Fairness and the Arm’s Length Principle in a Digital Economy

Fairness und der Fremdvergleichsgrundsatz in der digitalen Ökonomie

Stefan Greil (), Christian Schwarz () and Stefan Stein ()
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Stefan Greil: University of Hamburg
Christian Schwarz: Department of Economics of the Duesseldorf University of Applied Sciences
Stefan Stein: Quantum Steuerberatungsgesellschaft mbH

Duesseldorf Working Papers in Applied Management and Economics from Duesseldorf University of Applied Sciences

Abstract: The OECD Base Erosion Profit Shifting (BEPS) Initiative as well as the current fairness oriented public discussion regarding the taxation of digital business models highlight the importance and complexity of the arm’s length principle. In a theoretical model of an internationally fragmented digital good’s production process, we show that fairness considerations of tax authorities (namely inequity aversion) can result in a falling apart between a perceived “fair” and arm’s length distribution of profits across tax jurisdictions. Our model predicts that a multinational firm follows the fundamental paradigm of international taxation, i.e. the arm’s length principle, to properly incentivize internal agents involved in the production of a digital good. However, with inequity averse tax authorities, we find that tax authorities “prefer” a more equal distribution of profits compared to the arm’s length allocation. From a multinational firm’s perspective, inequity aversion among tax authorities dampens the strategic effect to – in accordance with arm’s length principle – shift profits to low tax countries.

Keywords: corporate income tax; profit-shifting; arm's length principle; fairness; Unternehmensbesteuerung; Gewinnverlagerung; Fremdvergleichsgrundsatz (search for similar items in EconPapers)
JEL-codes: F23 H25 H26 (search for similar items in EconPapers)
Pages: 30 pages
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Published in Forschungsberichte des Fachbereichs Wirtschaftswissenschaften der Hochschule Duesseldorf, 2018,42 ; ISSN 2365-3361

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Persistent link: https://EconPapers.repec.org/RePEc:ddf:wpaper:42

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