Tax Attractiveness Index
General Information
The Tax Attractiveness Index (T.A.X.) indicates the attractiveness of a country’s tax environment and the possibilities of tax planning for companies. The T.A.X. is constructed for 100 countries worldwide starting from 2007 on. The index covers 20 equally weighted components of real-world tax systems which are relevant for corporate location decisions, especially for multinational enterprises.
History
Former idea
The T.A.X. was developed by two German economists, Dr. Sara Keller and Prof. Dr. Deborah Schanz. Originally the T.A.X. covered 16 different components of real-world tax systems and the period 2005-2009.
Later development
The Index was further developed by Dr. Andreas Dinkel by adding four more components. The index gets constantly updated for upcoming years. Previous researched showed, that the T.A.X. has an explanatory power for location decisions of e.g. subsidiaries and patents.
Measurement
To construct the Tax Attractiveness Index, values are added for all 20 tax factors per country, which have been identified as determining a country’s tax environment, and divide the sum by 20. Hence, the index represents an equally-weighted sum of 20 tax factors. The Index has the purpose to indicate the attractiveness of a country’s tax environment and the opportunities of tax planning. As the components of the T.A.X. are measured on an annual basis, so is the index. To calculate the index, the variables need to be constrained to values ranging between zero and one. In cases quantification schemes had to be developed, the measurement of the respective tax factors has already been adjusted to this scale. A country’s tax environment is considered as more attractive, the more the value of the index approaches one. The T.A.X. is an alternative measurement to the statutory tax rate, and can be considered to be a more accurate proxy for a country’s tax environment. Many high tax countries, especially in Europe, offer extremely favourable tax conditions. Thus the T.A.X. reflects the tax attractiveness of a country better as single determinants.
Anti-avoidance rules
The tax law of many countries includes provisions aiming at preventing abuse. Tax authorities try to challenge fictitious or artificial transactions and try to combat tax evasion. Transactions which are only carried out to receive a tax benefit shall be prevented. Furthermore, transactions whose primary intention is tax allowance should be prohibited. If a transaction is considered as harmful tax avoidance under an anti-avoidance legislation, the tax burden is calculated as if the abuse had not occurred. As tax planning schemes might not work under certain anti-avoidance rules, it is favourable for companies if such legislations do not exist.
CFC rules
Generally, the country of residence of subsidiaries is allowed to tax the subsidiaries profits. The country of the parent only taxes profits that are distributed in the form of dividends. This system leaves room for abuses by multinational companies as it can be considered as incentive to transfer income to low taxed countries. Therefore, high tax countries implement controlled foreign corporation (CFC) rules to prevent the erosion of their tax base. If a country has CFC rules the companies have less scope in their tax planning activities.
Corporate income tax rate
In association with the tax base the corporate income tax rate is the main component of the corporate tax burden. Consequently, countries offering a lower statutory tax rate are more popular among companies as countries with high statutory tax rates.
Depreciation
Important elements of the tax base are tax depreciation rules. The faster companies can depreciate assets, the higher is the present value of the tax savings as the tax base is lowered earlier.
EU member state
In the European Union (EU) withholding taxes are reduced by the Parent-Subsidiary Directive as well as the Interest and Royalties Directive for transactions within the EU. As a consequence, royalties, interests and dividends might be able to be transferred between two EU member countries without withholding taxes being charged on the level of the source state.
Group taxation regime
Countries that offer group taxation, allow that losses of group members are offset against profits of other members of the group. In this way, the tax burden of a corporate group can be reduced. As a result, a group taxation regime is an advantage for companies.
Holding tax climate
Holding companies are a central tool in many tax planning strategies of companies. The location decision for holdings depends on multiple general tax factors (such as participation exemption for dividends and capital gains, a wide treaty network, low withholding taxes, a group taxation regime) as well as on specific holding regimes.
Loss carryback
Loss Carryback lowers the tax burden of companies. Current losses can be offset against profits of past periods. Loss carryback possibilities are an attractive factor for multinational enterprises.
Loss carryforward
Loss Carryforward lowers the future tax burden of companies. Current losses can be offset against profits of future periods. Loss carryforward possibilities are an attractive factor for multinational enterprises.
Patent box regime
Companies that own substantial intellectual property (e.g. patents or trademarks) often provide third parties with licenses and receive royalty payments in return. In some countries, ordinary business income is taxed higher than royalty income. Therefore, countries that tax royalties at low effective tax rates (i.e., patent box regime applies) are attractive for companies.
