount to USD 50–80 billion annually. Yet, according to the OECD's preliminary estimates on the effects of the implementation of Pillar One, some states may lose tax revenues (OECD 2020e). So they may try to prevent the introduction, which may impede the general implementation (Schreiber et al. 2020). Moreover, the implementation of Pillar One requires major changes in national as well as international legislation, as already identified by the OECD (2020a). While changes in national legislation only depend on the commitment of one state, a consistent implementation on an international level is far more complex (De Wilde 2020). As mentioned above, the arm's length principle is part of bilateral tax treaties. Introducing the new Amount A-concept may require changing these treaties—although, e.g., Avi-Yonah (2010) discusses the possibility of preventing this by reinterpreting the arm's length principle. The OECD therefore suggests a multilateral convention for a simultaneous change (OECD 2020a). The realizability is still doubtful, though, as all states need to agree on one identical solution, and the coexistence of various regulations may lead to serious conflicts (De Wilde 2020). Although the OECD Inclusive Framework brings together more than 135 countries and jurisdictions and tries to reach a consensus-based solution on Pillar One, the proposals are not legally binding for members or nonmembers. The proposals are merely morally binding (OECD 2017b). Finally, according to the political-cultural market theory, actors try to secure their economic survival, and powerful actors can influence the behavior of other less powerful actors (Fligstein 2001; Fligstein and McAdam 2012). Since tax avoidance in market jurisdictions may be reduced by the new nexus, it is probable that more powerful actors who profit from the current tax system and may lose some of their advantages by the introduction of Pillar One will try to prevent this change (Schreiber et al. 2020; in general, Büttner and Thielemann 2017). In sum, although the OECD two-pillar approach recognizes the group at least in part more than the prevailing tax system, it is doubtful whether it is realizable.

Thus, the OECD approach represents an improvement in some parts but it also raises many questions and presents many challenges. First, although it at least partially recognizes multinational corporate groups, it does not seem to be suitable for achieving the goal of reducing tax avoidance. Second, the political feasibility and enforceability of the proposal within the framework of a consensus-based solution is doubtful, as the consequences of its introduction are not predictable and the introduction may contradict the interests of powerful actors. It is therefore necessary to consider and analyze further alternatives between the two extremes, for example, group consolidation, which is nationally implemented in Austria and Denmark (PWC 2020), for example, or other proposals, such as a destination-based-corporate tax (Avi-Yonah 2016). Figure 8 provides an overview of the types of group taxation discussed above, showing both extremes and, as one alternative in between, the OECD Pillar One Blueprint.

Figure 8