One of the important changes of the 1986 tax reform for U.S. multinationals is related to the allocation of interest expense. Prior to 1986, U.S. companies allocated domestic interest expense to the income of foreign affiliates on a non-consolidated basis according to the distribution of gross income or assets. After 1986, a U.S. multinational is required to allocate domestic interest expense on a consolidated basis according to the distribution of U.S. and foreign assets. We analyze the impact of the new interest allocation rules on the financial and investment decisions of U.S. multinationals using data from a survey of multinationals assembled by Price Waterhouse. We find that the allocation of interest expense increases the marginal cost of U.S. debt by about 38 percent for firms with excess foreign tax credits. Our empirical tests suggest that firms have altered the location of their borrowings in response to the new rules. We also find that the requirement to allocate interest expense has a significant impact on the effective tax rate faced by U.S. multinationals. For U.S. domestic investments, the interest allocation rules increase the U.S. effective rate from 17.6 percent to 21.9 percent. The rules also increase the effective tax rates on foreign investments made by U.S. firms.
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Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number
199410.
Find related papers by JEL classification: H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods
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Roger H. Gordon & James R. Hines Jr., 2002.
"International Taxation,"
NBER Working Papers
8854, National Bureau of Economic Research, Inc.
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Other versions:
Gordon, Roger H. & Hines, James Jr, 2002.
"International taxation,"
Handbook of Public Economics,
in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 4, chapter 28, pages 1935-1995
Elsevier.
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