Personal income tax rate
The tax burden of employees is represented by the personal income tax rate. It increases labor cost for corporations. The lower the income tax rate the more attractive the country thus is for a corporation.
R&D incentives
R&D investments represent a large expenditure and affect the future product offering. Thus, R&D incentives are crucial for many enterprises. Some countries offer tax incentives, for resident companies conducting R&D, which supports companies to reduce their after tax R&D cost.
Taxation of capital gains
A double taxation is caused by the taxation of capital gains, as capital gains contain past company profits and expected future company profits on an after tax basis. It is therefore advantageous for companies if a country grants (partial) tax exemption concerning capital gains.
Taxation of dividends received
Within a multinational group, it is possible to transfer profits generated in one subsidiary to other subsidiaries or the parent company via dividends. For multinational enterprises, it is very attractive if profits can be transferred easily without causing further taxation. An exemption of taxation guarantees the highest degree of flexibility.
Thin capitalization rules
Multinational companies have the opportunity to spread their debts across countries in the most efficient way by means of internal financing strategies. In high tax countries the deductibility of interest expenses is perceived to be most valuable. To contain the abusive use of debt financing, especially governments in high tax countries have implemented thin capitalization rules.
Transfer pricing rules
When enterprises enforce transactions with related companies they can set prices to shift profits to the entity in the country with the lowest tax burden. To ensure that these transactions are priced according to the arm's length principle, many countries tax authorities have implemented transfer pricing rules.
Treaty network
To avoid double taxation of profits from foreign sourced income double tax treaties are implemented. Furthermore, double tax treaties serve the purpose of lowering or even avoiding royalty payments and interest as well as on withholding taxes levied on distributed profits. This is a reason why companies are located in countries that have signed double tax treaties with many countries worldwide.
Withholding tax rate dividends
Withholding taxes on dividends grant the source country its share in tax revenue. From the perspective of a company, withholding taxes are disadvantageous. Profits are taxed again when they are distributed (in contrast to dividends that are not distributed across borders) even though they have already been subject to corporate taxation.
Withholding tax rate interest
Withholding taxes on interest grants the source country its share in tax revenue. As tax interest payments to lenders are lowered on an after-tax basis, withholding taxes are not attractive from the perspective of a company. Therefore, in countries with higher withholding tax rates lenders demand higher before tax interest rates from debtors.
Withholding tax rate royalties
Withholding taxes on royalties grants the source country its share in tax revenue. As tax royalty payments to licensors are lowered on an after-tax basis, withholding taxes are not attractive from the perspective of a company. Therefore, in countries with higher withholding tax rates licensors demand higher before tax royalty rates from licensees.
Ranking
The ranking indicates that off-shore tax havens, such as Bermuda, the Bahamas, and the Cayman Islands provide very favourable tax conditions as reflected by high index values. However, some European countries, such as Luxembourg, Cyprus, the Netherlands, Ireland, and Malta achieve high index values as well. Surprisingly big industrial nations like the United States and China are in the bottom quartile.
Anti-Avoidance Rules
Description
By means of anti-avoidance rules, tax authorities try to combat tax avoidance and try to challenge fictitious or artificial transactions. Anti-avoidance legislations prohibit transactions whose primary or dominant purpose is the reduction of a tax liability; moreover, transactions which are solely carried out to obtain a tax benefit are to be prevented. In case a certain transaction falls under the scope of anti-avoidance legislation, the tax liability is determined notwithstanding the benefits that would result from the abuse of the law. Therefore, companies located in countries with strict anti-avoidance rules have a smaller set of tax planning options and thus are considered less attractive.
Measurement
For countries where no anti-avoidance rules are in place, Anti-Avoidance Rules receives the value one. In case national tax law contains a general anti-avoidance rule, a general substance-over-form principle is applied but not codified, or only a special anti-avoidance law is applicable, the respective country receives the value 0.5. For countries where a general rule plus special anti-abuse clauses apply, Anti-Avoidance Rules receives the value zero.
CFC Rules
Description
High tax countries implement controlled foreign corporation (CFC) rules to prevent the erosion of their tax base by means of profit shifting to non-operational subsidiaries in low tax countries that only generate passive income (e.g., interest and royalties). As long as these profits are not distributed, they are kept away from the country in which the parent company is located, enabling multinational companies to heavily decrease their total tax burden if no CFC rules are in place. If the requirements of CFC rules are fulfilled, tax authorities of the parent country are able to include non-repatriated income of corporations in foreign countries in the domestic corporate tax base of the parent companies. Therefore, companies in countries with CFC rules have less leeway in their tax planning activities.
