To reduce corporate tax avoidance, Gabriel Zucman has proposed to tax corporate earnings where they are earned, rather than where the corporation is based:

Say Google’s parent company Alphabet makes $100 billion in profits globally, and 50 percent of its sales in the United States (a relatively similar scenario to the first quarter of this year, in which that figure was 48 percent). In that case, $50 billion would be taxable in the United States, irrespective of where Google’s intangible assets are or where its workers are employed. A system similar to this already governs state corporate taxes in America.

Such a reform would quash artificial profit-shifting. Corporations may be able to shift around profits, assets, and subsidiaries, but they cannot move all their customers to Bermuda.

One advantage of allocating taxable profits as I suggest is that this reform can be adopted unilaterally. There is no need for the United States (or any other nation that wants to cut down on tax avoidance) to obtain permission from anybody.

Apparently, the European Parliament has adopted a motion proposing to reform corporate taxes as such, but it is not their decision. For the EU to adopt this, any member state has veto right, so it may not happen on an EU level. But as Zucman points out, a nation can do it unilaterally. One might argue about double taxation, but if a multinational corporation is currently paying near 0% corporation tax through a clever use of tax shelters, that hardly seems a severe problem.

Given that it is possible to unilaterally declare to tax corporate profits where they are earned rather than where the corporation is based, I wonder: are there any countries that have introduced such a system in the present or the past?

  • 4
    I think you are onto something brilliant here. The "move all their customers to Bermuda" idea seems like a winner. Google: reminder, i'm a customer (for realz. Bought Google productz with money and all).
    – user4012
    Apr 13, 2018 at 11:00
  • 2
    VAT gets charged based on where the client is in the EU - including if you're a US-based business. Apr 13, 2018 at 13:49
  • 2
    @DenisdeBernardy VAT is, but corporate earnings aren't.
    – gerrit
    Apr 13, 2018 at 16:47

2 Answers 2


Income Is Taxed Where It Is Earned

The premise of the question is mistaken, at least in terminology, even if not in terms of basic thrust.

While the title makes it sound like the question is about whether any countries use a "territorial" system of international taxation rather than a "worldwide income" system of international taxation (the U.S. at least until 2018, and a couple of other countries), the actual question is getting at a different issue, as demonstrated by the example given, which proposed something different than a territorial system of taxation. This easy to make mistake is due to the slipperiness of the word "earned" as discussed below.

Almost all countries tax corporations on income where it is earned, rather than where the corporation is incorporated. Even the United States, which is an outlier that taxes corporations incorporated in the United States on their worldwide income rather than territorially, the U.S. also taxes corporations incorporated outside the United States on all income that is "effectively connected" with the United States.

(To be clear, the U.S. "worldwide" tax system is not quite as much of a tax grab as it seems. Most wage and salary income of expatriates is exempt from income taxation and self-employment and property related income subject to worldwide income taxation of businesses and individuals is entitled a credit for all taxes paid to the jurisdiction where it is deemed "earned" by the taxpayer. Also, for what it is worth, the shift of U.S. international taxation from a "worldwide" tax system to a "territorial" tax system effective January 1, 2018 under the Tax Cut and Jobs Act of 2017 was partial and something of a kludge, rather than a complete and systemic transition to the "territorial" international tax system from the bottom up. Basically, the U.S. still has a "worldwide" international tax system but then adjusts "worldwide" taxable income which is the starting point, to be closer to, but not identical to, "territorial" taxable income under the 2017 act, although I am oversimplifying this analysis.)

The Problem

The Historical Rule For Localizing Intangible Income

The real issue is not that countries don't tax income where it is earned, the issue is that determining where income is earned is a non-trivial matter with no "natural" answer.

Historically, income from intangible assets (which have no geographic or tangible location), such as royalty income, interest income, dividend income, and life insurance profits, has been deemed to be earned where the owner of that asset is located. These assets are sometimes called "hot assets" in the international tax literature because they can be quickly relocated (which can be confusing because "hot assets" means something different in the international asset protection literature where a "hot asset" is one that is prone to generating liability).

