The effect of a worldwide tax system on tax management of foreign subsidiaries
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The effect of a worldwide tax system on tax management of foreign subsidiaries Saskia Kohlhase1 and Jochen Pierk2 1
Rotterdam School of Management (RSM), Erasmus University Rotterdam, Burgemeester Oudlaan 50, 3000 DR Rotterdam, The Netherlands; 2 Erasmus School of Economics, Erasmus University Rotterdam, Rotterdam, The Netherlands Correspondence: S Kohlhase, Rotterdam School of Management (RSM), Erasmus University Rotterdam, Burgemeester Oudlaan 50, 3000 DR Rotterdam, The Netherlands e-mail: [email protected]
Abstract Under a worldwide tax system, firms pay taxes on their domestic income and repatriated foreign income, whereas under a territorial tax system repatriated foreign income is exempt from taxation. We examine whether worldwide tax systems reduce the incentives of multinational corporations to engage in tax management in their foreign subsidiaries. Using two quasi-natural experiments, we show that multinationals lower the effective tax rates in their foreign subsidiaries after countries switch from a worldwide to a territorial tax system. Thus, multinationals subject to a worldwide tax system face competitive disadvantages compared to competitors from countries with a territorial tax system. Journal of International Business Studies (2019). https://doi.org/10.1057/s41267-019-00287-9 Keywords: cross-border investments; foreign subsidiaries; dividend repatriation; tax avoidance; territorial tax system; worldwide tax system
The online version of this article is available Open Access
Received: 3 July 2018 Revised: 23 September 2019 Accepted: 28 October 2019
INTRODUCTION When a multinational corporation (MNC) subject to a worldwide tax system reduces taxes in its foreign subsidiaries, the parent company will generally be subject to additional taxes when such foreign earnings are repatriated. In light of additional home country taxation upon repatriation, the worldwide tax system may reduce the incentive for MNCs to manage taxes in their foreign subsidiaries. In contrast, if the parent company of an MNC is subject to a territorial tax system, the tax management behavior of foreign subsidiaries does not affect the parent’s domestic tax liabilities, and the MNC can reap the full benefit of reducing taxes when repatriating foreign earnings. We investigate the tax management behavior of foreign subsidiaries depending on whether they are owned by a parent company located in a country that has a worldwide or territorial tax system (hereafter, worldwide-parent subsidiary versus territorial-parent subsidiary). There are several nuances that influence the incentive of MNCs subject to a worldwide tax system to manage taxes in foreign countries. First, worldwide tax systems usually offer the possibility to defer taxation of foreign-source income until dividends are repatriated. If MNCs reinvest foreign earnings and delay
Tax management of foreign subsidiaries
repatriation far in the future, the difference in tax payments between a worldwide and a territorial tax system shrinks in net present value terms if the reinves
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