Measurement
CFC Rules equals one if a country has not implemented controlled-foreign corporation rules and zero if they have.
Corporate Income Tax Rate
Description
The statutory corporate income tax rate is a main determinant of the corporate tax burden. Therefore, countries with a lower statutory tax rate are more attractive than countries with high statutory tax rates.
Measurement
Corporate Income Tax Rate combines the corporate income tax rate including all surcharges imposed by the central government as well as sub-central government taxes. If progressive tax rates apply, we take the maximum tax rate into account. If corporate tax payers are subject to a distribution tax levied on distributed profits instead of on accrued profits, we treat the distribution tax rate as the statutory tax rate. Using the maximum observed tax rate among all countries in a year, the factor Corporate Income Tax Rate [=(maximum tax rate per year – tax rate per country per year) / maximum tax rate per year] is normalized to range between zero and one. A higher value indicates a more attractive (i.e., lower) statutory tax rate.
Depreciations
Description
For most companies, tax depreciation rules are important determinants of the tax base. The faster assets can be depreciated, the earlier the tax base can be lowered and the higher are present values of tax savings. As depreciation for machinery is too specific for the variety of firms in different industries, we account for this variable by focusing on depreciations on commercial property.
Measurement
The component Depreciations calculates the pre-tax present value of the depreciation allowances granted for one unit of expense on commercial property. The variable is normalized to range between zero and one by dividing the resulting present values for each country by the highest observed value among all countries in a year.
EU Member State
Description
Within the European Union (EU) the Parent-Subsidiary Directive as well as the Interest and Royalties Directive aim to eliminate withholding taxes on dividends, interest and royalties and, thus, reduce double taxation.
Measurement
EU Member State is a dummy variable indicating whether a country is a member of the EU (value=1) or not (value=0). Since to the EU has entered into a similar agreement with Switzerland, this country receives the value one, too.
Group Taxation Regime
Description
Under group taxation regimes, multiple companies belonging to the same corporate group are allowed to file a consolidated tax return. Thus, group members’ profits and losses are aggregated and the aggregate is taxed. In doing so, the overall tax burden of a corporate group can be lowered. Therefore, a group taxation regime is an attractive feature of a country’s tax environment.
Measurement
For countries that do not allow for a group relief scheme, Group Taxation Regime amounts to the value zero, while for countries offering such a system but restricting it to domestic group members, Group Taxation Regime equals 0.5. Countries allowing for an international group relief system receive the value one.
Holding Tax Climate
Description
Holdings, i.e., companies that hold shares of other companies, serve as a central tool in many corporate tax planning strategies. Besides tax factors applying to both holdings and operating entities, the location decision for holdings also depends on specific tax factors. Special rules for holdings include the exemption from current taxation (e.g., Luxembourg until 2010) or exemption from local corporate income tax (e.g., Switzerland). Additionally, in some countries holding companies have a special status for the application of participation exemption rules.
Measurement
Holding Tax Climate is a dummy variable indicating whether a country offers a special holding regime (value=1) or not (value=0).
Loss Carryback
Description
Loss carryback rules allow for current losses to be offset against profits of past periods. This way companies can lower their tax burden. Hence, multinational enterprises perceive loss carryback possibilities as being attractive.
Measurement
For countries that offer a loss carryback, Loss Carryback receives the value one, and zero if they do not.
Loss Carryforward
Description
Loss carryforwards allow for current losses to be offset against profits of future periods. By doing so, companies can lower their future tax burden. Hence, multinational enterprises perceive generous loss carryforward possibilities as being attractive.
Measurement
Countries that offer a loss carryforward up to five years obtain a Loss Carryforward value of zero, while for countries in which losses can be carried forward for more than five and up to twenty years, Loss Carryforward equals 0.5. Countries where losses can be carried forward more than twenty years obtain the value one.
Patent Box Regime
Description
Companies owning substantial intellectual property (e.g., patents or trademarks) often provide third parties with licenses and receive royalty payments in return. In some countries royalty income is taxed lower than ordinary business income (i.e., patent box regime applies). This is either reached by a reduced tax rate for royalties or a tax exemption of a certain percentage of royalties. Countries that tax royalties at lower effective tax rates are therefore attractive for companies.