So, for example, if the owner of 100 shares of Microsoft stock lives in Paris, France, then the dividends from that stock are considered to have been earned in Paris, France.

Consequences Of The Historical Rule For Intangibles

The virtue of this rule is that someone with intangible assets can fill out one tax return for their domicile regardless of the myriad places where the payers of those intangible assets are located. For example, if you have a stock portfolio with companies in fifty different countries and U.S. states, you'd have to fill out one tax return with the historical rule, but fifty tax returns if you taxed intangible income where it was generated.

But, it turns out to be trivially easy to manipulate the jurisdiction where the owner of intangible assets is located because the owner of intangible assets doesn't have to do anything other than have a mail box to receive checks.

This wasn't historically a very big deal because intangible assets and liabilities weren't a very significant part of the total balance sheet of most firms. Also, at the time the income tax was invented, the only way to form a new corporation in many states and countries was by an enactment of the legislature and it was harder to form a corporation than it is today even where legislative approval was not required to form one.

But, in the tech era, intangible assets are often the principle asset of a firm and highly leveraged companies are common (leverage is a form of intangible liability). This kind of tax evasion by shifting jurisdiction is very minimal in brick and mortar businesses like retail stores.

There are many ways to abuse this historical rule. One of the biggest is to have a separate subsidiary company own intellectual property, and then to reach agreements between operating companies that sell goods, and intellectual property holding companies, that have the practical effect of allocating most of the profits on each sale to the intellectual property royalty payment.

Localizing Transactions In Cyberspace

Similar issues arise in cyber transactions that don't involve intangible assets. For example, there is no "natural" rule to determine whether a purchase from Amazon.com takes place in the customer's location, the delivery location if different from the customer's location, the location from which the good is shipped, or the location of the company selling the goods, ambiguities that aren't present in brick and mortar sales. There are legitimate arguments for each of these fundamentally arbitrary rules of the road. Also, historically, this has been an area governed by formalist rules formulated before the consequentialist analysis of the impact of those rules in a cyber/tech environment was possible.

The Problem With The Territorial System

The "Territorial System", which is different from what Zucman, cited in the question, is proposing is particularly prone to gamesmanship if the problem of localizing assets is not resolved well, which is why the U.S. adopted a worldwide income system of taxation prior to 2018.

The main reason that the Tax Cut and Jobs Act of 2017 (mostly effective January 1, 2018) provides 80% of its benefit to non-U.S. persons is that it steps away from the "worldwide income" basis of taxation to a territorial one where income is taxed only where it is earned to a great extent, without changing the rules to determine where income is earned very much.

Footnote On Value Added Taxation

The Value Added Tax system is an important part of European tax systems, in part, because it has a different way of localizing tax burdens involving tangible goods and services that solves some of these issue.

In a Value Added Tax system, a seller of goods and services in a jurisdiction pays a tax on 100% of the gross receipts of a sale in a jurisdiction, but gets a credit for 100% of the purchase price of goods and services in the jurisdiction used for later sales upon which the seller paid a value added tax in the jurisdiction.

In the case of a domestic transaction, a value added tax is equivalent to a tax on profits from the sale of goods or services. But, in the case of an international transaction, where no domestic value added tax was paid on the items purchased from abroad, the VAT effectively disallows any deduction for expenses that went into the domestic sale of goods or services.

One of the things the EU has done is to facilitate reciprocal credits among member nations of VAT credits for purchases from other EU members, which works, because none of the EU members is a tax haven with respect to VAT taxation, to avoid double taxation.

By imposing third-party reporting of expenses, a VAT system reduces tax evasion relative to a self-reported income tax system like that used in the U.S. where the IRS periodically audits business expenses, but there is widespread abuse in the area of business expenses (especially in small businesses that often treat what should be considered personal expenses as business expenses) due to a lack of third-party reporting of business expenses the way that it has third-party reporting of business income via 1099 information tax returns.

The trouble with a VAT system (or benefit, depending upon your economic and policy preferences), however, is that unlike an income tax, a VAT does not tax investment income that is not spent on VAT taxable goods or services.


A variety of alternatives rules have been proposed.

