Economic Substance Requirements and Multinational Firm Behavior
February 14, 2017
By Aparna Mathur and Kartikeya Singh
Abstract
The OECD’s Base Erosion and Profit Shifting project has focused on income attributed to intangibles with an objective of curtailing perceived artificial profit shifting by multinational firms. A key part of this effort is a renewed emphasis on the concept of “economic substance.” Economic substance standards require companies to locate employees and other people functions in jurisdictions where the companies report profits related to intangibles. Our analysis suggests that an emphasis on economic substance tied to people functions can have a significant impact on the scale as well as the location of economic activity (i.e. employees dedicated to the creation and use of intangibles). Furthermore, the likely implications on economic activity can be highly unfavorable for high-tax jurisdictions. Viewed from a U.S. perspective, this new international environment provides one more impetus to strive for a reform of the corporate tax code to make it more competitive. In the absence of such changes, the United States—which taxes corporate income at a rate higher than most developed economies—will risk losing economic activity to other countries.