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EU looks at using R&D costs to solve digital tax impasse


The European Commission is set to look at the possibility of using R&D costs as a way of reallocating income. This may be the starting point for an EU-wide solution to taxing the digital economy.

The European Economic and Social Committee (EESC) has approved a report on how to tax the digital economy. It follows on from the idea of a common consolidated corporate tax base (CCCTB), but focuses on the details of the formula applied to residual profits.

Traditional formulas apply three keys – employment, sales and assets – whereas the report looks at the possibility of a fourth key to tackle marketing intangibles. This is where research and development (R&D) comes in.

TP Week spoke to Krister Andersson, vice president of the Employers' Group at the EESC, who drafted the report.

“We started with the CCCTB allocation keys and added a fourth factor, R&D costs,” Andersson said. “So you would allocate profits not just on employment, assets and sales, but also on R&D costs.”

“The goods and services that yield residual profits are often connected with marketing intangibles,” he explained. “These intangibles are the result of R&D investment.”

This would help shift taxing rights to the country of origin, where the R&D investment takes place, where marketing intangibles are developed and the business line functions. This is arguably much more precise than allocating on the basis of user participation.

“R&D costs are a proxy for intangibles,” Andersson said. “It’s not a perfect match, but it’s something you can measure and assess and use as a tax base.”

“You have financial accounting when it comes to R&D costs. You have to register how much you spend on various items,” he told TP Week. “It’s much more tangible than a vague notion of user participation.”

It might also be the best way to rebalance the distribution of income between smaller countries with strong R&D infrastructure and larger countries with a lot of consumers. This tension goes to the heart of the debate on digital tax.

Meanwhile, the traditional alliance between the US and Europe has broken down. The US wants to defend Silicon Valley, while the EU wants to make sure Google and Facebook pay their fair share. At the same time, the OECD will be watching this proposal closely since it may conflict with its own attempts to find a multilateral solution to digital tax.

“There is a risk that the OECD will go too far,” Andersson said. “It’s somewhat surprising that suddenly a lot of countries seem to agree that a lot of taxing rights should be handed over to market jurisdictions.”

Andersson is concerned that there has not been a full impact assessment. “It should have been done before the process started,” he explained. “BEPS Action Point 11 was only assessed at the very end of the project after the anti-BEPS measures were worked out.”

An impact assessment is crucial to reallocating taxing rights since such a shift will impact the tax authorities and the possibility of double taxation.

“We need to analyse how much power market jurisdictions have and what would be appropriate to hand over,” Andersson said. “There will be winners and losers.”

The EESC may have approved the report on July 17, but the European Commission will decide whether this is a useful blueprint for EU policy. Right now President Jean-Claude Juncker is handing over to his successor President Ursula von der Leyen, who takes office in November.

All signs suggest President von der Leyen will pick up where Juncker left off. In other words, the commission will continue to search for a common European solution to taxing the high-tech sector, but the race is on and the stakes are high.

Risks and rewards

Taking R&D costs as the key to a formulary tax system has widespread implications for existing TP norms such as the arm’s-length principle (ALP) and how national governments grant special tax benefits to businesses rich in intellectual property (IP) assets.

Many taxpayers will fear this shift would mean double taxation, a greater risk of controversy and legal challenges. However, there are ways to mitigate such consequences and there may be opportunities for business, even with great risks.

Arm’s length

As an economist, Andersson understands the concerns of business leaders when it comes to fundamental principles of transfer pricing. He wanted to make it clear that the use of R&D costs to allocate income would not be the end of arm’s length.

“You have these allocation keys on top of the ALP,” Andersson said. “It’s really tinkering with the concept of arm’s length pricing by introducing the formula. But it doesn’t invalidate the principle.”

“The arm’s-length principle will still apply to routine profits,” the economist stressed.

“We should try to maintain as much of the ALP as possible and not embark on a completely new system,” he said. “We should stay as close to arm’s length pricing as possible.”


It’s not just about first principles. Many EU countries have designed R&D tax credit regimes and patent boxes to raise the incentive for high-tech innovation and entrepreneurship. Taking R&D costs as an allocation key could help make such regimes the norm and not the exception.

 “If governments don’t get to tax the returns of highly profitable businesses, why would the governments be willing to take on the costs of supporting R&D for the bulk of businesses that never make a profit?” Andersson asked.

“Otherwise, there is very little incentive to create a good business environment,” he said. “That’s why we added a fourth factor to the allocation keys.”


Tax reform often means more complexity for businesses. The problem is that formulary apportionment might be simpler, but if companies want more nuanced policies the result will be that the the system is more complex.

“You have to not only determine routine profits, but you have to define residual profits and allocate those profits according to these four factors,” Andersson said.

“It’s a daunting exercise,” he said. “It may increase the amount of complexity and the administrative burden in the system.”

“You could just allocate a fraction of residual profits and use sales as the only factors,” the economist said. “It would be a simple system with some drawbacks. Market jurisdictions would get a lot of negotiating power but the need to quantify several components for allocation would disappear.”

The sensitivity over estimates of residual profits would be much less under such a regime. It might even be easier for the tax authorities to reach agreements.


One of the big questions facing taxpayers is how to manage the risk of disputes in a world of controversy and uncertainty. Not only do businesses fear the existing mechanisms for dispute resolution are not enough, companies worry new rules mean new risks.

“What I fear is that there will be increased tax uncertainty and the revenue authorities will say they have the right to tax so much of the profits and other countries will dispute this,” Andersson said. “Companies would end up facing double taxation and it would take years to resolve the disputes.”

“We need a stronger framework for dispute prevention and resolution to make this project work,” he said. “The business community has often expressed its feeling that we need mandatory binding arbitration. But many countries are reluctant to accept this.”

Mandatory binding arbitration is not the only option for national governments to consider. Andersson was eager to stress that it should be possible to forge agreements on when a country claims greater taxing rights.

“Companies should be allowed to defer payment and should only have to pay additional taxes if the country demanding a larger share of the tax base has a higher corporate tax rate,” he explained.

Mandatory binding arbitration

Businesses may want an international arbitration mechanism, but the debate is bound up with concerns about national sovereignty and legal jurisdiction. Some countries like the US might favour it; however, not every nation is going to agree.

“Some countries feel that arbitration is a constitutional issue,” Andersson said. “You might not want to handover such powers to an independent arbitrator to resolve tax disputes. But it should be possible to overcome such concerns.”

“Governments know they misuse their taxing rights, but they don’t want to run the risk of an international challenge,” he said. “The most aggressive governments tend to take a negative view of mandatory binding arbitration.”

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