Allocate Intangible Income To The Source Rather Than The Recipient

One is to locate intangible property for tax purposes where the person making the intangible property payment is located rather than where the person who is entitled to receive the intangible property payment is located, because the person making the payment often has less freedom to change their location and is often more closely associated with the production of the income.

In the case of cyber space transaction, the equivalent localization rule would be to treat the sale as taking place either where the customer is located or where the good is delivered when there is a physical good to be delivered. (There are pluses and minuses to a delivery rule. It depends upon whether the taxing jurisdiction believes that a customer location or a delivery address is more easily manipulated.)

Allocate Intangible Income And Expenses Pro-Rata Based Upon Key Factors

Another approach which is used in U.S. state and local taxation by virtue of an interstate compact, is to have entities (or consolidated groups of corporations) prepare one tax return for the entire world and then to allocate pro-rata percentages of that global return to different jurisdictions based upon a handful of factors that are relatively hard to manipulate and bear a meaningful relationship to where income is earned such as sales, employment and the location of physical assets.

A related proposal has been to allocate intangible expenses, like interest expenses, of a consolidated group of entities, on a similar basis.

Both of these approaches are a huge departure from the predominant practice of allocating earnings to particular jurisdictions on a transaction by transaction basis.

Strictly Regulate Transfer Pricing

A third approach which is currently implemented but is a running battle between multi-jurisdictional firms and tax authorities is to regulate "transfer pricing". For example, if a firm allocates 90% of profits to intellectual property royalties in a related party agreement, tax officials might "blue pencil" the agreement for tax purposes to allocate no more than 10% of profits to royalties and tax the firms based upon that revised figure.

Footnote On Corporate Tax Integration

Localization Make Eliminating Double Taxation Of Corporate Income Difficult

The problem of figuring out how to localize income from intangibles, which was mostly dividend income until recently, is one of the important reasons that it has been hard for the United States to come up with a corporate tax system that integrates corporate level taxation and individual level taxation on dividends.

The U.S. currently taxes "C corporations" once at the corporate level on its profits, and then again as income when dividends are distributed without a corporate level deduction, or an individual level tax credit to reflect the fact that taxes were already paid at the corporate level on the same income. Instead, the U.S. has found ways to cut taxes at the corporate level and has applied in recent years lower tax rates to dividend income, so that the combined burden of taxation on distributed income is lower, but it is still a sub-optimal solution which has been widely recognized to exist since at least the 1950s. The fact that corporate income is subject to "double taxation" is one reason that Congress has been willing to allow the erosion of taxation at the corporate level.

If you have a single jurisdiction that can control the entire corporate tax system, one of the easiest and most common ways to integrate corporate and individual level income taxes is to impose taxes on corporate profits at the corporate level, but then to give recipients of dividends who are subject to domestic income taxes a credit equal to the percentage of income paid by the dividend paying corporation, treating the corporate income tax as a withholding tax that becomes final when dividends are distributed to foreign taxpayers who don't pay domestic income taxes.

But, the United States has had massively multi-jurisdictional corporate income taxation due to the fact that both the federal government and state governments can impose corporate income taxes, for as long as there has been a federal corporate income tax. And, in the U.S., the federal government has almost no control over state tax policy (even less than the E.U. does over its member states).

A dividend withholding tax credit system is much more difficult to implement logistically in a massively multi-jurisdictional situation at the state level.

If Ford Motor Company pays corporate income taxes in 45 U.S. states in addition to its federal corporate income taxes, and distributes dividends to hundreds of thousands of shareholders in all 50 states and many foreign countries, figuring out how to properly give dividend payees the right amount of tax credit for state income taxes paid is an intractable problem. This same problem is why publicly held companies are required in U.S. tax law to be taxed as "C corporations" rather than having passthrough taxation the way that domestic limited liability companies and "S corporations" do in U.S. taxation, where similar complexities arise.

Potential Localization Solutions To Integrating Corporate Double Taxation

There are possible solutions to corporate "double taxation", but each has had barriers to adoption.

One solution would be to have an interstate compact that makes credits for state income taxes paid fungible and then settles up between states to reconcile mismatching each year. This has suffered from a collective action problem between the states.