Measurement
The component Patent Box Regime is the normalized effective tax rate on royalties received. The effective tax rate on royalties is either directly illustrated in the underlying source or needs to be calculated from the tax-exempt percentage of royalties. It is calculated as [=(1 – tax exempt income from royalties) × statutory tax rate on business income]. This effective tax rate is then normalized to range between zero and one [=(maximum tax rate on royalties per year – tax rate on royalties per country per year) / maximum tax rate on royalties per year].
Personal Income Tax Rate
Description
The personal income tax rate determines the tax burden for employees. Therefore, it increases labor cost for corporations since (internationally mobile) employees demand (c.p.) a higher wage in countries with higher personal income tax rates. Thus, low personal income tax rates are favorable for companies.
Measurement
Personal Income Tax Rat e is based on the statutory personal income tax rate imposed by the central and sub-central government. If a progressive tax rate applies, we include the maximum rate. We account for sub-central taxes by either using averages (e.g., for Belgium and Sweden) or by comprising the tax rate of a representative city or region (e.g., Zurich for Switzerland; Helsinki for Finland). We include other surcharges, such as solidarity surcharges, only if precise numbers are available. Using the maximum observed tax rate among all countries in a year, the factor Personal Income Tax Rate [=(maximum tax rate per year – tax rate per country per year) / maximum tax rate per year] is normalized to range between zero and one. A higher value indicates a more attractive (i.e., lower) personal income tax rate.
R&D Tax Incentives
Description
R&D tax incentives are important for many companies since their R&D investments usually are large expenditures and affect their future product offerings. Some countries offer tax incentives for resident companies conducting R&D, which help companies to lower their after-tax R&D costs. Possible R&D incentives covered by this component are tax credits and tax deductions.
Measurement
The componen t R&D Tax Incentives amounts to the value one if a country’s R&D tax credits or deductions in relation to R&D costs are among the top 25% most attractive incentives worldwide in the respective year. If a country offers tax incentives which are not among the 25% most attractive, R&D Tax Incentives receives the value 0.5. If no R&D Tax Incentives are offered, we assign the value zero.
Taxation of Capital Gains
Description
The taxation of capital gains causes economic double taxation, because capital gains include after-tax retained earnings or expected future after-tax income of the divested company. Thus, many countries grant a (partial) tax exemption for capital gains.
Measurement
We quantify the taxation of capital gains by considering the percentage of tax exemption. If capital gains are completely disregarded when determining taxable income, Taxation of Capital Gains equals one. The same applies if foreign capital gains are not included in taxable income due to the territoriality principle. If capital gains are only partially exempt, the proportion of exemption is displayed (e.g., 0.95 in Germany).
Taxation of Dividends Received
Description
Within a multinational group, profits generated in one subsidiary may be distributed as a dividend to the parent company. From the perspective of a multinational enterprise, it is most attractive if profits can be transferred without the burden of further taxation, when the dividend is received. De facto, dividends have already been taxed as profits at the level of the distributing subsidiary. Many countries account for this fact when taxing dividends received: in several jurisdictions, a participation exemption applies meaning that dividends received from domestic and/or foreign affiliated companies are disregarded when determining taxable income.
Measurement
We measure the taxation of dividends received by considering the percentage of tax exemption. Countries where dividends are not subject to tax at all (100% exemption) receive the value one. If only 95% of the dividends can effectively be obtained free of tax, Taxation of Dividends Received is 0.95. If only dividends received from other domestic subsidiaries are tax exempt, we assign the value zero. This measurement is similar to Taxation of Capital Gains .
Thin Capitalization Rules
Description
Multinational enterprises have the opportunity to allocate their debts across countries in the most efficient way by means of internal financing strategies. Debt financing can be considered more favorable to equity financing as interest is deductible for tax purposes. The deductibility of interest expenses is perceived to be most valuable in high tax countries. Affiliates in low tax countries, however, may be equipped with equity. To curb the intensive use of debt financing, governments especially in high tax countries have adopted thin capitalization rules. These rules aim at limiting the deductibility of interest expenses from taxable income and are therefore disadvantageous for companies.
