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We study how consumption taxes affect multinational companies’ (MNCs’) tax planning in the digital economy. We focus on the European value-added tax (VAT), a consumption tax collected and remitted by firms. Exploiting 43 staggered VAT rate changes, we show that MNCs in the business-to-consumer (B2C) service sector reallocate reported sales to benefit from VAT rate differentials across countries. Difference-in-differences analyses around a 2015 VAT reform that removed these VAT planning opportunities for digital B2C services indicate that MNCs reported disproportionally high digital B2C sales in Luxembourg, the country with the lowest VAT rate in 2014. Further analyses suggest that VAT planning behavior also shapes corporate income tax strategies. Contrary to conventional wisdom, pre-tax profits of MNC subsidiaries in the digital B2C sector were insensitive to changes in corporate income tax rates prior to 2015. However, since VAT planning strategies became obsolete, MNCs book substantially higher profits in Ireland and other low-tax European countries. Collectively, our evidence informs debates on taxing digital sales and tax strategies of MNCs in the globalized internet economy.
