Tax Competition with Multinational Firms

This paper examines tax competition between two countries that mutually undertake foreign direct investment via subsidiaries of the domestic industry. Different forms of corporate finance are considered, which allows for the analysis of a variety of different taxes that influence multinationals´investment. As in Mintz and Tulkens (1996), both countries maximise national welfare by taxing foreign subsidiaries operating domestically and abstaining from taxing domestic firms and their affiliates operating abroad. This can be achieved by all forms of double taxation relief (e.g. exemption, credit, deduction) when accompanied by appropriate domestic tax rules. These concern two aspects. The first one is the tax treatment of interest costs that the parent company incurs when it borrows to finance its affiliate´s shares and the second one is the taxation of foreign dividends at the shareholder level. In Germany, for example, the nationally optimal tax rules are enforced even when a double taxation treaty applies.