Reallocating Taxing Rights and Online Trade: Pillar One as a partial formula apportionment

To target the problem of “homeless profits” that digital firms earn in countries without a physical presence, the Pillar One proposal by the OECD aims to reallocate taxing rights to market countries based on the sales revenues of in-scope firms. This study theoretically investigates the implications of Pillar One by considering a global firm that conducts all its real activities in a tax haven and competes via prices in e-commerce with local firms in market countries. Our model identifies two core effects. First, all in-scope firms manipulate their routine profit threshold by increasing their total turnover. This reduces the newly reallocated tax base and crowds out the taxable profits of the local competitors. Second, when corporate tax rates differ across market countries, there is an incentive toward sales shifting, whereby the global firm increases prices in the high-tax country and books larger sales and taxable profits in the low-tax country. Thus, the high-tax country suffers from lower tax revenue and greater market inefficiency, all else being equal.