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Taxation and the Financial Structure of Foreign Direct Investment

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  • Frances Ruane
  • Padraig Moore

Abstract

The vast increase in foreign assets globally has raised interest in how the home country should tax profits flowing from these investments. Broadly speaking, countries have chosen either to exempt foreign income from taxation or to subject foreign income to taxation with credits/deductions given for foreign taxes paid. Recent research has focused on the effect of these foreign income tax rules on the relationship between aggregate FDI flows and corporate tax rates. In this paper we examine how foreign income tax rules can affect the financial structure of subsidiary-level FDI in Europe. The tax-deductibility of interest payments suggests that higher (host-country) corporate tax rates should be associated with a greater proportion of debt-financed FDI, as foreign income tax credit systems should, in theory, limit the benefits of shielding foreign income from host country taxation. Our results indicate that whilst multinationals from tax exemption countries adjust the financial structure of foreign investments in response to corporate tax rates, the effect of corporate tax rates is insignificant for FDI originating from tax credit countries. These results reveal an additional channel through which foreign income tax credit systems attenuate the forces of tax competition.

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Bibliographic Info

Paper provided by IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp88.

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Date of creation: 15 Dec 2005
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Handle: RePEc:iis:dispap:iiisdp88

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  1. Harry Huizinga & Gaetan Nicodeme, 2003. "Foreign Ownership and Corporate Income Taxation: An Empirical Evaluation," Public Economics 0310005, EconWPA.
  2. Fred Ramb & Alfons Weichenrieder, 2004. "Taxes and the Financial Structure of German Inward FDI," CESifo Working Paper Series 1355, CESifo Group Munich.
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  4. James R. Hines, Jr., 1996. "Tax Policy and the Activities of Multinational Corporations," NBER Working Papers 5589, National Bureau of Economic Research, Inc.
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  6. Desai, Mihir A. & Foley, C. Fritz & Hines, James R. Jr., 2001. "Repatriation Taxes and Dividend Distortions," National Tax Journal, National Tax Association, vol. 54(n. 4), pages 829-51, December.
  7. Nicodeme, Gaetan, 2001. "Computing effective corporate tax rates: comparisons and results," MPRA Paper 3808, University Library of Munich, Germany.
  8. Desai, Mihir A. & Hines, James R. Jr., 2005. "Reply to Grubert," National Tax Journal, National Tax Association, vol. 58(2), pages 275-78, June.
  9. Ruud A. de Mooij & Sjef Ederveen, 2001. "Taxation and Foreign Direct Investment: A Synthesis of Empirical Research," CESifo Working Paper Series 588, CESifo Group Munich.
  10. Mervyn A. King & Don Fullerton, 1983. "The Taxation of Income from Capital: A Comparative Study of the U.S., U.K., Sweden, and West Germany--The Theoretical Framework--," NBER Working Papers 1058, National Bureau of Economic Research, Inc.
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  12. Rosanne Altshuler & Harry Grubert, 2002. "Repatriation Taxes, Repatriation Strategies and Multinational Financial Policy," Departmental Working Papers 200009, Rutgers University, Department of Economics.
  13. Gropp, Reint & Kostial, Kristina, 2000. "The disappearing tax base: is foreign direct investment eroding corporate income taxes?," Working Paper Series 0031, European Central Bank.
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Cited by:
  1. European Commission, 2011. "Tax Reforms in EU Member States 2011: tax policy challenges for economic growth and fiscal sustainability," Taxation Papers 28, Directorate General Taxation and Customs Union, European Commission.
  2. Feld, Lars P. & Heckemeyer, Jost H. & Overesch, Michael, 2013. "Capital structure choice and company taxation: A meta-study," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 2850-2866.
  3. Peter Egger & Simon Loretz & Michael Pfaffermayr & Hannes Winner, 2009. "Firm-specific forward-looking effective tax rates," International Tax and Public Finance, Springer, vol. 16(6), pages 850-870, December.
  4. Gaetan Nicodeme, 2009. "Corporate Income Tax and Economic Distortions," Taxation Papers 15, Directorate General Taxation and Customs Union, European Commission, revised Apr 2009.
  5. Huizinga, Harry & Laeven, Luc & Nicodeme, Gaetan, 2006. "Capital Structure and International Debt Shifting," CEPR Discussion Papers 5882, C.E.P.R. Discussion Papers.
  6. Christian Keuschnigg & Peter Egger & Wolfgang Eggert & Hannes Winner, 2009. "Corporate Taxation, Debt Financing and Foreign Plant Ownership," University of St. Gallen Department of Economics working paper series 2009 2009-01, Department of Economics, University of St. Gallen.
  7. Serena Fatica & Thomas Hemmelgarn & Gaetan Nicodeme, 2012. "The Debt-Equity Bias: consequences and solutions," Taxation Papers 33, Directorate General Taxation and Customs Union, European Commission.

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