Picture the scene. It\u2019s August in New York and international negotiators are meeting to continue moves to ensure that multinational companies are finally required to pay taxes according to where their real economic activity takes place.<\/p>\n
Only one country is missing from around the table \u2013 the United States. Despite physically hosting the discussion, the Trump administration refuses to participate in the talks that will define the UN Framework Convention on International Tax Cooperation.<\/p>\n
Trump support for tax abuse \u2013 at the expense of the US<\/p>\n
This is part of a pattern. After coming to power in 2025, the administration upended everything that had been negotiated at the OECD since 2019. First they vetoed \u2018pillar one\u2019 of the agreement, and then they demanded an exemption from most of \u2018pillar two\u2019 \u2013 which was largely designed by the US to begin with. Now the negotiations have moved to the UN, and the US is being left behind.<\/p>\n
When combined with the deeply damaging Tax Cuts and Jobs Act passed by the first Trump administration, the result<\/a> is that US multinationals are now shifting twice as much profit out of the countries where they do business.<\/p>\n But don\u2019t imagine that the US is benefiting. On the contrary, those multinationals are paying even less tax to the US than they did before. Don\u2019t think that foreign multinationals are lining up to pay tax either \u2013 when in Rome<\/a>, after all. Nor has the US gained any jobs from giving away the farm \u2013 so pretty much everyone is a loser.<\/p>\n That includes US states, who typically base their state-level corporate income tax on whatever the US administration accepts at federal level, adjusted for the state\u2019s share of the multinational\u2019s real (US) economic activity. So as the second Trump administration again lets multinationals, US and foreign, walk all over their tax obligations, that laxness deprives the states of revenue too.<\/p>\n And this is where California is stepping up.<\/p>\n Pay where you play<\/p>\n The US states, just like the provinces of Canada and the cantons of Switzerland, among others, use a taxing method known as formulary apportionment to determine their corporate taxes. A multinational\u2019s total profits are added together and then distributed to states according to the share of its economic activity taking place there. Each state is then allowed to tax the share of profits that fits its share of the multinational\u2019s employees, assets, or sales. For instance, if half of the employees and half of the sales are happening in California, California would be allowed to tax half of the profits. \u00a0<\/p>\n The key point is to make sure that companies pay where they play \u2013 rather than making their profits in one place, but declaring them somewhere else for tax purposes.<\/p>\n The reason to rely on this formulary apportionment method is that the basis of international corporate tax rules \u2013 the arm\u2019s length principle \u2013 is unfit for purpose. This approach allows multinational groups to set \u2018transfer prices\u2019 for the exchange of goods and services between sister companies, as if they were operating independently (at arm\u2019s length from one another). Inevitably, multinationals succumb to the temptation to manipulate these transfer prices in order to shift the group\u2019s profit into entities in other jurisdictions where they will pay little or no tax. This allows companies to pay where they say the profits are, instead of where they actually arise.<\/p>\n The growing importance of intangible assets such as corporate brands and intellectual property, and the more recent phenomenon of digitalisation, has made it increasingly difficult for tax authorities to challenge abusive transfer prices. The result is that the scale of profit \u2018misalignment\u2019 \u2013 the share of multinationals\u2019 profits that are declared where they say, instead of where they play \u2013 has rocketed. Back in the early 1990s<\/a>, around only 5% of the global profits of US multinationals were misaligned in this way. That doubled within the decade and continued to rise ever since, reaching 20% by the 2010s and an average of 24%<\/a> for 2016-2021 \u2013 supercharged by the Tax Cuts and (No) Jobs Act.<\/p>\n The current Trump administration\u2019s recent changes, and undermining of even the limited OECD reforms, have further exacerbated the problem. Major US tech companies now pay tax at effective rates that are barely into double digits. Pharma companies and others channel vast profits through Switzerland, Ireland, Puerto Rico and Singapore<\/a>.<\/p>\n That\u2019s why the countries of the world, with the exception of the refusenik Trump administration, are now negotiating on a UN tax convention that would commit to allow all states to exert taxing rights over economic activity in their jurisdiction. This lays the base for the subsequent Conferences of the Parties to agree a formulary apportionment approach \u2013 an approach that may already be embedded in the protocol for taxing crossborder services which is being negotiated alongside the convention.