Another solution would be to have a deduction for dividends paid similar to the interest deduction, at the corporate level. But, this solution has the problem of depriving states that are impacted by corporate activity in their state of corporate income, in corporations that distribute their profits in full to shareholders who are located outside the state.

A third solution would be to exempt dividends from income taxation and tax corporate profits only at the corporate level. But, this would interfere with the proper operation of progressive income taxes and would lead to a hole of unreported income that almost always attracts abuses. Those concerns could be addressed, however, with a tax rate of zero percent or some other low percentage (perhaps 5%) on qualified dividend income, so that the income would be reported, but not taxed heavily.

A fourth solution would be not to impose corporate level taxes at all. But, this would lead to schemes to indefinitely defer income in a C corporation type system where dividends are taxed when received. This is the solution used for pass through taxation entities, where deferral of taxation is avoided by the pass through mechanism that immediately taxes shareholders whether or not profits are distributed, but it becomes complex when the entity incurs taxes in many states that must be passed on to all of the owners to report proportionately on their individual tax returns.

In short, the intractability of solving tax localization is real and is one of the main reasons that it is been politically difficult to craft a corporate tax integration proposal in the United States.

  • 2
    It appears I misunderstood and misrepresented the Zucmans proposal. He proposes to tax income where customers are located, so one could rephrase the question as, defining "where income is earned" as "where customers are located".
    – gerrit
    Apr 13, 2018 at 17:38
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    @gerrit It is a subtle difference and one of the big issues in international taxation debates is that people use terms that sound well defined when you say them but turn out to be ambiguous when applied.
    – ohwilleke
    Apr 13, 2018 at 18:40
  • The mistake is mine, and since I originally got the idea from a Dutch language article there's a translation/language barrier as well.
    – gerrit
    Apr 13, 2018 at 19:03
  • Any chance of an executive summary please?
    – user4012
    Apr 14, 2018 at 13:51
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    @user4012 It's in bold, quite early on: The real issue is not that countries don't tax income where it is earned, the issue is that determining where income is earned is a non-trivial matter with no "natural" answer. - If have UK investors, design a product in France, build it in Vietnam, sell it in the US, to an Indian, and have a Greek shipping company do the delivery to an address in Pakistan, where was the income earned, exactly?
    – Peter
    Apr 16, 2018 at 10:35

From a 2012 United States Senate Republican Policy Committee policy paper:

Most countries have a territorial system. Among G-7 countries, only the U.S. has a worldwide tax system. Among OECD nations, 26 have territorial systems including Australia, Canada, France, Germany, Japan, Spain, and the United Kingdom. Eight OECD nations have worldwide systems, including the U.S., Greece, Ireland, South Korea, and Mexico.

Territorial taxation is the official name of "tax corporate earnings where they are earned". Worldwide taxation is taxation determined by "where the corporation is based". This is from 2012, so it does not reflect changes made to US corporate taxes in 2017.

Mixing worldwide and territorial taxation causes both double taxation and zero taxation. That's how the Double Irish with a Dutch Sandwich works. It takes advantage of the untaxed locations of both the worldwide taxer Ireland and the territorial taxer Netherlands to avoid taxes.

Anyway, the move in the European Union to switch to territorial taxation isn't the first move. It's intended to pick up the last few countries using worldwide taxation in Europe. The quotation mentions Ireland and Greece as holdouts.

  • The system proposed by Zucman is not a territorial system. Also, one way that other tax systems avoid inter-jurisdictional base erosion is by giving domestic but not foreign recipients of dividends a tax credit for dividends received reflecting a dividend withholding tax concept of corporate level taxes. For foreign dividend recipients in that system the corporate level withholding simply becomes a final tax. But, those systems still have transfer payment issues similar to the U.S. For example, there are U.K. corporations that employ tax plans similar to Google despite its territorial system.
    – ohwilleke
    Apr 13, 2018 at 18:44
  • I misunderstood the system proposed by Zucman and therefore asked entirely the wrong question…
    – gerrit
    Apr 15, 2018 at 17:28

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