Measurement
For countries where the deductibility of interests is not limited, Thin Capitalization Rules amounts to the value one. If tax authorities are entitled to limit the deduction of interests if its amount is considered to be inadequate, Thin Capitalization Rules equals 0.5. If governments impose clearly defined thin capitalization rules, Thin Capitalization Rules equals zero.
Transfer Pricing Rules
Description
When companies conduct transactions with related companies they need to set prices to charge for products and services in order to ensure comparability to a transaction between non-related parties. In many countries tax authorities have implemented transfer pricing rules that demand these transactions to be priced at arm’s length. Countries with such specific rules cause high administrative effort and provide less leeway for profit shifting and are therefore less attractive from a corporate perspective.
Measurement
The component Transfer Pricing Rules assumes the value one if there are no specific rules concerning transfer pricing codified in law (beyond anti-avoidance rules) and the value zero if there are.
Treaty Network
Description
Double tax treaties help to avoid the double taxation of profits from foreign sourced income. Moreover, double tax treaties serve the purpose of reducing or even avoiding withholding taxes levied on distributed profits as well as on interest and royalty payments. Therefore, companies located in countries that have signed double tax treaties with many countries internationally (c.p.) have an advantage over corporations with a limited treaty network.
Measurement
Treaty Networ k is based on the number of double tax treaties in force per year. Double tax treaties that are under negotiation but have not yet been ratified are not taken into consideration. Even those that have been adopted but are not yet in force are disregarded. Furthermore, we do not account for Tax Information Exchange Agreements. Treaty Network is normalized to range between zero and one by dividing the number of double tax treaties in a country by the maximum number of treaties observed in any one country in a given year. A higher value for Treaty Network indicates a more extensive double tax treaty network.
Withholding Tax Rate Dividends
Description
By means of withholding taxes, the source country tries to secure its share in tax revenue. However, from a company’s perspective, withholding taxes are disadvantageous and can increase the total tax burden. Profits that have already been subject to corporate taxation are taxed again when distributed (in contrast to dividends that are not distributed across borders). Therefore, companies in countries with low withholding taxes can distribute dividends with a lower tax burden.
Measurement
Withholding Tax Rate Dividends accounts for the withholding tax rate levied on dividends. We include the standard withholding tax rate implemented in national law, irrespective of reductions implemented in tax treaties. If national legislation includes exceptions, we use the tax rates that apply in the standard case. Using the maximum observed tax rate among all countries in a year, the factor Withholding Tax Rate Dividends [=(maximum tax rate per year – tax rate per country per year) / maximum tax rate per year] is normalized to range between zero and one. A higher value indicates a more attractive (i.e., a lower) withholding tax rate.
Withholding Tax Rate Interest
Description
By means of withholding taxes, the source country tries to secure its share in tax revenue. However, from a company’s perspective, withholding taxes are disadvantageous because tax interest payments to lenders are lowered. Therefore, lenders (c.p.) demand higher before-tax interest rates from debtors in countries with higher withholding tax rates on interest. Companies in countries with low withholding taxes can raise foreign debt at lower cost.
Measurement
Withholding Tax Rate Interest accounts for the withholding tax rate levied on interest. We include the standard withholding tax rate implemented in national law, irrespective of reductions implemented in tax treaties. If national legislation includes exceptions, we use the tax rates that apply in the standard case. Using the maximum observed tax rate among all countries in a year, the factor Withholding Tax Rate Interest [=(maximum tax rate per year – tax rate per country per year) / maximum tax rate per year] is normalized to range between zero and one. A higher value indicates a more attractive (i.e., a lower) withholding tax rate.
Withholding Tax Rate Royalties
Description
By means of withholding taxes, the source country tries to secure its share in tax revenue. However, from a company’s perspective, withholding taxes are disadvantageous because tax royalty payments to licensors are lowered. Therefore, licensors (c.p.) demand higher before-tax interest rates from licensees in countries with higher withholding tax rates. Companies in countries with low withholding taxes can license intellectual property at lower cost.
Measurement
Withholding Tax Rate Royalties accounts for the withholding tax rate levied on royalties. We include the standard withholding tax rate implemented in national law, irrespective of reductions implemented in tax treaties. If national legislation includes exceptions, we use the tax rates that apply in the standard case. Using the maximum observed tax rate among all countries in a year, the factor Withholding Tax Rate Royalties [=(maximum tax rate per year – tax rate per country per year) / maximum tax rate per year] is normalized to range between zero and one. A higher value indicates a more attractive (i.e., a lower) withholding tax rate.