<\/p>\n California points the way<\/p>\n The state of California is now pioneering the approach in the US. At present, and like a number of US states, California offers companies an election: for the apportionment of tax base that underpins their state tax liability, they can either be assessed on their declared US profit, or they can elect to be assessed on the appropriate share of their global profit. To the extent that the US share of profits has historically been less than its share of economic activity, it has almost always been cheaper for multinationals to pay state tax on the basis of their US profits \u2013 and so they elect for \u2018water\u2019s edge\u2019 option, where the assessment stops at the US border.<\/p>\n California\u2019s proposed legislation, AB 1790, would end this election and require companies to be assessed on the unitary basis \u2013 according, that is, to the global profits of the whole group, rather than the claimed US profits only. This would mandate \u2018Worldwide Combined Reporting\u2019 (WWCR). That is, companies would have to report the global activity and profits of their group.<\/p>\n If the legislation passes, California will cut through the abuses of the arm\u2019s length principle and simply tax multinationals according to California\u2019s fair share of each group\u2019s global economic activity. This will not only point the way for other US states to follow, but also aligns with the direction of travel for negotiators at the UN: away from the obsolete arm\u2019s length principle, and towards a system of taxing rights based on the location of real economic activity.<\/p>\n As this new future of corporate taxation comes ever more closely into view, California\u2019s policymakers are weighing up their opportunity to end the loophole of the water\u2019s edge election and mount a powerful defence of their tax base.\u00a0<\/p>\n Thinking of the questions that policymakers might have, we\u2019ve put together a Q&A based on close engagement with expert allies. The full text is below, or you can download a pdf.<\/p>\n Q&A on California\u2019s proposed legislation on Worldwide Combined Reporting (WWCR)<\/p>\n Q1. How do multinational companies use profit shifting to avoid US state taxes?<\/p>\n In US states, a corporation\u2019s income tax base essentially begins with its federal tax base. That means that the offshore profit shifting that drains the federal tax base drains the state tax base as well. Profit shifting schemes take different forms, many incredibly complex and intentionally opaque. Often, they are engineered by creating paper transactions among artificially manipulated legal entities, typically in the types of jurisdictions that top our Corporate Tax Haven Index<\/a> \u2013 while the real economic activity that produced those profits never moves at all.<\/p>\n Q2. Do traditional anti-abuse rules eliminate state tax avoidance?<\/p>\n No. Traditional anti-abuse rules still rest on the legal fiction that the prices for internal transactions in a multinational group, including of subsidiaries transacting with their controlling parent, can be set as if they were independent equals operating at \u2018arm\u2019s length\u2019 from each other in a free market. This absurdity allows multinationals great leeway in practice to manipulate these transfer prices in order to make sure the profit from economic activity in one place, is declared in a much lower-tax jurisdiction elsewhere.<\/p>\n Q3. How does WWCR end multinational state tax avoidance?<\/p>\n Worldwide Combined Reporting (WWCR) ends multinationals\u2019 state tax avoidance by taxing them based on economic reality instead of on embarrassing fictions. When a commonly controlled group of affiliates are functionally integrated and mutually interdependent, as virtually all multinationals are, then WWCR treats them all as a single taxpayer. It requires complete reporting of the entire group\u2019s profits, everywhere. Then, to determine what portion of those profits the state may fairly tax, it uses a standard \u201capportionment formula\u201d (for example, the group\u2019s in-state share of its worldwide sales and employment).<\/p>\n Under WWCR, the entire group\u2019s worldwide profits are in the tax base, so shifting profits around the group achieves nothing. And corporate state-tax avoidance disappears.<\/p>\n Q4. Does WWCR have any impact on corporate location decisions?<\/p>\n Under WWCR, corporate relocation threats are hollow. The cost and disruption of relocating significant operations out of state can be enormous. Such decisions are based not on marginal increases in tax costs but on access to infrastructure, resources, trained workers, and customers. And, in the majority of states that apportion taxable profits by sales alone, relocation would not avoid a single dollar of tax.<\/p>\n Furthermore, no executive could credibly justify, to shareholders, the decision to abandon a profitable market over the end of an unfair tax advantage. If anything, WWCR improves the business climate: it levels the playing field for local small and medium-sized businesses that do not have shell companies in offshore tax havens. And this is crucial: by ending the unfair tax advantage that multinationals have over the smaller, local businesses that typically provide the bulk of employment and economic dynamism, WWCR is a fundamentally pro-business measure.<\/p>\n Q5. Why will corporate owners, not customers, be impacted by WWCR?<\/p>\n