Tax competition weakens, but bureaucracy grows

21 March 2023, Munich. Family businesses typically have strong roots in the cities and towns in which they are physically located. As a result, they do not have the ability to optimise their tax payments as cleverly as, for example, large corporations active in the digital industry. At the same time, however, they do suffer the disadvantages caused by the complex rules designed to curb tax competition between countries.

The Foundation for Family Businesses has now had this relationship analysed for the second time since 2018. The researchers at ZEW Mannheim around Professor Christoph Spengel come to the following conclusion: tax competition has weakened. Certain tools to counter profit shifting are effective. So far, however, this has not led to tax rates harmonising at a lower level.

Tax competition also as regards income tax

In terms of overall tax burden, Germany ranks second to last out of 21 OECD countries, according to the Foundation for Family Business’s Country Index. Thus, many family businesses are increasingly asking themselves whether they should invest more in tax-advantaged locations. The incentive also applies to their increasingly mobile workers, who may seek to move to favourable tax locations, Spengel said.

“This study once again clearly shows that Germany remains an expensive location, particularly in terms of taxation. If tax competition shifts to income taxes paid by employees, we will have an even tougher time attracting highly qualified employees in the future”, noted Professor Rainer Kirchdörfer, Chairman of the Foundation for Family Businesses.

Is tax harmonisation working?

For context: competition between nations also sees countries promoting their location above others through lower taxes on corporate profits. This competition can have a disciplining effect on the respective fiscal policy. But it can also lead to a ruinous downward spiral – and a chain of profit shifting by companies.

Research team takes a critical view of instruments

The Anti Tax Avoidance Directive (ATAD) has the potential to curb profit shifting, but is being implemented differently across the EU. According to Spengel, this means countries still have scope to differentiate themselves from expensive locations such as Germany.

The transparency obligations resulting from country-by-country-reporting (CbCR) have indeed reduced profit shifting somewhat. But the cost-benefit ratio seems out of proportion. The tax authorities are overwhelmed by the flood of data. The general public is not showing any interest. As a result, the researchers conclude that the confidential disclosure of the data to the authorities would be sufficient.

What the OECD has named its “two-pillar model” should also be viewed critically. Pillar 1 (adapting tax systems to digital business models) does not play a role for most family businesses due to high turnover thresholds. Pillar 2 (the introduction of a global minimum tax), on the other hand, partly does. Admittedly, it could reduce profit shifting. But the price is an immensely complex system of rules and regulations – and thus a considerable compliance burden weighing on the shoulders of companies.