Unitary taxation is a way of taxing multinational corporations based on where they do real work – ie, employ staff, operate factories, sell goods and services – instead of where they formally declare their profits – ie, tax havens.
Under current international tax rules, a multinational corporation with subsidiaries across the world doesn’t pay tax on the profit it makes as a whole corporate group. Instead, each of the multinational corporation’s subsidiary pays tax separately in the country where it is located, independent of other subsidiaries in the corporate group. That means the amount of tax a multinational corporation pays doesn’t depend so much on how much profit it makes as a whole but on which of its subsidiaries are the ones reporting profit
Imagine that Big Cigarette is a multinational corporation with a manufacturing company in Bangladesh, a sales company in Kenya and a holding company in Jersey. The manufacturing company in Bangladesh employs 5 people and makes cigarettes which are sent to Kenya. The sales company in Kenya employs 4 people and sells the cigarettes to local shop vendors. The sales company in Kenya then shifts its profits to the holding company in Jersey which employs 1 person. The companies in Bangladesh and Kenya both declare they have made no profits while the company in Jersey declares it has made $100 in profit.
Under current global tax rules, Big Cigarette does not pay tax on the profit it makes as a group of three companies. Instead each of Big Cigarette’s companies pays tax separately. This is known as the “arm’s length approach”. The Bangladeshi and Kenyan companies declared no profit, so they don’t pay tax. The corporate tax rate in Jersey is zero so the holding company pays no tax on the $100 profit it declared. Big Cigarette reports on its website that it made a total of $100 in profit globally and has paid the right amount of tax where it is due – in this case zero tax.
Under unitary tax rules, Big Cigarette would be required to pay tax on the profit it makes as a group of companies. Each country Big Cigarette operates in would have the right to tax a share of the $100 in profit that Big Cigarette made as a group. The size of each country’s share of the $100 would be based on how much genuine business activity Big Cigarette conducted in the country. In this simplified example, since half of Big Cigarette’s workforce (5 employees) is based in Bangladesh, Bangladesh would have the right to tax half of Big Cigarette’s profit ($50) at the local corporate tax rate of 25 per cent. Big Cigarette pays $12.50 in tax in Bangladesh. Forty per cent of Big Cigarette’s workforce is based in Kenya, so forty percent of Big Cigarette’s profit ($40) are taxed in Kenya at the local corporate tax of 30 per cent. Big Cigarette pays $12 in tax in Kenya. Big Cigarette employs just 1 person in Jersey, or 10 per cent of its workforce, so just 10 per cent of Big Cigarette’s profit ($10) is taxed in Jersey at the local corporate tax rate of zero. Big Cigarette pays no tax in Jersey. Big Cigarette has now paid a total of $24.50 in tax on its $100 global profits.